Don't Bank on Higher Profits

07/16/2013 9:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Banks have been leading the market higher since the late June lows, but MoneyShow's Jim Jubak, also of Jubak's Picks, says  that rising interest rates will certainly put a dent in bank profits going forward.

It was never about last quarter’s earnings. So while it was swell that Wells Fargo (WFC) beat Wall Street earnings estimates for the second quarter by 5 cents (at 98 cents a share) in results reported after the close Thursday, July 11, the real good news came in Friday’s relatively upbeat conference call in remarks about next quarter and the remainder of 2013.

The bank, a bellwether for the mortgage and housing sectors, said that looking forward it remained optimistic on the economy. Higher interest rates would indeed cut into mortgage originations and mortgage lending volumes would be down in the third quarter—directionally that is what investors expected to hear—but the deterioration described by the company didn’t sound too scary. Mortgage originations in the third quarter would decline, the bank guessed, to the vicinity of $100 billion versus $112 billion in the second quarter. (The $112 billion for the second quarter was up from $109 billion in the first quarter of 2013.)

Other metrics that had worried Wall Street going into the earnings report and the conference call got the same combo treatment of downward trend but not at a scary pace. For example, the bank said that net interest margins would probably be under pressure in the third quarter but that over a longer period it would be able to grow net interest income. (Net interest margins fell 2 basis points to 3.46% in the second quarter.) Absent deterioration in the US economy, Wells Fargo said, it would be able to continue to release reserves against bad loans (adding to the bottom line in the process.) In the second quarter provision for credit losses fell by $306 million and the quarter included a $35 million release from reserves. (When a bank adds to its loan loss reserves, it comes out of earnings. When it releases money from its loan loss reserves that flows through to earnings.)

This isn’t to say that everything was hunky dory in the quarter to June 30. Growth in commercial loans slowed to just 1.7% from the first quarter of 2013 and the runoff in the home equity loan portfolio continued with a drop of 3.4%. One worry that the quarter didn’t put to bed: The margins on gain on sale for mortgages fell 35 basis points. (A bank books a gain on sale when it sells a mortgage asset at a profit to investors. Selling mortgages that a bank has originated is essential to free up capital for new mortgage lending.) Wells Fargo did say in the conference call that it expected gain on sale margins to fall from current levels in the second half of 2013.

In short, nothing here to suggest a speedy run to the exits, but it is clear that an environment of rising rates will be tough on bank profits.

Shares of Wells Fargo were up 2.1% as of 2 pm New York time Friday. Shares of homebuilders Lennar (LEN) and Pulte Group (PHM) were down 0.9% and 0.8%, respectively.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of any stock mentioned in this post as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio here.

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