Wells Fargo (WFC) released earnings for last quarter and full year 2012 last Friday, and while there was a lot to cheer about the bank’s performance, the doubts raised in investors’ minds from the continuing net interest margin compression led the bank’s share price lower over trading that day.  In fact, concerns about falling interest margins also showed in a decline for shares of other major banks including Bank of America (BAC), Citigroup (C) and Capital One (COF) which are scheduled to report results this week. A reduction in share value despite record income figures for the quarter and year as well as an imminent increase in dividend payout from Wells Fargo speaks volumes about the impact this single factor has on the bank’s earnings over subsequent quarters.
We stick to our $38 price estimate for Wells Fargo’s stock, which is at a premium of less than 10% to current market prices.
Impact Of Low-Interest Environment Shows Through In Earnings Figures
Our analysis of Wells Fargo - illustrated in the chart above - shows that half of the bank’s value comes from three of its business divisions: mortgages, loans and credit cards. And these businesses rely heavily on interest rates as the interest income earned on the outstanding loan portfolio forms a bulk of each of their revenues. So when interest rates fall, there is a marked decline in the contribution of interest income towards the bank’s total revenues. Wells Fargo’s Q3 and Q4 2012 earnings figures evidently show this trend attributable to the low interest rates imposed by the Fed.
The situation is further aggravated by a spurt in the size of Wells Fargo’s deposit base. Core deposits at the bank jumped from $873 billion at the end of 2011 to $946 billion at the end of 2012 (an increase of $73 billion over the year), whereas loans only rose by $30 billion for the period - from $770 billion to $800 billion. As the bank incurs an interest expense on its deposit base, more deposits mean lower net interest margins. The overall result was a reduction in net interest margins from 3.89% for Q4 2012 to 3.56% for Q4 2012.
Investors' concerns about this situation stem from the fact that when deposits grow way faster than loans for banks, it shows that customers are cutting down on expenses and saving up - an indicator of weak economic conditions to come in the near future. This is obviously bad news for banks, as it points to lower interest incomes over subsequent quarters too.
Is The Mortgage Growth Engine Running Out Of Steam?
It sure would appear so. Wells Fargo originated $524 billion in mortgages over 2012 - a third of all mortgages in the country last year. But quarterly figures show that Wells Fargo originated the least number of mortgages in Q4 2012 - $125 billion compared to a peak value of $139 billion in Q3 2012.
And there is a good reason for this decline. Most of the mortgage originations over recent years has been due to a large number of home owners opting to refinance their existing mortgages to benefit from record-low mortgage rates and also from government-led initiatives. But the refinancing channel has nearly dried up over recent months. And while the housing market seems to be on a recovery path, it may take a few quarters for the demand for mortgage loans to catch-up with this in view of a cautious approach by people in general.
- Wells Fargo Reports Record Full Year and Quarterly Net Income, Wells Fargo Press Releases, Jan 11 2013
Disclosure: No positions.