Sizing Up Wells Fargo's Surprise

The company's record Q1 profit amid a financial crisis is a testament to its overall strength. But does it signal good news for other banks?

By Ben Steverman

In the depth of a credit crisis and recession, Wells Fargo (WFC) dealt Wall Street a shocker: a record profit.

Earnings of 55¢ per share were more than double analyst predictions. Revenues surged to $20 billion as Wells Fargo boosted mortgage lending and integrated troubled rival Wachovia, which it acquired at the end of 2008.

The results helped spark a stock market rally on Apr. 9. Wells Fargo shares surged 32% to 19.61. Other banks also rallied strongly, including JPMorgan Chase (JPM), up 19%; Bank of America (BAC), up 35%; Citigroup (C), up 13%; PNC Financial (PNC), up 20%; and U.S. Bancorp (USB), which jumped 23%.

Based on Wells Fargo's announcement, there are reasons to be optimistic about other banks and even the broader economy. Good news in the financial sector has been rare indeed over the past 18 months, so any reason to be optimistic is welcome.

But it may be some time before investors learn whether other banks truly are sharing in Wells Fargo's success. Wells Fargo offered a preliminary report on Apr. 9. First-quarter earnings from other big banks aren't expected for another week or two, and Wells Fargo's full results won't arrive until Apr. 22. For those concerned about the entire financial sector and the broader economy, Wells Fargo's results raise a worry: Many aspects of Wells Fargo's first-quarter success could very well be unique to that institution, already seen by many customers and investors as far stronger than its rivals. Rather than lifting up its industry, Wells Fargo may well be setting itself apart.

Will Other Mortgage Players Rebound?

Wells Fargo, like many banks, is benefiting from low interest rates, which help widen profit margins. Many Americans also are taking advantage of low interest rates to refinance their mortgages, and some may even be buying new homes. In fact, President Obama on Apr. 9 used his bully pulpit to encourage refinancing, noting that "there are 7 [million] to 9 million people across the country who right now could be taking advantage of lower mortgage rates. That is money in their pocket."

Wells Fargo's pipeline of mortgage business currently stands at $100 billion, up more than 40% since the start of the year.

Based on this, "other mortgage players should have very strong first quarters as well," Robert W. Baird analyst David George wrote, citing JPMorgan Chase and Bank of America.

Along with low interest rates and a surge of mortgage applications, the industry may also benefit from efforts by the federal government and the Federal Reserve to prop up the financial sector. But in this way, Wells Fargo is different. It was initially reluctant to take federal bailout funds, because it had a far smaller exposure to subprime and other toxic assets that plagued rivals. Its relative strength allowed Wells Fargo to beat out Citigroup to acquire Wachovia last year.

Strong Relative to Rival Banks

Nancy Atkinson, senior analyst at the Aite Group, a consulting firm, believes Wells Fargo may be benefiting because it "hasn't gotten in as much trouble as rivals." "Customers are looking for good, quality banks that have strong balance sheets," she says. "They're willing to reward those banks with their business."