Wells Fargo: Scandalous Headlines Masking Fundamental Weakness?

| About: Wells Fargo (WFC)
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Scandal this, scandal that, what matters is performance.

I discuss Q4 results which were anticlimactic.

Despite fundamental issues, stock should rise.

Scandal this. Scandal that. Wells Fargo & Company (NYSE:WFC) as we know has been battling fraud associated with its banking practices. There is no question it has weighed on the name, and tarnished the brand, at least in the short-term. However, the name rallied hard along with other financials in November and better days are ahead for the banks with rising interest rates. All unethical and illegal activity aside, what matters is where the name is going. Last year, before this came up there were concerns with credit, particularly exposure to energy. The main question is 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.

Let me start by saying the bank delivered results that were modest, and whiffed on expectations. However, the Street is positive on the stock as the sector overall reported positive news. So although the results were kind of anticlimactic after all of the drama this summer and fall, and following the rally post-election, there were some key signs of strength that matter. But first, to the headline numbers. Revenue was $21.58 billion, essentially flat year-over-year from Q4 2015. Meh. Rather unimpressive. They missed by A strong $840 million though. That's a touch eye opening. Earnings themselves were $0.96 per share and also fanned on estimates by $0.04. As such, net income was down year-over-year coming in at $5.3 billion compared to $5.6 billion last year. Of course, the $0.96 in earnings was down 4% from the $1.00 seen last year.

Are rising rates having an impact on net interest income yet? After all this is something I predicted with enthusiasm as we entered 2016 and am reiterating in 2017. Well, net interest income increased a strong 7% year-over-year mainly due to a growth in earning assets. There was also a positive return on investment in equities. The company saw $12.4 billion in net interest income. Net interest margin was also up from the September quarter to 2.87% from 2.82%. This was strongly associated with growth in long-term debt and deposits, partially offset by the benefit of earning asset growth. Non-interest income fell for much of the sector. Wells Fargo was hit particularly hard, and it came in at $9.2 billion, falling from $10.4 billion just last quarter.

Ouch right? Well, I've said it before and will say it again. In this article and in columns on other tickers. One of the most critical metrics for a bank is the efficiency ratio. The direction of this metric is absolutely critical. This is the second quarter in a row where the efficiency ratio was hit. 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 rose once again, which is bad. It clocked in at 61.2%. It rose from 59.4%, last quarter. Here is a key line from the release: "The company expects the efficiency ratio to remain at an elevated level." Translation=expect inefficiencies to remain in place.

Now I don't mean to come across bearish, but whether you hold this stock or not, this report has not been strong. To be clear, the stock should rise this year, thanks to the sector, not so much because of stellar performance. There's value here and there were strengths. But we must be intellectually honest. Not the best report. The other keys I look for are loan and deposit growth. The fraud issue I thought would weigh here, given the name was tarnished a bit. But I was wrong on this front. Total loans were $967.6 billion, up $6.3 billion from September 30, 2016. 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 Q4 2016. Finally, we need to be aware of nonperforming assets. I was pleased to see that nonperforming assets decreased by $644 million from Q3 2016, while non-accrual loans were down $603 million for the quarter as well.

While the fraud revelation crushed the image of the bank short-term, performance is what matters. This quarter was lackluster. The key metrics I look at show stalled growth. The efficiency ratio is a concern. 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 sports a strong yield, and there is value here. Despite the anticlimactic results, the stock is set to rise in 2017 barring catastrophic earnings reports, given that the sector is to benefit from rising rates.

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.