Wells Fargo profit increases 3.8% as home lending regains traction

With solid quarterly results, Wells Fargo & Co. showed why it has become a darling of banking investors, but it also raised a crucial question:

How can the San Francisco financial giant continue its hot stock performance at a time when economic growth remains slow, questions linger about its core home-lending business and low interest rates are eating into profit from lending?

Skeptics said it may be difficult.

Wells Fargo stock, up 21.5% over the last year, is “getting ahead of its history,” analyst Erik Oja at S&P Capital said.

Shares are trading at levels he described as more appropriate for large regional banks with better growth prospects, such as US Bancorp of Minneapolis and BB&T Corp. of Winston-Salem, N.C.

Wells Fargo is one of only four U.S. banks with more than $1 trillion in assets. If interest rates on loans stay low and the economy slows, Oja said, “I think they’re really set up for a fall.”

Wells Fargo likes to describe itself as fundamentally a collection of community banks, or a regional bank grown into a national footprint. Its focus on Main Street business and its No. 1 position in mortgage lending were displayed Friday as it kicked off the bank earnings season with a 3.8% increase in second-quarter profit.

Net income of $5.7 billion rose from $5.5 billion a year earlier, and the bank’s $1.01 in per-share earnings, up from 98 cents, met Wall Street expectations. Revenue, though falling 1% to $21.1 billion, beat analysts’ average estimate of $20.8 billion.

In addition, losses on loans continued to shrink, enabling Wells Fargo to release $500 million in reserves it had held against losses, the same profit-boosting amount that it released during the first quarter.

The bank’s chairman and chief executive, John Stumpf, said improvements in loan repayments were “driven by an improved economy, especially the housing market.”

The other banking giants — Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp. — will be challenged to match those results when they report their financial results next week.

Analysts said trading losses and legal claims continued to shadow those banks, which were more heavily involved than Wells Fargo in Wall Street trading and toxic investments, especially bad mortgage loans.

Wells stock, which fell 32 cents to $51.49 on Friday, has greatly outperfomed those rivals, as well as broader measures of the stock market, over the last 12 months. Its 21.5% increase in share price was well ahead of increases of 11.4% at an index of large bank stocks and 16.9% in the S&P 500 index.

Bank of America, having paid out tens of billions of dollars to settle mortgage claims, has seen its shares rise 12.1% in the last year.

Shares in JPMorgan Chase, socked by the government with a $13-billion settlement related to bad mortgages last year, have languished, rising just 1.1% over the year.

And shares of Citigroup, which is reported to be near a $7-billion settlement with the government over mortgage liabilities, have fallen 7.7% in the last 12 months.

Wells Fargo also has paid billions to settle mortgage claims, but analysts are more focused these days on its operating results.

With increases in business lines such as auto, credit card and commercial and industrial lending, Wells may find mortgages to be its biggest wild card. Home lending is not as strong as Wells executives had expected going into this year, the bank’s chief financial officer, John Shrewsbury, said in an interview Friday.

Still, things have improved. After a weak first quarter in which the bank wrote just $36 billion in new home loans, an increase to $47 billion in the second quarter was far more than many had expected, said Keefe, Bruyette & Woods analyst Christopher Mutascio.

Wells Fargo originated $112 billion in mortgages in last year’s second quarter, but that was during a last gasp of the refinancing boom that has now ended.

The focus now is on loans to buy homes. Mutascio believes that demand for those mortgages may remain weak because of several factors, including the easy money that made it possible for many borrowers to buy so-called McMansions during the housing boom. Those homeowners won’t be looking to trade up again, he said.

Another question mark, raised by Shrewsbury as well as Mutascio, is whether millennials — young adults, many burdened by student debt — will be willing to take on mortgages after seeing so many homeowners devastated by the housing crash.

Still, the outlook on Wells Fargo remains bullish for many. Analysts at RBC Capital Markets were “very encouraged” by the bank’s profitability, with revenue, loan growth and mortgage banking results higher than expected, analyst Joe Morford said.

“If Wells continues to execute the way it has been, we think it will continue to outperform its peers over time,” Morford said. “Thus. we’re sticking with our ‘outperform’ rating.”

scott.reckard@latimes.com

Twitter @ScottReckard