Wells Fargo Will Continue To Move Higher, So Buy Before 2013

| About: Wells Fargo (WFC)

Wells Fargo & Co. (NYSE:WFC) through its subsidiaries provides retail, commercial, and corporate banking services, primarily in the United States. Wells Fargo's headquarters are in San Francisco, California. The company has a market cap of $181.6 billion, and its stock price is at around $34.

Wells Fargo reported third quarter earnings on October 12. The company reported revenues of $21.2 billion, an 8% increase from revenues of $19.6 billion in 2011. Net income was $4.9 billion, a 22% increase from net income of $4 billion in 2011. The banks earnings per shares came in at $0.88, a 22% increase from 2011.

The bank's biggest driver of increased earnings came from its mortgage loan division. New mortgage loan originations rose to $139 billion from $89 billion in last year's third quarter. Wells Fargo's mortgage banking revenue jumped more than 50% from a year ago to $2.8 billion. Lower interest rates drove the mortgage loan business higher. During the third quarter earnings call, Wells Fargo's CEO John Stumpf said, "Real estate is getting better", and "We saw it in housing, and every quarter we have more confidence."

A second area of real growth for Wells Fargo was its trading division, which saw net income gains of $529 million, compared to a loss of $442 million in the third quarter of 2011. John Stumpf also noted that the bank had boosted fee income by selling products and services that don't depend on interest rates from loans.

The bad news that came out of the third quarter earnings report was that the bank's net interest margins had decreased. The net interest margin (the difference between what the bank collects on loans and the interest that it must pay to depositors and lenders) decreased to 3.66% from 3.91% in the second quarter, a bigger drop than it warned of last month.

Loans are the bank's primary source of revenues and income, and lower margins are a real concern. Bank executives tried to lessen concerns about lower margins and asked investors to focus on the banks growing earnings. Wells Fargo CFO Tim Sloan said, "We could easily have increased net interest margin by making bad decisions," and then added "We don't spend a lot of time focused on managing to that margin." He indicated that the bank could have increased net margins by issuing higher margin low quality loans, but chose against it.

Another area of concern for banks has been bad debt losses. During the third quarter, the bank's loan loss provision decreased by 14% to $1.59 billion from $1.8 billion in 2011.

Recent News on Wells Fargo

On October 12, it was reported that Wells Fargo's mortgage origination business didn't disappoint, with income from that division rising 53% Y/Y to $2.8B. Tier 1 capital ratio rises to 11.66% from 11.26% a year ago. Book value/share rises to 27.10 from $26.06 in Q2 and $24.13 a year ago, and shares were -2.5% premarket.

On October 12, it was reported by Wells Fargo that weak revenue was likely the result of sliding net interest margin - down 25 basis points to 3.66%. Total loans grew just under 1% sequentially. Non-interest expenses were off $285M to $12.1B. Net loan charge-offs rose to 1.21% of loans, from 1.15% in Q2. Non-performing assets rise to 3.23% of loans from 3.21% in Q2. A $800M gain (16% of net income) was booked from reserve release.

On October 12, Wells Fargo said it will provide financing for an 11.3 MW solar project being developed by MEMC Electronics (WFR, -6.6%) Sun Edison unit in New Mexico; it is the sixth Sun Edison utility scale solar project funded by WFC in the past year. El Paso Electric (EE) agreed to purchase the power supplied by the project for the next 25 years.

On October 10, it was reported that the mortgage-related lawsuits against Wells Fargo and JPMorgan (NYSE:JPM) were insignificant compared to the legal and asset write-down exposure at Bank of America (NYSE:BAC) and Citigroup (NYSE:C). For Wells Fargo, even a worst-case scenario would see a nickel cut from a forecast Q4 profit of $0.89, estimated KBW's Fred Cannon.

On October 9, the U.S Attorney for the Southern District of New York filed a civil mortgage fraud lawsuit against Wells Fargo for hundreds of millions of dollars over allegations of reckless underwriting and fraudulent loan certification by the bank. An investigation conducted with assistance from HUD found over 6K Wells Fargo mortgage loans with material violations.


On October 12, Wells Fargo reported what appeared to be strong third quarter earnings. But, on the date of the report, the stock price slumped by 2.7% on more than twice its average volume of trade. This was due to the company's lower-than-expected net margin rate. Tim Sloan conceded that there "is no question that in this slow rate environment, interest margins are under pressure, and the trend could extend through next year."

I realize that Wells Fargo made less money on its loans, but recent history tells us that Wells Fargo still makes more loans and higher quality loans than its competitors. Wells Fargo, the top U. S. mortgage lender, added about 2,000 people in the third quarter due to an increase in mortgage loan applications.

With Ben Bernanke's recent QE3 announcement, interest rates will remain low, and mortgage loan originations will probably rise even more. I consider Wells Fargo to be the "Best of Breed" amongst the large bank stocks, and with the recent QE3 and a (slowly) improving economy, Wells Fargo's stock price (which is up 29% over the last 52 weeks) will move higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.