Wells Fargo & Co: Earnings Preview

Wells Fargo  (NYSE: WFC  ) reports 2014 first-quarter earnings at 10 a.m. this Friday. Despite the expectation that the linked-quarter earnings will ease for the first time in 4 years, investors should read beyond the headlines and watch for a few hole cards in the press release.  

Earnings estimates
Street consensus estimates peg the bank to report $0.96 per share. Over the last two months, the estimate has remained unchanged. A few analysts have raised or lowered their views by a penny or so. The net result has been static.  

If the forecasts are correct, it would mark lower linked-quarter earnings per share after a string of 16 consecutive increases. I suspect the company may surprise to the upside. Last year, second quarter EPS surprised by a nickel; so it's possible. Another $0.05 upside surprise would keep the linked-quarter EPS increase streak intact.

Reserve releases
Wells has been working off high loan loss reserves for several years. The reserve release is determined by subtracting current Provision for Credit Losses from Net Charge Offs. For the fourth quarter, Wells Fargo released $600 million to net income; or about $0.11 per share. The prior quarter saw the bank take a reserve release of $900 million. While these releases must be justified, there is an element of management discretion involved, too.

Probing a bit further, the ratio of Allowance for Loan Losses versus Total Loans was 1.8%. In late 2007 and prior to the financial meltdown, this ratio hit a period low of 1.1%. This indicates that there may be room to improve this balance sheet metric. If this ratio were to approach the old 2007 low, it means that the current $14.5 billion allowance item could be run down to $8.9 billion. This would have the effect of providing a nice boost to the bank's shareholder equity.  

Capital returns to shareholders
After evaluating recent bank "stress tests," the Feds provided "no objection" to the Wells Fargo 2014 capital plan. Bank directors increased the quarterly dividend $0.05 to a total of $0.35 a share. The payout is now a penny higher than before the financial crisis.

In addition, I expect senior leadership to reiterate their plans to repurchase an additional 350 millions shares in 2014. This represents ~6.7% of the current diluted shares outstanding. Over the past several years, Wells has kept total shares about flat, on significantly lower repurchase plan activity.  The latest plan should make a dent to lower the share count.

Revenue
Stalled revenue growth has been a challenge. In the first quarter, the top line is expected to fall 3%, to $20.6 million. The mortgage refi business has been taking a hit. Management, aware of this development, has stated Wells will reach out for other sources of revenue. 

Specifically, investors should listen carefully for bank plans around building its credit card business. This has long been an underdeveloped business segment at Wells Fargo. About a week ago, Wells and department store kingpin Dillard's inked a deal whereas the bank will now handle the private label and co-branded credit cards. Look for more updates along these lines.

Management may also talk about gradually increasing long interest rates versus anchored short rates, thereby creating a steeper yield curve. This permits banks to generate better net interest income, and higher revenue. 

Forward targets
Wells Fargo provides investors specific target objectives for several key bank metrics. These include; Bank Efficiency (non-interest expense / total revenue), Return-on-Equity, Return-on-Assets, and Total Payout Ratio (total capital returned to shareholders as a function of net income). Here's a recap of the 2014 targets.

source: Presentation material from Credit Suisse Financial Services Forum 2/12/14

Meeting these goals would keep Wells Fargo near the top of its peer group in all categories.

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