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Wells Fargo And The Story Of NIM

|Includes:Wells Fargo & Co. (WFC)

Wells Fargo stock's most recent price inhibitor is a combination of fear that mortgage banking (AKA home loan origination) income will significantly decrease in coming quarters and its NIM (net interest margin....percentage) has decreased 35 basis in the last two quarters to a measly 3.56% at present. I don't contest either of these complaints, but I believe a bit of perspective is in order.

Mortgage Banking:

On the mortgage banking front, refinancings will drop over the next few quarters, especially now that interest rates are starting to rise. Management has repeatedly stated that there are significant offsetting factors to any decline in originations. First, as originations decline, so do related variable costs, very significant costs. The net income from originations isn't nearly the gross, maybe 30-40%, so if revenues drop by a $billion, or a third, net pre-tax income only takes a $3-400 million hit.

However, the value of Wells $2 Trillion MSRs (Mortgage Servicing Rights) goes up a bunch when actuarial assumptions about refinances determine they are much less likely henceforth. Likewise, if inflation causes interest rates to rise and houses to increase in value, the probability of foreclosures and a repeat of the last 5 year debacle decreases. Wells has made some extremely conservative assumptions about the value of servicing 12 million + mortgages at $36/month each in revenue to account for another debacle. The reversal of the conservative assumptions will largely offset the decline of originations.

In short, management has repeatedly stated that originations come and go (of course, they come when BAC and others hand you market share on a silver platter), but many offsets occur either way...I have no reason not to believe Well's management's assertion that loss of originations isn't that big a deal.

The Story of NIM:

As previously stated, Wells NIM is now "only" 3.56%, down from around 4.8-5% historically. (I quote "only" because a NIM at this level is the Gold Standard in this, even in a better rate environment). Analysts are punishing Wells because NIM went down 25 basis points in Q3 and 10 more in 4. My guess is that their trend line/linear analysis puts NIM crashing to 0 in a couple more years.

This linear analysis of NIM, with assumptions ranging from naive to preposterous, is the only reason the stock is held to a forward P/E of less than 10, and perhaps a 2014-15 P/E of less than 6.

Wells Fargo had a gross interest margin of 3.96% in Q4. Don't ya think it might be a bit tough getting better than 3.56% net, if you have to maintain $175 bil. of interest bearing term debt and pay a bit on a $Trillion of deposits?

Admittedly, loan growth, which directly benefits NIM has been disappointing. Couple this 10 year treasury yields of 0%- net of inflation, having dropped like a rock the past 4 years and gross interest margin on $1.44 Trillion of interest bearing assets is going to get hurt...Dah? Also note, that Wells is taking in deposits (a good thing) so fast that NIM suffers while it takes a few months to place them.

Wells could do what a few banks are doing, aggressively make loans and perhaps aggressively go to longer maturities on debt assets to pump up NIM. (Cramer seems to like Key Bank, which I believe is doing this.)

Alternatively, Wells believing rates will dramatically rise, could hold its powder and get massive NIM growth in the future when (yes, I believe it is a "when") rates revert to normal inflation plus 2-3%.

The question as a relatively long term investor is would you rather have a bank that stays liquid, to the detriment of NIM, so it can really ride a NIM increase in the near future, or a bank that wants to get on Mad Money by showing a relatively high current NIM (that will bite back...hard when rates rise)?


Interest rates have already started the slow path to normalization...10 year Treasuries are up 50 basis points from the fall low. This will show on Wells 1Q financials in the form of "increasing NIM." The analysts will now have to find some other reason to pan Wells...from a very short list of very dubious choices.

What has me more excited is 1-2 years out, when Wells, having held its powder, is in a position to deploy assets at a 2-3% higher rate. It made 5% NIM in the early 2000's with way less capital and way more debt, not to mention way less relative deposits. Wells can make 5% NIM with its eyes closed in reasonably normal times.

5% NIM pays for a lot of lost mortgage origination volume. Let's see 1.44% better interest (5% compared to the present 3.56%) X $1.442 Trillion in assets....well you do the math...a hint though: It adds something north of $2/share to post tax income....makes $5.90/year folks...less than 6 times the current stock price.

Stocks: WFC