Wells Fargo: No Good Deed Goes Unpunished

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The nation's largest mortgage originator and fourth largest bank by assets, Wells Fargo (NYSE: WFC  ) , reported third-quarter earnings this morning. For those of you who own shares in the bank or are considering investing in it, don't be fooled by the market's reaction. That shares in the company are trading sharply lower today, down 3.4% roughly halfway through the trading session, proves nothing more than the age-old adage that no good deed goes unpunished.

Wells Fargo's strong third quarter
Analysts' one-dimensional expectations aside, Wells Fargo's top- and bottom-line performances were resoundingly strong. While total revenue was marginally lower relative to the second quarter -- coming in at $21.21 billion and $21.29 billion, respectively -- on a year-over-year basis, it increased an impressive 8%. Meanwhile, the bank's diluted earnings per share notched an eleventh consecutive quarterly increase, coming in at $0.88 per share, equating to a 22% gain over the same quarter last year.

Perhaps most impressive, however, was the California-based bank's second quarter 13.38% return on equity -- the crème de la crème of financial profitability metrics. While a 15% ROE is the traditional industry benchmark, analysts continue to speculate whether that level is attainable in the post-financial crisis era of increased regulations and ballooning capital requirements. For instance, the other too big to fail bank to report today, JPMorgan Chase (NYSE: JPM  ) , reported a third quarter ROE of only 11.7%, and in the second quarter, Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) reported figures of 4.2% and 6.5%, respectively.

Three promising trends
Digging further into the numbers reveals three promising trends for both Wells Fargo and the economy as a whole. First, the bank did what all good banks do: It grew both loans and deposits. With respect to the former, total period-ending loans increased by 3% on a year-over-year basis. This was driven by a staggering $139 billion in home mortgage loan originations, equating to a 6% increase over the same quarter last year, and by a 9% uptick in business loans. With respect to the deposits, moreover, total core deposits increased by 6% over the same time period.

Second, credit quality improved on multiple fronts. Excluding the impact of new regulatory guidance, net charge-offs decreased sequentially by 19% and nonaccrual loans fell by 5%. Even more promising was the revelation that agency put-back requests related to the sale of faulty mortgages preceding the financial crisis decreased relative to the second quarter. As I've discussed in relation to Bank of America, these serve as arguably the single-largest current threat to the industry's bottom line.

Third, the bank's leadership has eschewed the irresponsible short-term approach to managing profitability favored by Wall Street analysts, choosing instead to lay the foundation for strong earnings going forward. Much of the disappointment underlying Wells Fargo's stock performance today relates to two things: its marginal, sequential decline in revenue, and the 25-basis-point decrease in the bank's net interest margin. Yet, the first is wholly a function of the lender's decision to retain high quality conforming loans on its balance sheet as opposed to realizing immediate revenue from selling them into the securitization industry and then purchasing the product, residential mortgage-backed securities, which yield markedly less than the underlying loans themselves. And the second is due in large part to faster than expected deposit growth in September and prudent liquidity management. Both factors, in turn, pave the way for monster profits going forward.

Don't be fooled by Wall Street
Early this morning, CNBC's Jim Cramer bashed Wells Fargo in his usual irresponsible manner, saying that he expected more from the bank and that its investors deserved answers. While pinning down the sultan of scream's uninformed expectations is an exercise in futility, Wells Fargo's second quarter-earnings release provided plenty of answers.

Make no mistake about it: Wells Fargo had a superb quarter virtually across the board. That traders are bidding its shares down, in turn, could only be viewed as a good thing for the enterprising investors, as its shares trade for a dear 1.35 times book value, nearly two-thirds higher than JPMorgan's valuation, and almost triple that of Bank of America and Citigroup.

The biggest value in bank stocks
While Wells Fargo is unquestionably the only big bank built to last, if you're looking to double or triple your money over the next five years, the bank stock that's best positioned to do so is Bank of America, the nation's second largest bank by assets. Before boarding this massive money train, however, check out our new in-depth report on Bank of America, which gives the reasons it could skyrocket as well as the risks associated with holding its stock. To view this report instantly, simply click here now.

John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. Motley Fool newsletter services recommend Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (4)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 12, 2012, at 3:31 PM, strummin wrote:

    The ONLY big bank built to last? I think thats a little closed minded.

  • Report this Comment On October 12, 2012, at 3:55 PM, MKArch wrote:


    I didn't catch your BofA report you linked when it came out in September so I'm going to go a little off topic here and bring that one up. You say there are $132B in bad loans most of which are GSE however BAC already has settlements with both FNM and FRE. I realize that FNM at least is suffering from settlers remorse in addition to buyers remorse and somehow trying to put back more loans. I'll fall on my sword and admit I don't understand what the new issue however the question I have for you is are you sure none of the $132B of bad loans is not already covered in the existing agreements with FRE and FNM?

    Maybe I misread you but it sounds like you are counting every delinquent loan as qualifying for a put back. A delinquent loan would only qualify if there was improper documentation or fraud. How many loans are the GSE's claiming are improperly documented or fraudulent? How many of those are already covered in the existing settlements?

  • Report this Comment On October 12, 2012, at 4:07 PM, MKArch wrote:

    BTW just food for thought; how does someone who intentionally buys a portfolio of sub-prime loans consisting of "liar loans" and "no document loans" claim fraud and insufficient documentation after the fact?

  • Report this Comment On October 12, 2012, at 4:50 PM, JohnMaxfield37 wrote:


    The $132B figure refers to the total outstanding principal balance of loans sold to the GSEs between 2004-08 that are either in default or severely delinquent.

    Yeah, I don't know how many qualify for a putback. To your point, certainly not all of them. Or even close to all of them for that matter. I cited that figure simply because it gives the worst case scenario.

    How many were associated with fraudulent or sufficiently negligent underwriting? I don't know.

    Also, there appear to be outstanding contractual/legal issues about whether the GSEs can put back loans that were up-to-date for two full years, or went into default more than 18 months ago.

    The discussion about this is in BAC's 2Q 10-Q, starting on page 56. There's also a section about it starting on page 192. I provide a link to it below. Also, for what it's worth, these issues were discussed on the last conference call.

    BAC's 2Q12 10Q:

    BAC's 2Q12 Conference Call transcript:


  • Report this Comment On October 12, 2012, at 4:52 PM, JohnMaxfield37 wrote:

    And to your second point, it's hard to disagree with you. Though, I suppose that fraud is fraud.

  • Report this Comment On October 12, 2012, at 4:59 PM, MKArch wrote:

    Thanks John, I appreciate the links. Looking at the ending date of 2008 and factoring in the the discussion about loans that performed for at least 2 years I think the answer to my other point might be that the existing settlement with the GSE's covered loans that were less than 2 years old. I think the new claims are going back further, even though the loans were current for at least two years.

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