MSR Impairment Does Little Damage to Wells' Bottom Line

Wells Fargo reported record second-quarter income despite taking a $304 million impairment hit to the value of its mortgage servicing rights.

Wells Fargo & Co. earned record diluted earnings per share of $1.12, up 12% from the prior year, on record net income of $1.91 billion, up 11%.

But don't think the impairment of mortgage servicing rights left the nation's second-largest mortgage lender unscathed. Wells Fargo said that revenue was up 6% from the prior year. But revenue from businesses other than Wells Fargo Home Mortgage was up 16%.

Home mortgage revenue declined $559 million, or 42%, from $1.3 billion in the second quarter of 2004 to $774 million in the second quarter of this year.

But despite the revenue shortfall, Wells Fargo continued to grow its residential real estate loan portfolios. Its residential first mortgage and home-equity portfolios both grew at a double-digit clip in the second quarter.

Unlike many banks, Wells Fargo reported a widening of its net interest margin during the second quarter compared to one year earlier. Wells said the net interest margin increased by six basis points to 4.89%.

Wells Fargo said that a "repositioning" of its balance sheet earlier in the year, which included the sale of $18 billion of adjustable-rate mortgages and auto loans, helped boost the net interest margin even as it slowed asset growth temporarily. Wells reported 6% growth in earning assets year over year.

Non-interest income increased by $129 million, or 4%, but again Wells Fargo said the growth would have been more dramatic were it not for the drag of the mortgage banking unit. Excluding mortgage banking, Wells said that non-interest income increased 14% from the second quarter of 2004.

"The growth in non-interest income reflected double-digit increases in trust and investment fees, card fees, loan fees and gains from equity investments, offset by a $256 million decrease in mortgage banking non-interest income," said CFO Howard Atkins in the company's earnings release.

But Wells Fargo did report some positives from its mortgage unit as well. Origination volume totaled $85 billion in the quarter, up $20 billion from the first quarter. And Wells Fargo ended the second quarter with $73 billion of home loan applications in the pipeline.

The owned mortgage servicing portfolio grew to $874 billion, up 17% from a year earlier. And the company's home-equity portfolio grew 26% to $56 billion at the end of the second quarter.

Mark Oman, group EVP for home and consumer finance, said Wells Fargo is pleased with the underlying performance of the residential real estate lending business despite posting lower mortgage revenue.

"With lower interest rates and a strong housing market, we saw significant growth in home mortgage applications in the quarter," he noted in the company's announcement.

But lower interest rates forced the company to reduce the valuation rate on its mortgage servicing rights.

Mr. Atkins said in a company earnings call that despite the lower mortgage revenue, the underlying home loan business remained robust in the second quarter and that the impairment charge is temporary.

"The year-over-year decline in mortgage revenue was due to normal servicing revaluation, including a $304 million temporary impairment charge as mortgage rates declined significantly in the second quarter of 2005."

As of June 30, Wells valued its MSR asset at $8.5 billion, or 1.12% of the balance of the loans its services. That was down from a valuation ratio of 1.37% a year earlier.

SNAPSHOT: Wells Fargo & Co.


Diluted EPS $1.12 12%

Net Income $1.91B 11%

Home Loan Rev. $774M (42%)

Servicing Portfolio $874B 17%

Source: WFC

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