The Dow Jones Industrial Average (DJINDICES:^DJI) was down 19 basis points in early afternoon trading on Friday. The movement came at the end of a tough week for investors as the market retreated from all-time highs just in time to kick off earnings season.
Wells Fargo (NYSE:WFC) was the highlight of the earnings calendar this morning, releasing second-quarter results before the opening bell.
The megabank reported earnings of $1.01 per share, meeting the consensus estimate but falling from the second quarter of 2013. This ends a 17-quarter streak of earnings growth for the bank.
The story of Wells Fargo is inextricably linked to the U.S. real estate market. Digging into Wells' second quarter can give us a boots-on-the-ground view of exactly how the market is evolving today.
Hot activity in the mortgage business
The bank reported strong results in its mortgage origination business, a potential harbinger of better results across the industry.
Wells originated $47 billion in residential mortgages, up 31% from the first quarter. Applications were up 20% to $72 billion, and the pipeline grew by 10% to $30 billion. This growth was supported by a continued focus on credit quality, a hallmark of Wells Fargo's culture and long-term success.
These results -- and this growth -- look great on the surface, but don't forget to look at the short- and long-term trends.
In the second quarter of last year, Wells accepted applications for $146 billion of new mortgage loans, about double the volume reported this morning. The reason for the decline? The end of the refinance boom.
The second quarter of 2013 saw mortgage rates bottom then sharply rise after comments from then-Federal Reserve Chairman Ben Bernanke. That sharp spike in rates squashed the refinance market, a reality that continues to today. Fifty-four percent of second-quarter mortgage applications in 2013 were for refinances; that number in 2014 is just 36%.
The impact isn't limited to just refinances. Looking at those percentages in dollar terms, the bank received $46 billion in 2014 for new mortgages -- not refinances -- versus $67 billion last year. This still represents a 31% decline.
It's good, but it's also kinda bad
The market reacted to Wells' earnings by sending the stock down nearly 0.4%. This is partly a result of the company's lower than expected revenue. But I have a suspicion there is also some concern about the real estate market going forward.
I wrote recently that the housing market may not be as strong as you think, and the market's reaction to Wells' earnings today support my theory.
It's true that the bank had major upticks in mortgage loans and applications in the second quarter. But that growth is relative to an abysmal first quarter in which GDP declined by 2.9%. The economy essentially froze solid with the cold winter weather.
Examining the bank and the real estate market over a longer time horizon shows that the strong second quarter is simply a reversion to the mean. That's not exactly a reason for celebration.
The Federal Reserve will undoubtedly raise interest rates at some point. When that happens, both banks and the real estate market are in for some major changes.
For real estate, rising rates will be a major headwind and will almost certainly slow the recovery. The hope is that the market will be strong enough to press forward through that resistance. It is yet to be seen how that will play out.
For banks, rising interest rates will boost revenues as loans reprice to the newer, higher-rate environment. At the same time, though, origination volume will likely decline, as consumers and businesses will pay a higher cost for access to loans and capital. Again, the hope is that the economy will have the strength to power through the headwinds and maintain loan application volumes.
The next 12 to 18 months have the potential to transform the status quo for both banks and real estate. Investors in either should be alert -- both for downside risk and also for opportunities to buy great banks or properties on the cheap.
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Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.