Well Fargo (WFC) boosted earnings by 18%, increasing $675 million to $4,403 million, in Q2 2012 as net interest income increased 4%, fees from the mortgage business boosted non-interest income by 6% and expenses fell by 1%.
The numbers were well received and WFC's biggest shareholder, Warren Buffett, continues to praise WFC's mortgage business. However I can see very little justification for WFC's valuation premium with a historic PE of 11.2 compared to 8.6 at JPMorgan Chase (JPM) and 8.7 at Citi (C).
Comparisons to the first quarter are not good. Revenue was stagnant at $21.3 billion (Q1: $21.6bn), net interest income was stagnant at $11.0 billion (Q1: $10.9 billion) and non-interest income fell to $10.3 billion (Q1: $10.7 billion).
Similarly, comparisons to 2011 give little reason for cheer in the mortgage business. First lien retail mortgages only increased by 2.2% and overall loan business also only increased 2.2%. There is little sign here of the recovery.
So where did the improvement come from? Answer, it largely came from a $389 million reduction in interest expense as the company redeemed higher cost trust preferred securities. In short a once off improvement that will not lead to future improvement.
In fairness, WFC is a great bank that came through the financial crisis relatively unscathed and is well placed to benefit as the US housing market eventually improves. It is correct that it should be priced at a premium to riskier peers.
However, the risks that face peers are now significantly reduced. Years of slow and selective lending mean that their lending books are well seasoned and problem portfolios have generally been identified. Sharp reductions in loan provisions have boosted profitability and core businesses are again beginning to recover.
Citi's Q2 figures reported stabilization within consumer banking while investment banking and the payments business showed tangible signs of recovery. It is apparent that Citi's diversified business model has much potential upside and will benefit strongly, along with WFC, from an improving housing market.
Similarly, JPM reported resilient profitability of $5 billion for the quarter which more than offset the $4.4 billion of losses related to the London Whale. As investors increasingly accept the London Whale incident was a once off and relatively minor incident, JPM can expect significant upside if valuation multiple increases to more normal levels.
Most of us, including myself, are followers of Warren Buffett's every word. After making further purchases of WFC last year Mr Buffett told Charlie Rose "I like buying on Sale". However, for me, the stocks currently priced at a discount are JPM and C.
Disclosure: The author is long JPM. The author holds no positions in WFC or C and has no intention to initiate any in the next 72 hours.
Disclaimer: This article does not constitute a recommendation to buy or sell. Investing in stocks or other securities and derivatives is a high risk activity and not suitable for everyone. It is strongly recommended that individuals should consult with a SEC registered investment advisor prior to making any investment decisions.