Wells Fargo: A bargain if you're bullish on housing

  @Money September 27, 2013: 4:11 PM ET
wells fargo

Wells Fargo has become the leading bank in home mortgages.

(Money Magazine)

Five years after the financial crisis, "housing" isn't a dirty word in banking anymore. That puts Wells Fargo (WFC, Fortune 500) in an interesting position.

The nation's fourth-largest bank is a powerhouse in mortgages, thanks to the fact it ended up with fewer toxic assets than other big banks, and was able to snap up another large mortgage player, Wachovia.

Refis as a % of mortgage applications
Q3 2012 Q4 2012 Q1 2013 Q2 2013
72% 72% 65% 54%
Source: Wells Fargo

So is Wells, whose stock price has already risen 64% in two years, a good buy now that home prices are rising? That depends on what's driving the rebound: Is it just low rates -- now rising -- or a healthier economy too?

The housing heavyweight

Home prices are up more than 10% this year, and many signs point to a continued recovery. Builders are hiring more workers, sales of foreclosures are falling, and inventory has been getting tighter in markets from Southern California to Washington, D.C.

"[Wells] has a lot to gain from a housing recovery," says Morningstar analyst James Sinegal. It originates more than 22% of home mortgages -- double the amount of the second-biggest lender. Its balance sheet is getting healthier too. Charge-offs, or loans Wells considers uncollectible, are at their lowest since 2006.

Related: Are we still heading toward 5% mortgages?

Wells increased its dividend 20% in April to $1.20, and Edward Jones analyst Shannon Stemm expects the payout to grow 7% a year into 2018.

Rising rates hit refis

After sinking to historic lows, interest rates are rising as investors anticipate higher growth because the Federal Reserve is signaling it will slow down its economic stimulus effort, a bond-buying program known as quantitative easing.

How to prepare for rising interest rates

The good news: Higher rates mean Wells' fee stream from mortgages it services becomes more predictable as fewer borrowers refinance, says S&P Capital IQ analyst Erik Oja.

The flip side is that Wells is losing a big chunk of its mortgage originations. If the economy strengthens, more home sales will make up for some of that lost refi revenue, but Christopher Mutascio, an analyst at Keefe, Bruyette & Woods, thinks it won't close the gap for Wells.

Leaning in to Wall Street

Another increasingly important part of Wells Fargo's success is its asset management business. In the second quarter of 2013, net income from managing money rose 27% compared with 2012. The stock market's performance -- the S&P 500 (SPX) returned 16% in the past year -- has bolstered results. But Wells "may not be able to sustain this momentum in a tougher equity market," Sinegal wrote in a recent report. Mutascio worries the end of quantitative easing could trigger that tough market.

Related: Wells Fargo lays off 2,300 employees

With a price/earnings ratio of 11 based on 2014 expected earnings, Wells' shares are a bit cheaper than other banks' stocks, but it has more riding on the performance of both real estate and Wall Street. That makes Wells Fargo a buy only for bulls. To top of page

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