Wells Fargo: The Only Thing That Matters

| About: Wells Fargo (WFC)


Q3 earnings are out following the fraud revelations at WFC.

I discuss the results and their implications.

The key metrics I discuss are what you need to watch.

Wells Fargo & Company (NYSE:WFC) as we know has been battling fraud associated with its banking practices. Because of this the name and the stock has been under pressure heavily of late. Some may see the pain as an opportunity to get long the bank. All unethical and illegal activity aside, before this came up there were concerns with credit, particularly exposure to energy, but this name is one of the few that not only survived the Great Recession, but didn't need to fleece the taxpayers to do so. After the fraud revelations, can we expect growth? To answer this important question, I will examine in this article the company's most recent quarterly report from this morning and its key metrics, as well as discuss the outlook for the bank. I will once again hone in on the metrics I care most about for a large bank.

Let me start by saying the bank delivered results that were modest, but beat expectations. The Street was negative on the results. Revenue was $22.3 billion, up 1.9% year over year from Q3 2015. Earnings themselves were $1.03 per share and also beat estimates by $0.02. I also want to point out, however, that like other banks reporting, net income was down year over year coming in at $5.6 billion compared to $5.8 billion last year. Of course, the $1.03 in earnings was down 2% from the $1.05 seen last year.

I have said many times that interest rates coming up will help large banks like Wells Fargo. So now that the Fed raised rates minimally to end 2015, how did that impact net interest income? Well, net interest income increased $219 million quarter-over-quarter mainly due to a growth in earning assets, including those from the GE Capital acquisitions the company made. There was also a stronger return on investment in equities. The company saw $12.0 billion in net interest income. Net interest margin was 2.82 percent, down 4 basis points from second quarter 2016 primarily due to growth in long-term debt and deposits, partially offset by the benefit of earning asset growth. Non-interest income was flat. It came in at $10.4 billion

So far so good right? Well, I've said it before and will say it again. One of the most critical metrics for a bank is the efficiency ratio. Still, so many seem to ignore this key metric, despite it measuring how effective the company is at generating revenue from its expenses. The efficiency ratio was hit. It rose to 59.4%, compared to 58.1% in Q3 2015. It rose quarter over quarter as well. However, under 60% is still very strong.

Now, the other keys I look for are loan and deposit growth. The fraud issue I thought would weigh here. However, total loans were $961.3 billion, up $4.2 billion from June 30, 2016, driven by broad-based loan growth and the acquisition of loans and capital leases from GE Capital. Still, this is stellar growth for a bank of this size. Further, total average deposits were up nicely as well. Total average deposits were up another 2% quarter over quarter to well over $1.3 trillion in Q3 2016. Finally, we need to be aware of nonperforming assets. I was pleased to see that nonperforming assets decreased by $1.1 billion million from Q2 2016, while nonaccrual loans were down $977 million for the quarter as well.

So just where is the pain from the fraud? In checking and credit cards. New checking account openings were down 25% Y/Y, and customer visits with branch bankers were down 10%. Credit card applications slid 20%. Further, mortgage referrals from Retail Banking were down 24% in September from August. That is pretty serious. In addition, some governments have halted their activity and accounts with the bank.

Still, despite a fraud revelation that crushed the image of the bank, the quarter was pretty strong. Of course, the toll may be taken further here in Q4, but this remains to be seen. The fact that the company continues to grow revenues and earnings with minimal help from rates is a testament to the company's ability to grow organically. The key metrics I look at are mostly strong. I love the efficiency ratio which remains under 60%. I will add that I am pleased to see that there is continued growth in total loans and deposits even in light of the fraud. The stock still yields 3.4% as well and I expect the dividend to grow. Under $45, it is tough not to want to buy the name here. But I would hold off for obvious reasons and the uncertainty they bring to the outlook for the bank.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we 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.

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