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jclyak
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JD, CPA, 18 years CEO/CFO, investor for 50 years
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  • Wells Fargo And The Story Of NIM

    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 industry...ie..great, 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)?

    Conclusion:

    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.

    Tags: WFC, Banking, Finance
    Feb 09 1:02 PM | Link | Comment!
  • A Romney Victory Might Equal Wells Fargo At $67 And Change By Early 2014?

    I thought I'd put to pen my back-of-napkin thoughts of the impact of a Romney victory on Wells stock. Of course, the composition of Congress will have some effect on these thoughts, but by and large, the outcomes I articulate are conservative IMHO. I believe these effects will roll out before the end of 2013.

    Interest Rate Spread:

    The 10 year T-bond yield will return to 3%+ from the present 1.8% (which is already up 40 basis points from recent lows) The yield increase will occur by virtue of a less paternalistic Fed and a general improvement in the economy, etc.. The net effect would be a 50 basis point gain in Wells' NIM (Net Interest Margin)--This is $6.7 Billion/year pre-tax to Wells' bottom line.

    Regulatory Back-off:

    The Durbin amendment and some of the other costly, unnecessary and onerous provisions of Dodd-Frank will go away. Wells would save $2 Bil./year pre-tax.

    Economic Rebound:

    This is really a variable number and involves huge things like the economic impact of Obamacare repeal, but I believe dramatic loan growth and other activity will add a bundle to Wells income. Let's just throw in $2 Bil/year to the pre-tax run rate, a ridiculously low number

    Corporate Tax Reform:

    Romney has articulated a corporate tax rate reduction to a 25% top bracket from the current 35% rate.

    P/E Multiple Expansion:

    Wellls now has a Trailing 12 P/E of 10.8. Historically that number has been in the 15 range. Once all the bank-bashing diminishes and the regulatory-tax outlook stabilizes, there is no reason that historical P/E shouldn't return, especially with the 10-year treasuries at even 3%.

    Will the P/E return to 15 in 2013? No. However, I believe 13 P/E is attainable almost immediately after a favorable election outcome.

    Some Math:

    T-12 earnings were about $17 Bil. post tax yielding a pre-tax (@35%) earnings run rate is $26 Bil. for the last 12 months (current run rate, based on annualized 3Q is $29 Bil). Add up the above pre-tax 2013 benefits of a Romney win and the total is $10.7 Bil/year for a theoretical run rate of $36.7 Bil. in 2013 (might not instantly kick in though, so this is a bit hazy, however, this analysis also shorts Wells to the extent that the current run rate is much higher than the T-12 run rate). Apply a new tax rate of 25% and you end up with $27.5 Bil. of income after taxes, about $5.20/share.

    Put a multiple of 13 on $5.20 and Wells common trades at $67.60, by say 1Q 2014?

    Disclosure: I am long WFC.

    Oct 20 11:32 AM | Link | Comment!
  • Wells Fargo Should Buy....Wells Fargo!

    Over the past year I've been pleased with all the progress Wells has made in terms of cleaning up all high cost debt from its balance sheet…the 8% + TRUPs, etc.. I'm also very pleased that Wells really doesn't have any more of this easy "debt" fruit to pick. Furthermore, at the end of Q2 Wells will be at 8.2% Basel III capital, enough to satisfy the regulators forevermore.

    What's next?

    If I were Wells I'd look no further than the mirror to determine the optimal capital deployment over the next few quarters or even years. Wells pre-tax annual ROI on stock repurchases is at minimum 15%...assuming earnings remain flat, except for the anticipated $1.5 Bil. a quarter expense reduction by Q4.

    What makes the 15% ROI particularly juicy is that it is achievable at a stock repurchase price of $38 per share. Let's do some math:

    In Q1 Wells made $.75/share after tax. However, it had $419 million of intangible deposit amortization which, if added back to earnings, puts the per share earnings at $.83. If one adds the anticipated $1.5 bil./Q of expense savings management has repeatedly promised, earnings go north of $1/share per Q and company earnings at about $5.5 Bil. a quarter after taxes …This is baked in, at least in the eyes of management, and I believe management.

    Wells is spending about $1.1 bil. Q on dividends, so it is left with $4.4 bil./Q to spend. If Wells saves $600 mill. / Q for capital enhancement, that leaves $3.8 billion to spend on share repurchases, while still keeping the regulators happy. With a post tax P/E of say 9, the pre-tax ROI is 16% on this repurchase for the company.

    Fast forward to 2014 with a normalized yield curve and 8 Qs of a 2% buyback program..What do you think the ROI will be on the 16% of the float that was repurchased if the company's earn rate improves by $10 bil./year with a normalized NIM, not to mention the rest of the earnings improvement thru normal revenue growth. I believe management has to be visualizing a 25% forward ROI on share repurchases? I believe buybacks at even $50++ a share math nicely for Wells in comparison with almost any other conservative investment option.

    Expect to see the buybacks begin in Q 3 in a major way.

    Jun 23 3:17 PM | Link | Comment!
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