Citigroup Inc (C), Wells Fargo & Co (WFC): Banking on Banks

Wells Fargo & Co (NYSE:WFC) owns 22% of the mortgage origination market in the US and is the number one player in that market. While Wells Fargo & Co (NYSE:WFC) saw a 3% decline in mortgage related income this quarter, in the future, the mortgage business is going to be a big driver for Wells Fargo & Co (NYSE:WFC).

If mortgage rates keep rising, then the spread for banks between the cost to borrow (through deposits and CD’s) and the mortgage rate goes up. Thus, banks make a lot more money lending in the mortgage market as long as the cost to borrow rises at a slower rate.

According to Freddie Mac, 30-year fixed US mortgages rose from 3.56% to 4.51% in the past year. Over that same time period, CD’s and money market account rates have remained flat. So, mortgage lenders can start making significantly more money now. This will bode extremely well in the years ahead for Wells Fargo & Co (NYSE:WFC).

Wells Fargo & Co (NYSE:WFC) has a PE (TTM) of 11.7, is expected to grow its EPS by 7% over the long term, and pays out a 2.8% dividend with a 26.5% payout ratio. Wells Fargo last announced a dividend increase in the earnings prior to this one and will continue to boost its payout in the years ahead.

Wells Fargo does trade at 1.55 times book value, but with a strong dividend and growth runway ahead in the mortgage industry, Wells Fargo is a good safe stock to own. While it may see its stock grow in line the with the market, the dividend will boost your return further. I’m bullish on Wells Fargo in the long term

Final thoughts

Bank earnings are helping push the S&P 500 to record highs as they continuously beat expectations. But not all earnings are made equally, which is why you have to sift through them. If the income spread for banks starts to increase, companies like Wells Fargo & Co (NYSE:WFC) and Citigroup should see some strong income gains in the years ahead. If Goldman Sachs wants to keep growing and justify its 1.1 book value multiple, it needs to start being more aggressive with its investments.

Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Wells Fargo. The Motley Fool owns shares of Citigroup Inc (NYSE:C) and Wells Fargo. Callum is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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