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Wells Fargo (NYSE:WFC) is the second largest bank in the U.S. by market capitalization with around $130 billion in outstanding balance on commercial real estate (CRE) loans. Wells Fargo competes with other banks like Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), and Citigroup (NYSE:C) among others.

Despite making up as much as 17% of Wells Fargo's total loan portfolio, the CRE loan business makes up only 2.5% of our $32.18 price estimate for Wells Fargo.

Commercial Real Estate Loans Business at a Glance

The commercial real estate loan portfolio of Wells Fargo includes real estate mortgage loans and real estate construction loans. Wells Fargo earns revenues on CRE loans in the form of interest on outstanding loans balances as well as charges and fees on loan originations and late payments.

Wells Fargo's CRE portfolio is highly diversified into various product categories. By product type, the largest segments of the portfolio are office buildings and industrial/warehouse, which represent 23% and 11% of the portfolio respectively.

Key Drivers of CRE Loans Business -

(Chart created by using Trefis' app)

Average Outstanding Balance on CRE Loans

Average outstanding balance on CRE loans jumped by 34% to $137 billion in 2009, despite a decline in demand for CRE loans in the U.S., as Wells Fargo's acquired Wachovia. In 2010, average outstanding balance on CRE loans decreased to $130 billion as demand for CRE loans remained weak.

Going forward, we expect the outstanding balance to remain constant in 2011 and then increase for the remainder of our forecast period alongside improvement in the broader U.S. economy.

(Chart created by using Trefis' app)

Provisions as a Percentage of CRE Loans Outstanding

Provisions as a percentage of CRE loans outstanding increased to 2.5% in 2008 primarily due to higher default rate as the U.S. economy entered recession and net charge offs on CRE loans increased.

It declined slightly in 2009 to 2.4% despite an increase in net charge offs as the average CRE loans more than doubled due to the Wachovia acquisition coupled with the fact that loans acquired from Wachovia were included in total loans, net of related purchase accounting net write-downs. In 2010, provisions decreased further to 1.5% of loans primarily due to lower levels of inherent credit loss in the loan portfolio.

Going forward, we expect provisions as a percentage of CRE loans outstanding to decline gradually to the pre-crisis average of ~0.6% and then remain constant.

Disclosure: No position

Source: A Look at Wells Fargo's Real Estate Loan Business