Wells Fargo Is America’s Best Bank

Wells Fargo reported blockbuster fourth-quarter earnings. Matthew Zeitlin reports

Record profits fueled by mortgages. A CEO boasts of a great year. The stock is up. No, it’s not Countrywide Financial in 2005. Rather, it’s Wells Fargo in 2013. The San Francisco–based bank has notched another massive quarter, with $5.1 billion in net income, capping off a year in which it earned $18.9 billion on $86.1 billion in revenue. Profits in 2012 were up 19 percent from 2011—even with Wells Fargo having to pay its $644 million share of the recent $8.5 billion federal mortgage settlement.

And how did Wells do so well? CEO John Stumpf said in a statement accompanying its earnings: “2012 was an outstanding year for Wells Fargo. “We saw the continued benefits of our diversified business model and reported record full-year and fourth-quarter earnings, robust deposit and solid loan growth, and strong performance across our business units.”

Translation: The bank took in deposits, on which it paid very low interest. Then it lent a lot of money, at somewhat higher interest rates, to normal people who used the cash to buy homes and refinance their mortgages. This is also known as “banking.”

Wells Fargo also took over an ever-growing share of the mortgage-servicing industry (managing and collecting mortgage payments), an area that huge competitors such as Bank of America are fleeing. With investment banks shrinking and megabanks shedding divisions like so many unwanted relations, the fourth-largest bank in the country has become the dominant player in the mortgage market. Turns out that banking can work for banks. At least one of them.

The story of Wells in the last year is one of increasing activity everywhere, even if the lending itself hasn’t gotten much more profitable. Net interest margin, a common metric of the profitability of loans, actually fell to 3.56 percent in the fourth quarter of 2012 from 3.89 percent in the 2011 fourth quarter. "The net interest margin has been declining almost every quarter... but we still reported earnings growth every quarter," said Chief Financial Officer Timothy Sloan in a conference call with analysts. And while profits from mortgages were down slightly in the fourth quarter compared with the third quarter, a huge portion of the bank’s net income came from mortgage servicing and origination.

Year over year, the bank’s quarterly income from fees from residential mortgages rose about 30 percent to $3.1 billion. In the fourth quarter of 2012, issuance of new loans actually slowed slightly from the third quarter of 2012, with $125 billion in the fourth quarter compared with $139 billion. But for all of 2012, originations totaled $524 billion, a 47 percent increase from $357 billion worth of new mortgages in 2011. Of the $152 billion of mortgage applications, 72 percent were refinances, down from 78 percent a year ago. In 2012, Wells Fargo made $11.6 billion in mortgage banking income compared with $7.8 billion in 2011. Have we mentioned that housing is back?

Like other banks, Wells Fargo profits by making mortgage loans and then selling them in bulk to Fannie Mae and Freddie Mac, the government mortgage companies. But it has also started keeping mortgages on its balance sheet, where they earn income from interest and principal payments. The bank kept $9.7 billion worth of first mortgages on its balance sheet. Not selling those means it is passing up the opportunity to earn some $340 million in fees from Fannie and Freddie. But due to the improving housing market and economy, Wells Fargo thinks that the long-run returns to collecting interest payments are a better bet.

Wells Fargo clearly has generally been a smarter, more careful lender than its peers. Of the mortgages it serviced in the third quarter, 7.32 percent are in delinquency or foreclosure, compared with a 10.17 percent average for the industry not including Wells Fargo. At Bank of America, just more than 13 percent of the mortgage-servicing portfolio is delinquent or in foreclosure and JPMorgan Chase is at 10.7 percent. In the fourth quarter, that ratio for Wells Fargo is down to 7.04 percent.

Wells Fargo’s fourth-quarter profits were almost exactly evenly split between interest payments on loans, known as spread or interest income, and income from fees—i.e. noninterest income. At other huge banks, noninterest comes from investment banking or trading. At Wells Fargo, which doesn’t have much of a Wall Street presence, these fees come from things like mortgage origination and servicing (27 percent) and credit-card fees (6 percent). At Wells Fargo, investment-bank-like activities accounted for just 13 percent of noninterest income. Two other core banking activities—auto loans and credit-card issuance—were up 3.9 percent and 8 percent over the year, respectively.

The rap on Wall Street and the big banks is that they are disconnected from the Main Street economy. Thanks to their international operations and high-end wheeling and dealing, they big investment banks can prosper while the rest of the country suffers. But Wells Fargo, despite its size, is more like an old-fashioned small-town bank. It just so happens that the small town it operates in is a big chunk of America. So as long as more Americans are working, spending, buying cars and purchasing homes, Wells Fargo will prosper. Sometimes, being the number four isn’t so bad.