Here’s Why Warren Buffett Made The Right Call With Wells Fargo

We’ve been seeing the recent data that shows us the price of homes are rising. We’ve also noticed that the foreclosure rates have dropped considerably. The mortgage refinancing and lending industry is expecting gains. Wells Fargo’s third-quarter earnings will cause both Warren Buffett and Berkshire Hathaway to sing the praises of the housing recovery.

The 2011 rebounds in the housing market were weaker than expected, and that slowed down Warren Buffett’s talk about the rise of the mortgage industry. But looking at the strong loan growth volumes of Wells Fargo could very well be an early warning sign that a true housing market rebound is finally taking place. So far we have only seen a couple of false starts.

The housing market has lagged considerably during the overall US recovery. Warren Buffett actually apologized in his annual letter in 2011 when he forecasted a full-blown recovery. He said “I was dead wrong,” which he mentioned in this year’s letter. But Warren was still very optimistic in regards to an overall housing recovery, which he stated on CNBC in a July 12 interview, “[In] residential housing, we’re seeing a pickup. It’s noticeable. It’s from a very low base.”

The third quarter is actually expected to be fairly weak for large-cap banking underwriting, as well as advisory revenue and trading, there are many Wall Street analysts that now tell us that refinancing and mortgage lending has picked up. They are also going to be one of the main drivers of industry wide earnings. Wells Fargo is currently the nation’s largest mortgage lender, and they are slated to gain the most from a pickup in the housing market. Their shares have actually gone up 30% year to date, and this is due to a very strong loan growth taking place during 2012.

Wells Fargo, as well as many of the other banks in the sector, need to wonder whether or not the pickup in housing will offset some of the negative areas like lower interest rate-based earnings.

We learned about QE3, which is the plan that the Federal Reserve told us about during September, and it is going to be their third easing effort. Their plan is to buy $40 billion in mortgage bonds per month for the foreseeable future. This is going to keep interest rates near zero through mid-2015. We have been warned by many experts in the banking sector, and they are telling us that this easing effort may really hurt the earnings of the banking sector for 2013.

“[We] need to determine the relationship between the expected (and rather substantial) net interest margin compression and the strength in mortgage banking income,” according to Stifel Financial analyst Christopher Mutascio, during his earnings preview of the third quarter. Does the strength in mortgage banking activity more than offset a net interest margin that is expected to compress roughly 15 basis points during the quarter?,” noted the analyst.

Mutascio believes that Wells Fargo and their impressive earnings growth could falter if they guide lower due to drops in interest rate based earnings.

Matt O’Connor, analyst for Deutsche Bank, downgraded PNC Financial and Wells Fargo. He lowered them from a buy to a hold. The reason being that the interest rate pressures and their ability to maintain such strong mortgage lending growth.

“We believe WFC is best positioned for mortgage activity remaining stronger than expected given its market share of about one third… However, both of these are well-known and we believe already reflected in the stock,” says O’Connor. He actually recommends Fifth Third Bank and Goldman Sachs as the banks that are going to outperform based on quarterly earnings.

The housing market is one of the major “bets on America” from eternal optimist Warren Buffett. In his annual letter – as well as his most recent commentary – he has stressed that there is still quite a ways to go with overall housing market improvement.

It’s still relatively certain that big mortgage underwriting volumes are going to play a large role in whether or not megabanks, as well as Wells Fargo, can experience any third quarter growth, and make more money due to Fed induced earnings hits. But the bigger question that we need to look at in regards to the economic recovery and the overall US housing market is what does this say about these particular events. If the US economy picks up quickly, then Warren Buffett may want to begin speaking bullishly about the housing market recovery.

No matter what, Warren Buffett and Berkshire Hathaway are definitely positioned correctly for an economic rebound. Berkshire owns stock in Clayton Homes, which is the largest producer of homes in the United States of America. They also own stock in paint retailer Benjamin Moore. But not only that, they own other businesses focused on the housing market such as Acme brick, Shaw carpets, Johns Manville for insulation, and their roofing play in MiTek. Plus, the big banking bets that Berkshire owns which will certainly benefit from housing activity are Wells Fargo, U.S. Bancorp, BB&T and M&T Bank.

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