Wells Fargo (NYSE: WFC ) is one of the four true megabanks of the United States, but it has generally steered clear of the proprietary trading, elaborate derivative books, and foreign operations of larger peers like JPMorgan Chase (NYSE: JPM ) , Bank of America, and Citigroup. That leaves the bank considerably more dependent on consumer and business demand for loans and other services. While there are industrywide headwinds, the better loan growth and improving credit picture at Wells Fargo is encouraging.
Expenses and NIM take a toll
How we as investors make adjustments to reported bank earnings is a little like chilli recipes -- everybody has their own way, and they'll argue fiercely that theirs is best.
Revenue (again, adjusted) fell 6% from the year-ago level and was basically flat sequentially. Net interest income rose 2% and exceeded expectations, but that beat had everything to do with a double-digit (11%) year-over-year increase in earning assets. Net interest margin was weaker than expected, falling 30bp from the year-ago period, and 12bp sequentially.
Fee income was also weak (down 13%), but this was expected given the challenges in the mortgage market. Both JPMorgan and Wells Fargo saw significant year-on-year declines in mortgage fee revenue.
Expenses rose 2%, and one could argue Wells Fargo missed slightly on its efficiency ratio -- but it's still one of the best in the game. Given the weak rate and lending environment, expense control is one of the few levers bank managements have right now, so this miss is a little more disappointing. All in all, pre-provision profits declined by a mid-teens percentage.
The bright spots
Wells Fargo delivered some encouraging lending growth in the fourth quarter. Loan balances rose 2% from the third quarter, with better than 2% growth in commercial lending and 2% growth in consumer lending.
With JPMorgan also reporting sequential C&I lending growth, that should be a good sign for more C&I-focused banks like Comerica and Fifth Third.
Wells Fargo saw its non-performing loan formation drop 7% during the quarter, helping improve the non-performing asset ratio from just over 3% a year ago to 2.36% this quarter. Net charge-offs also declined, with the NCO ratio falling from over 1% to just under 0.5%.
Focused on what it does best
One of the oddities about Wells Fargo to me as an investor is that the Street never seems to really be happy with Wells Fargo as it is. Even before the value-destroying acquisition of Wachovia, Wells Fargo's consistently near-20% ROEs were greeted less with applause and more with pointed questions about when the company would expand into areas like foreign banking.
Keep in mind, this is a bank with more than 10% national deposit share. Moreover, the bank earns quite a lot from its sizable asset management business, and management likes to mention that roughly one in every three households do business with Wells Fargo in some capacity.
Still, some concerns are valid to a point. With more than one-quarter share of the mortgage market, more than 5% of the auto lending market, and a sizable presence in businesses like crop insurance, there are questions about where more growth can come from in the future. Cross-selling across these platforms to the old Wachovia customer base is a value-creating opportunity, but the company can still stand to grow its asset management, treasury, and specialty lending businesses.
The bottom line
Barring a recession, Wells Fargo should continue to generate returns on equity in the mid-teens and produce 8% EPS growth. Given the opportunity to make additional returns in a more favorable rate environment, the stock's tangible book value multiple could creep closer to 2.1 times or 2.2 times today.
With an attractive valuation and improving lending conditions, Wells Fargo is still a stock worth consideration at these levels.
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