Wells Fargo Riding High On Value, Growth Prospects
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Wells Fargo (NYSE: WFC), the nation's fourth largest bank with about $1.3 trillion in assets, released an excellent report on its first quarter of 2012 earnings. It reported profit growth, but unlike all of 2011, that profit growth was not entirely predicated upon lower loan loss provisions and reversals of reserves. Loan and revenue growth carried the company's earnings.
The stock prices of large banks soared over 40% in the first quarter of 2012, with investors obviously expecting improving earnings. Large banks, with their abilities to legally manipulate reserves, charge offs, and asset values, among other things, can theoretically manipulate their earnings at will. With many banks in 2011, I felt income reports were manipulated often by their rising earnings, often just enough to beat estimates or some other threshold, all the while most large banks actually were shrinking. Wells Fargo was an exception to the rule, in that it intended all along to grow its way out of the recessionary years. The first quarter of 2012 affirms that strategy, with just one exception.
For the quarter, Wells Fargo reported profits of $4.25 billion, up 13% over the first quarter of 2011. The per share came to $0.75, an 11% improvement from the year ago quarter. This came on revenue of $21.64 billion, up about 6½% from the year ago's $20.33 billion. Both revenue and profit numbers beat Wall Street estimates for the quarter, which were for profits of $0.73 per share, and revenues of $20.46 billion.
I have been railing a long time about the apparent use of banks' loan reserves as piggy banks. For Wells Fargo, the practice slowed, but certainly did not stop. Between a lower loss reserve, and a release of funds from the loan loss reserve provision, Wells Fargo had a $500 million head start on its earnings. But that was a relatively small part of the bank’s profits compared to previous quarters, so I am not too discouraged about Wells Fargo's quality of earnings. Net interest income rose slightly in the recent quarter to by 2% to $10.9 billion. While not much of an increase, I expect most other banks to record a decrease in net interest income in the quarter. Wells Fargo's overall loan portfolio increased by 2% also to $768.6 billion. Credit costs continued to fall steeply, from $1.82 billion in the first quarter of 2011 to $1.37 billion in the same quarter of 2012. The modest loan growth was a net interest margin of 3.81%, versus $4.05 in the year ago. I am heartened though as the nadir in the yield margin back in the third quarter of 2011 at 3.84%, before rising to 3.89% in the fourth quarter of 2011. As I mentioned, the company benefitted from a modestly lower loss provision along with that release from its reserve. But the really good news is found inside the income statement.
I expect many banks with large retail operations to have poor earnings comparisons in their non-interest incomes due to the Durbin Amendment. Wells Fargo's card fee income seems to have settled in at about 65% of the level it was prior to the Durbin Amendment, and will end up costing the bank about $1.4 billion in revenues annually. But Wells Fargo has been a mortgage origination leader seemingly forever. That position was only enhanced via its massive 2008 purchase of Wachovia. The government recently announced yet another home mortgage plan, this time focusing on refinancing to lower monthly payments. And no one took advantage of that any better than Wells Fargo. Its mortgage origination fee income in the first quarter of 2012 was $2.62 billion, more than double the year ago revenue of $1.15 billion. That big bump allowed overall non interest income in the quarter to rise to $10.75 billion, up over $1.1 billion, or 11% of the year ago total. The mortgage origination revenue is likely to increase further, as Wells Fargo's “pipeline” of mortgage applications is actually ahead of where it stood ninety days ago.
The bad side of the big ramp up in mortgage originations was the costs that went into running the business. Those expenses have slowed the implementation of Wells Fargo's cost cutting program, which it calls Project Compass, which was to have reduced non interest costs down to $11 billion per quarter by the end of 2012. In the first quarter of 2012, the expenses were $13 billion, and many analysts believe there is little chance to whittle expenses so far in such a short period that remains. Wells Fargo explains that the simple elimination of seasonal factors and the Wachovia integration should drive second quarter 2012 non-interest expenses to no more than $12.3 billion, at worst, but that is still a ways from the expense goals.
Going forward, in addition to benefiting from revenue growth from mortgage origination, reduced non-interest expenses, and a gently rising yield margins, Wells Fargo has evidenced its intent to not just grow business, but acquire it is as well via its purchase of energy loans from French BNP Paribas SA. Other European Banks may be interested in offloading assets to improve capital margins, and banks like Wells Fargo can benefit from that.
Other large banks like Citigroup and Bank of America will soon be reporting their earnings. I do not expect either to exceed estimates, and with Bank of America would be pleased to at least see a profit. Wells Fargo has come through the recessionary years as strong as any big bank in the country. It does not have sophisticated international or investment bank operations, so its profits are relatively predictable. With a price to earnings ratio of under twelve, and a 5 year PEG of 1.06, Wells Fargo still has plenty of value and upside. I recommend it to all growth and income investors.
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