Banks Can Learn From Wells Fargo
Tim is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When JPMorgan Chase (NYSE: JPM) released earnings on Friday the news was not good, nor surprising. Analysts and many investors had predicted a significant drop in profits year-over-year, and that’s exactly what they got. Though the numbers were in line with expectations, those expectations had already been lowered.
JPM’s Q4 net income of $3.7 billion or $0.90 a share is a significant drop from the $4.8 billion or $1.12 per share seen a year earlier. What’s even more significant for investors is the cause of the drop -- a 30% decline in trading and investment results. Now compare that with results from Wells Fargo (NYSE: WFC) and even Citi (NYSE: C). It’s not just the numbers that are key here; it’s where the numbers came from.
Wells Fargo’s 20% jump in earnings was a pleasant surprise certainly, and the stock has reaped the rewards in today’s trading. But the exciting part for investors is the fact that the numbers come from core banking operations and an aggressive expense cutting program. According to management the results are because of the rise in both commercial and retail lending activity. Imagine, banks making money by acting as banks; who’d a thunk it? There are also two other factors at work here worth noting.
One, not only were loans up, but so too were the quality of the loans. The decrease in the loan loss provision (the amount banks set aside to ensure solvency should loans go south) is an indication of that, and has a direct impact on cash flow. A lower credit loss provision had the same positive effect. Amazing what can happen when banks concentrate on traditional, quality banking and business management activities.
The second positive note from all this is an offshoot of the first. Earnings generated from core banking activities are more sustainable, all things considered, than those derived from investment or trading activity. As JPM and Citi can attest, when a large percentage of revenue is dependent on non-core activities, a bad quarter or two can be costly. It should be noted WFC’s loan activity was aided by portfolio purchases, but newly originated loans were up significantly too. So it wasn’t just a matter of running out and buying performing assets.
So what does Citi have to do with all this? They missed earnings and the expected drop in share price ensued. However, this is one to keep an eye on for value investors looking for an opportunity. Here’s why -- Citi is still too exposed to the capital markets, ala JPM and they’re paying the price. But an increase in loan originations and a slowly improving capital position make this an intriguing option going forward. Is C a good opportunity right now? Probably too early -- investors would be wise to let the balance of the coming week’s bank earnings announcement shake out. There’s bound to be a lot more volatility ahead in this sector.
But at 7.8 times earnings and trading a lot closer to its 52-week low than high, don’t be surprised when Citi becomes a $35 stock in 2012.
For too long now banks have been making money like insurance companies or investment houses. That was all well and good when the market was riding high, because earnings were there and that appeased investors. Solid, long-term growth requires banks to focus on the core, sustainable activities that make them and their investors money.
The investment opinions included are just that, opinions. Tim is not a licensed investment professional, nor has he been for several years. Investing involves risk, as you well know, so consider your decisions wisely.