Wells Fargo Gets Boost from Higher Rates but Loan Growth Stagnates -- 4th Update

Wells Fargo & Co. reaped the benefits of higher interest rates in the second quarter, which helped push profit at the nation's third-largest bank up by 4.5%.

The San Francisco-based bank's shares fell 2% in midday trading, however, as stagnant lending, weaker revenue in areas like mortgage banking and higher costs overshadowed progress on the bottom line.

Shares in Wells Fargo and other big banks had been on a tear since the U.S. presidential election as investors wagered that the Trump administration would take a more cordial approach to regulating Wall Street and fostering growth. But with little change to either the economic outlook and policy toward banks, it is unclear when banks' earnings potential will catch up to their higher valuations.

"Much of [the run-up in stocks] was probably aggressive or not fully warranted," said John Shrewsberry, Wells Fargo's finance chief, in an interview. "The realized outcome doesn't look any different than the realized outcome a year ago. So I think markets have to grapple with what does that actually mean."

Wells Fargo reported a profit of $5.81 billion, or $1.07 a share. That compares with $5.56 billion, or $1.01 a share, in the same period of 2016. Analysts polled by Thomson Reuters had expected earnings of $1.01 a share.

The bank's results included a $186 million tax benefit during the second quarter, most of which was related to a deal it reached in June to sell its commercial insurance business. That boosted Wells Fargo's per-share earnings by 4 cents. Excluding this, the company's earnings would have come in at $1.03.

Net interest income at the bank rose 6.4% to $12.48 billion from the same period last year. The rates Wells Fargo charges customers to borrow on credit cards, home equity lines of credit and other loan types vary along with the Federal Reserve's target, so the central bank's policy moves in recent months have directly improved banks' lending income.

The bank's net interest margin, a measure of how profitably it can lend out its customers' deposits, rose to 2.9% from 2.86% last June, and its return on equity rose to 11.95% from 11.7%. The bank said it exercised discipline in repricing deposits, which helped them capture more of an increase in loan yields.

The overall size of Wells Fargo's loan book stalled at $957 billion. During the quarter, the bank backed off making certain car loans and commercial real estate loans due to higher risk in those segments, executives said on a conference call with analysts.

Wells Fargo's income from fees fell 7% to $9.69 billion, with several of its businesses facing challenges in the quarter. Mortgage-banking fee income fell 19% due in part to tougher competition, and net gains on the bank's trading activities fell 46% due in part to trading losses.

The bank, led by Chief Executive Timothy Sloan, had been one of the most consistent big banks at growing earnings and revenue. Shares have underperformed those of other banks after Wells Fargo last year agreed to a $185 million settlement with two regulators and a city official over opening as many as 2.1 million accounts with fictitious or unauthorized information. It also continues to face a spate of state and federal investigations that the bank has said it is cooperating with.

About $110 million in additional charges related to remedying Wells Fargo's operations following the sales-practice scandal contributed to a 5.2% increase in expenses, which totaled $13.54 billion in the quarter. Expenses as a share of revenue in the second quarter were 61.1%, slightly above the new target of 60% to 61% set at an investor presentation in May. That is also higher than the two-year target the bank set last year of 55% to 59%.

"There's no reason why they can't manage their expenses better," said John Hadwen, a Toronto-based portfolio manager at CI Investments Inc. that owns about $315 million in Wells Fargo stock."The market believes there's a lot more they can do there, and we're becoming impatient."

In May, the bank announced an initiative to cut an additional $2 billion in costs by the end of 2018. Executives on Friday said they are making progress on that plan.

"Operating at this level [of expenses] is just not acceptable," said Mr. Sloan on a conference call with analysts.

Write to Peter Rudegeair at Peter.Rudegeair@wsj.com

(END) Dow Jones Newswires

July 14, 2017 14:49 ET (18:49 GMT)