With Wells Fargo (WFC) reporting tomorrow morning, April 12th, before the opening bell, we thought we would hit a few of the main points on the bank prior to the report.
Last week, when we published our JP Morgan (JPM) and Goldman Sachs (GS) preview, we combined JPM and GS together since - as capital market sensitive banks - and given their mix of businesses, JPM and GS are more similar than JPM and WFC.
Wells Fargo is more a traditional bank in that the trading and capital-market functions are less important, given that WFC accounts for about 1/3rd of total mortgage originations - mortgage banking revenue accounts for between 20% - 25% of WFC's non-spread income - and since WFC has shunned the higher-risk businesses of many other large money-center banks.
WFC is expecting $0.88 in earnings per share (EPS) on $21.6 billion in revenues for expected year-over-year growth of 17% in EPS on flat revenues. Excluding the dividend, WFC is up about 11% year-to-date, slightly trailing the SP 500. And therein lies the problem.
The last two quarters WFC's stock has gotten pounded after earnings on "net interest margin" (NIM) compression, which is essentially just the difference between what WFC earns on its loans / assets, and what it pays in terms of its cost of funds.
After reporting the Sept. '12 quarter, WFC's stock fell from over $36 to $32 on unexpected "NIM compression" or narrowing, and again in the December '12 quarter reported in January, NIM was narrower than the majority of analysts had modeled although the stock didn't react much.
I suspect that issue is now behind WFC as the balance sheet re-pricing and the relatively stable mortgage rates the last 6 months, but a research note out of Trefis, dated April 9th thinks we might see some lingering issues around NIM.
From a portfolio management standpoint we own WFC since it is less "brokerage-like" than the other large banks, and it gives us exposure to the financial sector, with less market risk. Here is WFC's progression in annual earnings:
* Source: thomsonreuters
Looking at the above numbers, WFC clearly benefited from the mortgage boom and refi boom after the '08 financial crisis, and perhaps more importantly, Street consensus is expecting earnings growth to slow materially as mortgage rates stabilize and bottom.
On a valuation basis. WFC is trading at 11(x) the consensus 2013 EPS estimate of $3.64 and 10(x) the consensus 2014 EPS estimate of $3.84 for expected growth this year and next of 8% and 6%, so even if growth does slow materially the stock has discounted that expected slower growth.
I do worry about what happens to that mortgage origination revenue line item, once interest rates do start to rise, and the refi boom dries up, but WFC's 2.7% and excellent capital ratio's should allow the bank to continue to return capital to shareholders.
We don't think interest rates will be an issue for spread institutions like WFC for at least through 2013. Mortgage originations might be lower and the bank might give you less earnings delta with capital markets tailwinds, but WFC's slower and steady low-cost-of-funds, basic business banking model, with a decent dividend and the ability to repurchase shares should fare well in 2013.