Wells Fargo Beats as Rev Ups
Wells Fargo & Company’s (WFC) first quarter 2012 earnings of 75 cents per share were 2 cents ahead of the Zacks Consensus Estimate. Results improved from earnings per share of 73 cents in the prior quarter and 67 cents in the year-ago quarter. First quarter net income applicable to common stock came in at $4.0 billion, up 3% sequentially and 13% year over year.
Wells Fargo’s results were primarily driven by a higher top line. The company reported a growth in mortgage banking revenue. It also reported $400 million (pre tax), attributable to improved portfolio performance. However, an increase in operating expenses was on the downside.
The quarter’s revenue came in at $21.6 billion, which was above the Zacks Consensus Estimate of $20.5 billion. Revenue was also up 5% sequentially and 6% year over year. The sequential improvement in revenue at Wells Fargo was driven by a growth in non-interest income while net interest income remained stable. Notably, the company experienced solid mortgage banking and market sensitive revenues in the quarter.
Furthermore, segment wise, on a sequential basis, Wholesale Banking reported an 11% growth in revenues while the Community Banking and Wealth, Brokerage and Retirement segments reported rises of 3% and 1%, respectively.
Performance in Detail
Wells Fargo’s net interest income for the quarter came in at $10.9 billion, flat sequentially. Average earning assets were unchanged from the prior quarter. However, net interest margin advanced 2 basis points sequentially to 3.91%. Disciplined deposit pricing and redistribution of short-term investments into long-term securities offset the runoff of higher yielding loans and investments.
Non-interest income at Wells Fargo came in at $10.7 billion, up 11% from the prior quarter. The increase was driven by a growth in mortgage banking and market sensitive revenues as well as trust and investment fees.
As of March 31, 2012, total loans were $766.5 billion, flat sequentially. While the company experienced a growth in loans in the core portfolio, it was offset by continued run-off in the non-strategic/liquidating portfolio. Average core deposits were $870.5 billion, up 3% (annualized) from the prior quarter and 9% from a year ago.
However, non-interest expense at Wells Fargo was $13.0 billion, up 4% from the prior quarter. The rise in expenses reflects higher personnel costs and increased revenue. The company incurred higher commissions and incentive compensation, reflecting higher revenue-related mortgage banking, retail brokerage, and insurance expenses.
Notably, the company currently projects a $500-$700 million decline in second quarter 2012 expenses due to the elimination of merger expenses and the absence of the first quarter seasonally higher personnel costs.
However, for higher-than-expected revenues, mainly mortgage banking and acquisition-related revenues, Wells Fargo currently aims fourth quarter 2012 non-interest expense of around $11.25 billion, which represents the upper end of the formerly disclosed range of $10.75–$11.25 billion.
Credit Quality
Credit quality was mixed in the quarter. Though the company experienced a drop in chare-offs and provisions, nonperforming assets reported an increase in the reported quarter. On the whole, the rate of improvement this year is expected to be slow with losses approaching normalized levels. The company also expects future reserve releases in 2012 in case the economy improves significantly.
Wells Fargo’s allowance for credit losses, including the allowance for unfunded commitments, totaled $19.1 billion as of March 31, 2012, down from $19.7 billion as of December 31, 2011.
Net loan charge-offs were $2.4 billion or annualized 1.25% of average loans, down from $2.6 billion or annualized 1.36% in the prior quarter. Provision for credit losses fell 2% sequentially to $2.0 billion in the reported quarter.
However, nonperforming assets ended the quarter at $26.6 billion, up from $26.0 billion in the prior quarter. Non-accrual loans advanced to $22.0 billion from $21.3 billion in the prior quarter. The increase was due to industry-wide supervisory guidance related to the junior lien portfolio.
Capital Position
Wells Fargo reported an increase in capital in the reported quarter. The Tier 1 leverage ratio was 9.35% as of March 31, 2012, up from 9.03% as of December 31, 2011. The Tier 1 common equity ratio was an estimated 7.81% as of March 31, 2012 under the Basel III capital proposals. Tier 1 capital ratio was 11.74% as of March 31, 2012 compared with 11.33% as of December 31, 2011.
Moreover, book value per share improved to $25.45 from $24.64 in the prior quarter and $23.18 in the prior-year quarter.
The company redeemed $875 million of trust preferred securities with a coupon of 6.38%. It also bought back around 8 million shares of its common stock that was basically related to the settlement of a forward repurchase contract entered into in the fourth quarter of 2011. Moreover, the company also paid quarterly dividends of 22 cents per share in the first quarter.
Acquisition and Integration Update
Wells Fargo successfully completed the Wachovia merger integration in the reported quarter. Also, the company announced the acquisition of BNP Paribas’s North American energy lending business. This is expected to be accomplished in April 2012 and includes approximately $3.9 billion of loans outstanding.
Peer Performance
Concurrent with Wells Fargo, JPMorgan Chase & Company (JPM) also kicked off the earnings season for the banking sector by reporting its earnings today. Similar to Wells Fargo, JPMorgan also posted higher-than-expected earnings per share of $1.31 based on improved top line.
Next week, the major Wall Street Banks reporting includes Citigroup Inc. (C) which will report on April 16, while Goldman Sachs Group Inc. (GS) will report on April 17 and Bank of America Corporation (BAC) on April 19.
Our Viewpoint
We believe that over the long term, investors should not be disappointed with their investments in Wells Fargo given its diverse geographic and business mix which enables it to sustain consistent earnings growth. Going forward, we believe that strategic acquisitions will help expand Wells Fargo’s business and improve its profitability.
In fact, Wells Fargo’s growth plans have historically included a large number of acquisitions, Wachovia being the largest in December 2008. The company also acquired substantially all of the US-based operating assets of Foreign Currency Exchange Corporation, a wholly owned subsidiary of the Bank of Ireland Group (IRE), in an effort to expand its international banking capabilities.
Of late, the company accomplished the purchase of Burdale Financial Holdings Limited (Burdale) and the portfolio of Burdale Capital Finance Inc. from Bank of Ireland. The deal would enable Wells Fargo to broaden its horizon and expand its asset-based lending business into the UK, which in turn would help the company to serve its US-based customers doing business in the UK.
Though the stock is not undervalued at this moment, we believe that long-term investors, who can absorb the risks related to economy and regulations, can expect a decent growth in Wells Fargo’s earnings in future. Solid capital levels, expense management as well as improved credit quality will also support its profit figures.
Notably, Wells Fargo passed the stress test of the Federal Reserve with flying colors in March. Following the approval of the capital plan by the Federal Reserve, Wells Fargo has hiked its dividend by 10 cents to 22 cents per share.
The capital plan also includes an increase in share repurchase activity in 2012 compared with the prior year. It also incorporates selective redemptions of trust preferred securities that no longer count as Tier 1 Capital under the Dodd-Frank Act. Such efforts have a positive impact on the stock price.
Yet we believe the top-line headwinds would persist, given the protracted economic recovery. Plus, a low interest rate environment would keep its margin under pressure. Wells Fargo’s unrelenting legacy mortgage issues also remain a concern. With the thrust of new banking regulations, there will be pressure on fees and loan growth could remain feeble.
Wells Fargo currently retains a Zacks #2 Rank, which translates into a short-term Buy rating. Considering the fundamentals, we also maintain a Neutral recommendation on the stock.
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