Wells Fargo Beats On Earnings, Concerns Over Higher Rates Remain

| About: Wells Fargo (WFC)
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Wells Fargo (NYSE:WFC) is the most highly valued of the large banks at the moment, with a Price-to-Book ratio of 1.48 as of Thursday's $41.89 closing price. Heading into earnings, WFC has performed with the overall market - gaining roughly 3 percent over the past month, the same as the S&P 500.

This could be considered strong performance, considering that during this time the Federal Reserve and financial regulators also announced that banks would need stronger capital requirements. Additionally, the spike in yields on the 10-year Treasury note could impact WFC's mortgage business - a strong driver of profits.

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Wells Fargo was expected to grow profits by double-digits year-over-year. Earnings were seen at $0.93 per share, up 12 percent. However, revenue at WFC was expected flat at $21.2 billion.

As for the equity reaction, options traders were pricing in below average moves for Wells Fargo post-earnings. Compared with an average move of 3.15 percent post-earnings, options were pricing in a move of 2.8 percent - suggesting traders think that this report could be relatively uneventful.


Earnings per share came in at 98 cents, above expectations, while revenues also slightly beat expectations - at $21.4 billion compared with a $21.2 billion estimate.

The bank's credit quality improved dramatically - with the company writing off just 58 basis points, down from 115 basis points a year earlier and 72 basis points in Q1. These declines in charge-offs bring Wells Fargo more in line with its peers.

However, Wells Fargo is the largest mortgage lender, with a 22 percent share of the U.S. market. And, higher interest rates are sure to impact that business. Refinancings will undoubtedly slow, but what should be seen as a strong point for the bank is that purchase originations increased 44 percent in the second quarter over the first quarter. Overall, this increase helped mortgage originations grow to $112 billion from $108 billion in the first quarter.

Unlike JPMorgan (NYSE:JPM), Wells Fargo was able to sustain net interest margin in the second quarter - keeping it at 3.46 percent compared with 3.48 percent in Q1. At JPM, net interest margin declined to 2.6 percent from 2.83 percent.

Where From Here?

Wells Fargo has indicated 1 percent higher in the pre-market (at writing), and could move above recent highs at $43 per share. However, Wells Fargo is the most richly priced financial. Trading at a Price/Book of 1.48 and a forward Price/Earnings of 10.7 at a time when higher mortgage rates could hamper WFC's ability to grow its business, WFC could be approaching a short-term top.

Price action as the rest of the financial sector reports earnings will set the stage for the next leg in WFC - whether it is higher or lower. I may be too cautious as there are other financials that are less exposed to the mortgage market that I like better, but trimming a WFC position at these levels seems like a no brainer.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.