4 Things Wells Fargo and Citigroup Are Telling Us About The Banking Sector

As the first two "big banks" to report earnings, there are a few things investors should take notice of from Wells Fargo and Citigroup's quarterly reports.

Jul 15, 2014 at 5:11PM

Wells Fargo (NYSE:WFC) kicked off earnings season for the banks on Friday July 11, and started things on an upbeat note. Citigroup (NYSE:C)followed on Monday July 14 with its own good news. Both companies had solid quarters and beat analysts' expectations.

Wells Fargo Photostream

There are a few things to pay particular attention to from both banks earnings, simply because they could be indicative of overall industry trends.

The consumer lending and credit quality of assets were very positive aspects of both reports. Wells Fargo's industry-leading mortgage business did well, and Citi's fixed-income trading revenue was better than expected.

Here's a rundown of some of the key points from the second-quarter's earnings.

The mortgage business isn't as bad as it looked
Wells Fargo is the largest mortgage lender in the U.S. and its results are a good indicator of overall trends in the industry.

During the first quarter of this year, all of the big banks saw decreased mortgage activity but it was unclear how much of it was due to real weakness in the real estate and refinancing businesses, and how much was a result of the unusually harsh winter. Total mortgage originations declined sharply in the first quarter, and a drop in refinancing played a large part.

US Mortgage Originations Chart

The results seem to indicate the slowdown in mortgages might be temporary. Even though business is down year-over-year, mortgage originations were up by 35% from the quarter. The amount of loans currently in the pipeline at the quarter's end was $10 billion more than they were at the end of the first quarter.

So, at this point it looks like the first quarter mortgage results were a temporary dip.

Fixed-income is down, but better than expected
Continued uncertainty in interest rate markets, as well as historically low volatility has produced a significant drop in fixed-income trading revenue so far in 2014. Citigroup is the first big bank with a significant fixed-income business to report earnings, and the news was better than analysts expected.

Citi

While a 12% year-over-year drop may sound pretty dismal, it was a breath of fresh air after Citigroup's CFO John Gerspach prepared investors for a drop of 20-25% during a May investment conference.

Even though Citigroup is just one company, performance trends tend to affect the whole banking industry. So, if fixed-income is doing better than expected, it could provide a nice boost to the banks yet to report earnings.

Lending is very strong
Both banks posted very strong results in lending. Citigroup posted an 11% year-over-year increase in its loan portfolio and a 3% increase in credit card revenue. There was particularly strong growth in personal loans (18% from 2Q 2013) and the portfolio of real estate loans (13%).

Wells Fargo's lending business was also very strong for the quarter. The bank's total loan portfolio grew by 4% from last year, a little less than Citi's due to higher real estate exposure. Still, Wells saw excellent year-over-year increase in commercial loans (10%), auto lending (11%), credit card balances (10%), and foreign lending (15%).

The higher lending activity is a result of the stronger U.S. economy (less unemployment, more discretionary income), increased consumer confidence, and looser lending standards.

Credit quality continues to improve
Finally, and the piece of data most indicative of the health of the banks, credit quality is up dramatically.

For the first time since it was created in response to the financial crisis, Citigroup's Citi Holdings unit actually turned a profit. Citi Holdings' $111 billion portfolio of troubled assets produced an adjusted profit of $244 million, much better than the loss of $591 million a year ago.

Wells reported impressive improvement as well, with net charge-offs down nearly 40% year-over-year and a 14% decrease in nonperforming assets.

While Wells Fargo never really had the problems with bad assets Citigroup has dealt with, both companies are dramatically healthier than they were a few years ago.

Basically, the banking industry is getting stronger every quarter and is doing a great job of putting the financial crisis firmly behind it. And, if these two banks are good indicators of the rest of the industry, we could see many more positive earnings surprises in the days and weeks ahead.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Citigroup and 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.

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