Wells Fargo Continues Record Run Despite Mortgage Setback

Apr.16.13 | About: Wells Fargo (WFC)

Wells Fargo (NYSE:WFC) faced a mixed response from investors when it revealed its performance figures for the first quarter of 2013 last Friday. [1] Despite the fact that the country’s fourth largest bank churned out record earnings of $5.2 billion for the quarter was a reason to cheer, a marked decline in revenue figures combined with dwindling prospects for mortgages in view of falling origination volumes raise questions about the bank’s profitability in subsequent quarters.

Quite notably, a quick glance through Wells Fargo’s numbers for the quarter show that the record earnings despite lower revenues and almost flat non-interest expenses were a result of the bank setting aside a substantially lower amount as provisions ($1.2 billion) compared to any quarter since the economic downturn of 2008. This figure is just two-thirds of average provisions of the $1.8 billion Wells Fargo set aside each quarter in 2012. While this can be seen as a positive indicator of improving credit quality, if Wells Fargo is understating this figure, the bank is merely drawing from future earnings and the impact will be seen as huge charge-offs in the loan portfolio over the coming quarters.

As of now, we stick to our $38 price estimate for Wells Fargo’s stock which is slightly above the current market price. It must be mentioned here that the current market price of the bank’s share is about 30% higher than the bank’s book value of $28.27 at the end of Q1 2013.

Wells Fargo Is Still Struggling With Its Net Interest Margin

The biggest concern for Wells Fargo continues to remain its steadily declining net interest margin (NYSE:NIM). And while the bank was helped by higher fee-based income streams over the last two quarters, it lacked such a benefit this time around with better net income figures resulting from improved operating costs and reduced provisions as described above.

The table below summarizes Wells Fargo’s reported net NIM figures for each of the last nine quarters:

Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013
4.05% 4.01% 3.84% 3.89% 3.91% 3.91% 3.66% 3.56% 3.48%
Click to enlarge

The decline in NIM this quarter quashes the optimistic outlook of the bank’s top management, which aimed at improving interest margins for the period. You can better understand the impact of falling net interest margins on the bank’s total value by making changes to the chart above, which represents Wells Fargo’s NIM on outstanding mortgages.

It’s Official – The Mortgage Refinancing Boom Is Gone For Good

Wells Fargo reported mortgage originations of $109 billion for the quarter - well below the Q3 2012 high of $139 billion and a further reduction from the Q4 2012 value of $125 billion. This is because most of the mortgage originations over the recent years have been due to home owners opting to refinance their existing mortgages to benefit from record low mortgage rates and also from government-led initiatives. With the big banks almost exhausting loans that can be refinanced, and with demand for fresh mortgages yet to pick up, the overall effect is seen as a marked dip in origination volumes.

This does not bode well for Wells Fargo which focuses considerably on the mortgage business. The bank is the leader in the industry by a huge margin and derives more than a quarter of its value from mortgages.

Disclosure: No positions.