Wells Fargo’s Pleasant Surprise Doesn’t Mean Banks Are Out Of The Woods

Wells Fargo & Co., Inc. (WFC) delivered a pleasant surprise to the markets this morning by announcing that it expects a net income of $3 billion, or $0.55 per share, for 1Q09, as against estimates of earnings of $0.23 cents per share. Revenue projection for the quarter at $20.0 billion was also ahead of the estimates of $18.98 billion. The Company will report its financial results on April 22, 2009.

The bank said that the revenue received a boost from exceptionally strong mortgage banking results and strong capital market activities. It appears that the bank benefited from a larger share in the mortgage markets after acquiring Wachovia, and also from the demise of some smaller players.

WFC reported $100 billion in mortgage originations during the quarter, providing loans to more than 450,000 people, for either buying or refinancing a home. With the mortgage rates at their record lows, there is a rush to refinance the existing mortgages.

The bank expects net interest margin of approximately 4.1% for the quarter. With the fed funds rate at nearly 0%, the funding costs of the banks have come down sharply. As such, we expect most banks to report healthier profits on traditional banking businesses.

Further, the relaxation of the mark-to-market accounting rules as well as the passing through of American International Group, Inc. (AIG) bailout funds to some of the large banks also seems to have helped the banks, especially the big ones like JP Morgan Chase (JPM), Citigroup Inc. (C) and Bank of America Corp.
(BAC).

Does this all mean that the banks are out of the woods? The answer is NO. We suspect that the losses on the housing loans, Commercial Real Estate (CRE) loans as well as Consumer loans will continue to rise in the coming quarters, as housing and CRE prices continue on the downslide and unemployment continues to rise.

Deterioration in Commercial Real Estate loans has started rather recently, and the downturn in this class will also probably be very challenging. Further, credit card delinquencies rose to a record high in February and are expected to rise further.

But at the same time, the share prices will get support from the improvement in the accounting profits, mainly resulting from relaxation of the mark-to-market accounting rules.

We currently have a Hold recommendation on WFC.

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