Wells Fargo Shows Competitive Risk Looming For Mortgage Bankers

Wells Fargo delivered an early Easter gift of good news for the banking sector Thursday, stating it expected to post a better-than-expected profit of approximately $3 billion in the most recent quarter.

Wells Fargo shares soared on the news, climbing nearly 32% in early market trading.

Originally slated to deliver its results later in April, the San Francisco-based banking giant issued guidance for the first quarter, saying it expected to report net income of about $3 billion, or 55 cents per common share vs. forecast earnings of 23 cents per share per analysts average expectations.

"Our business momentum is strong, and we expect our operating margins to remain at the top of our peer group," Wells Fargo CEO John Stumpf said in a written statement.

Wells Fargo CFO Howard Atkins, attributed the latest financial results to strong performances in both its traditional banking and mortgage businesses as well as the Wachovia acquisition. These financial results will be the fully consolidated numbers of what were two separate businesses that Wells Fargo will have reported. Wachovia helped Wells improve financial results on two major accounts. Wachovia provided Wells Fargo with a larger footprint and additional deposits and assets which collectively provide an even larger base for Wells to drive profits.

The Wachovia transaction enabled Wells Fargo to expand its coverage nationally into the Southeast and Mid-Atlantic. Wells Fargo indicated that Wachovia accounted for 40% of combined revenue during the quarter.

Clearing the more than 150 basis point move downward in mortgage interest rates is spurring a refinance boom and assisting with jolting purchase real estate activity back to life in many markets across the US. The net result is highly positive on earnings for large banks such as Wells Fargo.

While the wholesale and mortgage broker/banker channel is in complete disarray with much of its operational capacity removed in the past 18-24 months, large banks such as Wells clearly have the ability to take huge market share for both refinance and purchase business.

Mortgage applications surged during the most recent quarter, with Wells reporting staggering volume of more than $83 billion in applications during the month of March alone.

Wells Fargo indicated it has funded more than $100 billion in mortgage loans during the first quarter of 2009. Wells Fargo said it has an application backlog of more than $100 billion. The bank said it initiates one in seven U.S. mortgages. This represents combined volume for both home purchases and refinancing further bolstering the case that Federal Reserve and government efforts focused on unfreezing the mortgage markets is showing signs of progress and having an effect on the earnings of banks such as Wells Fargo.

Today’s surprise release by Wells was not all good news. Wells Fargo said it set aside $1.3 billion for future loan losses during the quarter, while provision expenses for losses reached $4.6 billion.

Wells Fargo also has a competitive advantage over many smaller mortgage shops in it’s ability to ramp up processing and underwriting resources or move them from other operational units which are not seeing record demand. Scale and size wins in the current race – something that Wells excels in on both accounts.

I would expect to see larger Banks such as Wells Fargo, JP Morgan Chase and Bank of America take considerable market share from smaller mortgage players from economies of scale, asset base size and operational scalability. These issues, when combined with the scarcity of warehouse funding sources for mortgage brokers and mortgage bankers mean serious challenges for independent brokers as the real estate market continues through what looks to be a bottom and returns towards recovery.

An additional challenge for mortgage banks is meeting deadlines – a critical contractual issue with purchase mortgage business. We are already seeing major cracks in the system with even the largest independent mortgage banks. Unless they can meet their loan commitment deadlines, the real estate industry may have no choice but to move business long-term to banks such as Wells Fargo.

If the slowness of the mortgage broker/mortgage banking channel to scale down in the most recent real estate market correction is any indicator, it is going to be a tough road ahead for them to ramp up to levels needed to compete against the likes of large banks such as Wells Fargo.

As volumes grow, banks such as Wells Fargo will be potentially so far ahead of smaller independent mortgage bankers and brokers – even those with large national operations- that it will be likely difficult to impossible to catch up.

By Kevin Cottrel. Keving is a Mortgage broker in St. Louis area and blogs at cottrellrealty.com.