Are Wells Fargo’s Sinking Margins Indicative of a Dangerous Industry Trend?

wells_fargo_140By setting aside less money to cover bad loans, Wells Fargo (NYSE:WFC) was able to break profit records in the most recent quarter, the bank reported Friday. Coupled with an increase in revenue from mortgage fees, the change boosted profit 24 percent in the three months ended in December.

However, shares are trading lower on Friday as the bank reported that it made fewer mortgage loans in the third quarter and net interest margin declined.

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Revenue from mortgage fees rose 30 percent from the year-earlier period in the fourth quarter to $3.1 billion as homeowners took advantage of low interest rates to refinance their homes. But the lower rates that are spurring refinancing are also responsible for the smaller margins that have investors concerned.

Furthermore, the bank had $81 billion in unclosed home loans at the end of the fourth quarter, down from $97 billion in the previous quarter, and issued $125 billion in mortgages in the fourth quarter, down from $139 billion in the third quarter…

mortgagepic1Seasonal trends may be partly to blame — home sales tend to decline in the winter — but industry watchers are concerned that the decline might indicate a larger trend as the rate of homeowners seeking refinancing slows.

It’s a double-edged sword, because while banks are relying on refinancing revenues during a time when fewer people are buying homes, margins on refinanced mortgages are shrinking, as owners pay down older loans that had higher interest rates. Wells Fargo’s net interest margin fell to 3.56 percent in the quarter, from 3.66 percent a year earlier.

The one silver lining to this refinancing trend is that it makes it easier for borrowers to come up with the funds to make their payments on time. As a result, Wells Fargo’s provision for loan losses fell from about $2 billion to $1.8 billion.

And while margins may be down, net income is still up a whopping $1 billion in the last year. Net income for the October through December quarter was $5.1 billion, or 91 cents a share, compared to $4.1 billion, or 73 cents a share, in the year-ending quarter in 2011…

Overall, Wells Fargo is reporting more upside than downside, but investors seem concerned that it won’t last if margins continue to shrink, ultimately taking a toll on mortgage revenue.

Wells Fargo was the first big U.S. bank to report fourth-quarter results. Investors are now looking forward to reports next week from Bank of America (NYSE:BAC), Citigroup (NYSE:C), and particularly JPMorgan (NYSE:JPM), the country’s second-biggest lender with a 10 percent market share.

In next week’s reports, margins will again be an area of close scrutiny, as they can be indicative of future growth or declines. However, though undeniably important, mortgages won’t likely be given the same weight in future reports as they were with Wells Fargo. And that’s because Wells Fargo was the top U.S. mortgage lender in 2012, with roughly three times the market share of JPMorgan. No major bank relies more heavily on mortgage revenues than does Wells Fargo, which means any dip in revenues from that sector is more strongly felt by Wells Fargo than by competitors.

Investing Insights: Wells Fargo Earnings: Here’s Why Investors are Selling Shares.