These Results Were Stronger Than You Think

By Chad Henage - October 17, 2012 | Tickers: BBT, JPM, WFC | 0 Comments

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I never cease to be amazed at the market's short-term thinking when it comes to certain companies. With Wells Fargo (NYSE: WFC) reporting earnings recently, most of the headlines I saw said that the stock took a hit because revenues came in lighter than people expected. However, most would acknowledge that the company did beat earnings expectations, and if you look at the results overall the numbers are impressive. Wells Fargo continues to be one of the stronger big banks, and their business model is actually pretty easy to understand. For investors looking for exposure to the banking sector, this company would be a good place to start.

Reported Earnings:

In the recent quarter the company reported revenue up 8.05%, and reported EPS increased 22%. Considering that their competitor J.P. Morgan (NYSE: JPM) reported revenue growth of 6%, you would think that investors would have been satisfied with a better than 8% increase. However, both companies earnings per-share were boosted dramatically by their mortgage operations. Well there's no question that the mortgage refinance boom cannot continue forever, Wells Fargo looks strongly positioned to profit even after the current refinance craze. The company reports in essentially three different divisions, but overall loans and deposits are the two most important things to any bank. Wells Fargo reported total loans up almost 3%, and average core deposits up 7%. By comparison, J.P. Morgan shows both loans and deposits up 4%. Another competitor, BB&T (NYSE: BBT) in their last quarter reported loans up 6.3% but deposits jumped over 17%. While the BB&T results are a few months old, you can see it appears Wells Fargo is keeping up with loan and deposit growth at their competition. Let's look at each division individually and see what else is going on with the bank.

Community Banking:

The Community Banking division shows a mixed bag of results. Revenue increased 4.8%, and net income was up almost 18%. However, loans were down almost 1%, and mortgage originations were up just 6%. In fact, application volume for mortgages was down almost 10% versus last quarter. This is very important to understand, because mortgage applications lead to close loans and if applications are down, future loan closing should be down as well. There was no single greater contributor to Wells Fargo's current quarter earnings per-share than their mortgage division. In fact, without huge mortgage growth, earnings-per-share would've increased less than 5% compared to the 22% increase reported. On a positive note, core deposits increased almost 7% giving the company additional liquidity to use for future lending. In addition, Wells Fargo continues to maintain one of the strongest cross sell ratios in the banking industry of 6.04. For those unfamiliar with cross sell, this simply means the number of products and services the average customer has with the bank at a given time. Considering this measure increased from an already impressive 5.90 last quarter, you can see the company is engaging its customers and continually looking for new ways to deepen their relationship. 

Wholesale Banking:

Where Wells Fargo really shined in the last quarter was their Wholesale Banking division. The company reported revenue up almost 16% and net income increased better than 10%. While these figures were impressive enough, what was really impressive was the company's loan and deposit growth. Loan growth of 9.35% increased faster than the overall company's total loans. Core deposits in the Wholesale unit grew by 7.69%, which was also better than the company's overall numbers.

Wealth, Brokerage, and Retirement:

Wells Fargo's Wealth and Brokerage unit is a smaller part of the whole and that's probably a good thing based on this division's results. Revenue was up 5.02% and net income was up over 16%, but the organic growth wasn't as good. Loans actually decreased by 0.14% and core deposits were up just 2.55%. This is both a problem and an opportunity. The company's cross-sell ratio shows the company can engage its customers, but the branch network needs to do a better job of looking for referrals to Wealth and Brokerage.

Credit Quality:

In banking one of the biggest issues is the credit quality of the company's portfolio. Bank of America is still dealing with the fallout from their purchase of Countrywide and the abysmal credit quality at that prior company. Wells Fargo's credit quality has weakened just slightly from the prior quarter with non-performing assets at 2.69% versus 2.65% last quarter. What is interesting is the company's credit quality got better in its commercial portfolio and got worse in its consumer portfolio. This continued a trend in the overall business as Wells Fargo showed weaker results in its consumer business and strength in its commercial dealings. If there is one thing that worries me about the company's credit management, it's the fact that the company decreased its allowance for losses. On a quarter-to-quarter basis, Wells Fargo's allowance for losses dropped from 91% of non-accruals to 85%. This means the company has less money set aside for potential loan losses, even though on a percentage basis they have a greater amount of loans that are in non-accrual status.

Conclusion:

While investors should keep an eye on Wells Fargo's credit quality, the remainder of the company's results look solid. The company repurchased 17 million shares during this quarter and has already set an agreement to repurchase another 9 million shares next quarter. Wells Fargo also looks strong when it comes to the company's net interest margin. While BB&T shows a net interest margin of 3.95%, Wells Fargo comes in just behind at 3.66%. J.P. Morgan has a decidedly lower net interest margin at just 2.32%. When it comes to dividend yield and growth, Wells Fargo also looks attractive. The company's almost 2.6% yield and expected 8% growth compare favorably to J.P. Morgan at 2.88% and 6.86% respectively. While BB&T offers a slightly better combination of yield and growth at 2.47% and 10.31%, the stock is also priced slightly higher at nearly 12 times forward earnings. Though analysts are calling for about 8% growth in earnings, Wells Fargo has beaten estimates in each of the last four quarters. If Wells Fargo can continue its strength in its commercial unit and improve results at the consumer division, the company could turn in better earnings results than analysts expect.

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