Avoid Debt Ridden Wells Fargo And Buy Healthy U.S. Bancorp Instead

Includes: C, UBS, USB, WSB
by: Investment Underground

By Kay Fitzpatrick

The banking sector remains badly beaten down with little to be optimistic about in the near future. The difference between sink and swim is a healthy balance sheet able to withstand blasts from the past and future uncertainty.

Wells Fargo (NYSE:WFC) lowered its rating on the banking sector to “market weight” in August based on lowered expectations for economic growth and low interest rates which will likely remain so through 2012. Anaylsts at Citigroup (NYSE:C) and UBS (NYSE:UBS) lowered their earnings estimates for the bank sector for the next several quarters.

In spite of the tepid outlook, Wells Fargo delivered some optimistic news in its third quarter earnings report. The company announced a record net income of $4.1 billion, up by 21 percent from the prior year. Third quarter revenue of $19.6 billion was slightly down from the previous quarter. Net loan charge-offs declined to $2.5 billion, down $227 million from the prior quarter and down $1.5 billion from 2010. In its report, the company also announced reorganization of its management structure in its insurance division to streamline operations and enhance efficiencies.

Wells Fargo took the seemingly bullish step of raising its dividend to 12 cents from five cents in 2010. Should investors look at these announcements as optimistic signs?

A closer look at Wells Fargo cash flow and balance sheets for the end of 2010 show glaring hot spots pointing to trouble for the company. Total liabilities of $1,131,720,00 is now nearing assets of $1,258,128,000. The balance sheet also shows near term debt of $55,401,000 billion going into 2011. With net income for last year at $12,362,000 and negative cash flow of negative $11,036,000, the debt load looks unsustainable.

Add to that the fact that the company’s subsidiary Wells Fargo Bank negotiated a settlement with the Office of the Comptroller of the Currency, Securities and Exchange Commission, the U.S. Internal Revenue Service, U.S. Department of Justice and a group of state Attorneys General to resolve prior public investigations into the activities of former employees in Wachovia Bank’s municipal reinvestment and derivatives group before that bank’s merger with Wells Fargo. The total amount of the settlement is $148,243,013 and adds more onerous liabilities to the company’s ailing balance sheet going forward.

It’s not so dismal for all banks. U.S. Bancorp reported good results for its third quarter, and has a better balance sheet. The company reported record net income of $1,273 million, and a net revenue record of $4.8 billion. New lending activity increased by nearly 13 percent. Loan growth averaged 5 percent with commercial loans growing 11.9 percent over 2011 third quarter.

Average deposits also grew by 17.9 percent and average savings by 13.5 percent. Total net revenue grew at 4.5 percent over 2010’s third quarter and 2.2 percent over the 2011 second quarter.

The company reported solid earnings growth from fees. Net charge-offs declined 10.4 percent from the second quarter. Non-performing assets decreased by 6.9 percent from the previous quarter.

A glance at U. S. Bancorp’s cash flow and balance sheets from 2010 show the company going into 2011 in a healthier state than Wells Fargo.

Total assets of $307,786,000 exceeded liabilities of $278,267,000. The company had short/current/long debt of $32,557,000. The cash flow statement indicates a change in cash and cash equivalents of $8,281,000 – a marked improvement over the two prior years’ negative cash flow.

U.S. Bancorp showed considerably more financial strength than Wells Fargo going into what has been a dismal year for the banking sector, and U.S. Bancorp’s stock performance reflects that fact.

Wells Fargo is trading about 23 percent below its 52-week high with a 9.83 PE. At approximately seven percent off from its 52-week high with a 11.84 PE, U.S Bancorp stock performance is far more robust. That fact that it has managed to climb back approximately 33 percent from its 52-week low probably limits much more room for growth.

With the banking industry under extreme pressure from the low-interest domestic environment combined with the ongoing added threat of possible impending European bank implosions, the banking sector just looks too risky for value investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.