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Wells Fargo Has Plenty of Upside

Richard Saintvilus

NEW YORK ( TheStreet) -- I have always considered Wells Fargo to be the safest bank among the "big four", which includes JP Morgan Chase , Bank of America and Citigroup .

While I'm not ready to change my mind on this sentiment, Wells Fargo's first-quarter earnings report did cause a bit of concern. Although the absolute performance was solid, there wasn't much growth to get excited about. And unfortunately, the areas where Wells Fargo did show some strength, were not the areas that matter.

Already Looking Forward to Second Quarter

The good news first -- management showed incredible fiscal awareness this quarter. Although expenses did rise slightly on a sequential basis, overall costs were down 2% year over year. Given the highly competitive nature within this sector, this is no small accomplishment. Unfortunately, though, cost-management was the extent of the positives that I could find in this report. Equally unfortunate was that the 4% sequential increase in expenses, while relatively small, also hurt profitability.

Operating income, or what is known in the banking industry as pre-provision net revenue, advanced just 1% year over year and dropped 7% sequentially. This is likely due to the slight sequential uptick in expenses which resulted to earnings miss.

Likewise, Well Fargo's net interest margin, which has seen some recent declines, arrived down 33 basis points year over year and 8 basis points from the fourth quarter. As a consequence, net interest income suffered a 3% decline year over year.

Now, with these sort of numbers, it should come as no surprise that overall revenue was down 1% both year over year and sequentially. Non-interest income was also disappointing, growing just 2% year over year, while also arriving flat sequentially. I'm sure by now you're noticing a pattern.

Wells Fargo management had a hard time growing the bank's usually strong mortgage lending business, which posted much less favorable activity during the quarter to the extent that loan originations arrived down 13% sequentially. As a result, overall mortgage revenue shed 3% year over year and 9% sequentially.

Can Things Turn Around?

With such sluggish mortgage and loan demand, the fact that loan balances increased by only 8% was actually a pleasant surprise. But that's not the sort of results that Wells Fargo is accustomed to. While I'm willing to look on the bright side here, investors shouldn't take this for granted and assume that loan balances will get better, especially since loan collection is an area of the business that the company can't always control.

That said, if loan balances are rising, it suggests that consumers aren't paying. Management can, however, offset this weakness by growing other aspects of the business. I've said on more than one occasion, that given the bank's strong brand, Wells Fargo can certainly benefit from international expansion. Unfortunately, I don't think that management has addressed these sort of areas well enough.

Granted, the management team is well respected and has solid grasp of the bank's operation, but with loan balances on the rise, it was a surprise that management opted to expand its credit card business, suggesting that Wells Fargo plans to double its loan volume to (roughly) $50 billion. I'm not sure that this is the ideal strategy.

The degree to which raising credit loans can boost revenue and other operational deficits remains a question mark. Given that the competition from the likes of JP Morgan and Bank of America increased, it seems it would make more sense for Wells Fargo to attack back using its strength in mortgage lending, while looking to gain share in branch network and deposits. So, we'll just have to wait and see.

It's not all bad, however. While growth seems to have been impacted this quarter, the qualities that have made Wells Fargo so impressive still remain. Unlike JPMorgan or Citigroup, Wells Fargo continues to benefit from a business that is unburdened from unfavorable risk such as investment banking and significant exposure to the European market, which is still battling fiscal headwinds.

From an investment perspective, there will always be a premium placed on banks with above-average growth prospects that still meets certain criteria of safety. At $38 per share, there is still plenty of upside to Wells Fargo. The results of this quarter notwithstanding, the bank has consistently executed while showing strong leverage. With better improvement, these shares should reach $45 sometime in the second half of the year.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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