Wells Fargo: Strong Q2 Earnings Reveal Core Strength
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Wells Fargo (NYSE: WFC), the nation's fourth largest bank and best performing of the country's trillion dollar asset banks, had another predictably terrific quarter ended June 20, 2012. Earnings came to $4.4 billion, an 18% advance from the second quarter of 2011. Earnings per share came to $0.82 per share, up from $0.70 per share in last year's quarter. The bank achieved a return on assets of 1.41%, and its efficiency ratio drove below the key 60% level to land at 58.2%, a credit to the bank's commitment to revenue growth and cost cutting program. It was a trick free, honestly conducted financial success, one I expect to be repeated over the next several quarters, at least. Let's see how Wells Fargo does it.
By the end of the second quarter, Wells Fargo's loan portfolio had grown to $775.2 billion, $24 billion more than at the same point of 2011. Credit costs declined by $400 million, or 23% from the second quarter of 2011, and despite lower yields, interest income was stable with the year earlier quarter. The provision for credit losses fell by just 2%, or $38 million, to be at a $1.8 billion. Of course, the rate of return on interest earning assets also fell, so the net interest margin contracted from 4.01% a year ago to 3.91% in the just completed quarter. While the margin was lower, I expect that it will be the highest net interest margin among all large banks. The larger loan portfolio plus lowered net interest margin equaled interest income essentially the same as a year ago at $12.4 billion.
On the non-interest income side, mortgage fee income was up nearly $1.3 billion, or 79%, from last year's quarter to $2.9 billion. Somewhat offset that huge income increase were declines in realized securities gains, debit card interchange fees, and gains from trading activities. Overall, non-interest income came to $10.3 billion, up by $550 million, or 6% from the second quarter of 2011.
Under the bank's "project compass" cost cutting program, Wells Fargo was to reduce annual expenses by $1.5 billion by the end of 2012, with a goal of non-interest expenses running at about $11 billion quarterly. These goals were to be obtained by completing the integration of the massive and largely successful merger of Wachovia in 2008, along with cost cutting. I doubt that Wells Fargo was anticipating utterly dominating the nation's mortgage market the way it has, and it is unlikely we will ever see an $11 billion expense quarter. But non-interest expenses did fall in the quarter to $12.4 billion, down about $80 million, or less than one percent from last year's quarter. Not surprisingly, management made a point in the second quarterly report that "we believe our efficiency ratio is a better measure of our expense management than specific dollar estimates." I fully agree, and as long as that number stays below 60%, I will regard expenses as being under control.
Wells Fargo is America's leading retail bank. And that community division of the bank carried the overall success of the quarter; the division's net income was up over $400 billion from the year earlier, carried by the mortgage income. Income for the division was just over $2.5 billion. Wholesale banking, focusing on mid and large sized businesses, investment bank and commercial mortgage operations, saw revenue in the division up 11% from last year's second quarter, to $6.1 billion. But profits in the division fell less than one percent, down to $1.88 billion. The fall in income came from increased expenses and substantially increased provisions for loan losses.
Wells Fargo's other big division is its wealth management unit. Its revenues and expenses were both down about 4% on a year over year basis. Earnings came to $343 million, up from $337 million last year. The size of this division is dwarfed by the wholesale and especially the community bank, yet it is a profit center and completes Wells Fargo as a full service bank.
I am thrilled that Wells Fargo was able to substantially increase its profits while maintaining a healthy provision for loan losses. You might recall that in a feeble attempt to save its quarter, JPMorgan Chase (NYSE: JPM) virtually eliminated its provision in the second quarter of this year, reducing it for comparison purposes by some $2 billion. As the nation's mortgage lender, and with its acquisition of Wachovia supplying a vast number of shady loans, Wells Fargo has been hit, and will continue to be hit, by large numbers of warranty claims from Fannie Mae and other government agencies. Wells Fargo has reserved over $1.1 billion dollars for agency claims so far this year, $669 million of it in the second quarter. The agencies seem increasingly aggressive in pursuing relief from large and intermediate mortgage issuers, and it is something to watch.
I do not want to portray Wells Fargo as free from issues. Any institution with nearly $1.4 trillion in assets and a presence in all 50 states, is going to have legal and regulatory issues. Earlier this month, it settled for about $150 million a case of housing loan discrimination stemming from the 2003 to 2008 time period. In May, it settled a claim of predatory lending against minorities suit filed by the City of Memphis for $432 million. These types of suits are to be expected and a more or less normal part of being as huge a mortgage lender as Wells Fargo is.
Wells Fargo, in some small part due to Bank of America's (NYSE: BAC) retreat from the mortgage market, has come to utterly dominate the nation's mortgage market. At the same time, Bank of America has missed out on the refinancing surge. Through the first quarter of 2012, the bank had written 33.9% of the nation's mortgages, a pace that did not appear to abate in the second quarter. Wells Fargo virtually invented the notion of cross selling in a bank environment. In the second quarter, the average cross sell penetration was just over six times per customer. That is the real value of all these new and refinanced mortgages.
The downside of all that mortgage activity is many of these people are locked in at a low interest rate for a long time. Neither you, nor I, know where interest rates will be three, five, ten or twenty years from now, and Wells Fargo could be in for a real squeeze if interest rates move substantially higher anytime in the near to intermediate term. But in the meantime, this innovative revenue generator will continue to be the most profitable and efficient large bank in this country. There is no bad time to buy shares in a great company.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short APR 2012 $21.00 puts on Wells Fargo & Company, short APR 2012 $29.00 calls on Wells Fargo & Company, short OCT 2012 $33.00 puts on Wells Fargo & Company, and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.