The Bank That Does Just About Everything Right

Wells Fargo reported earnings last Friday. Management recapped an outstanding quarter, beating analyst expectations, and painted an optimistic picture for the future.

Apr 17, 2014 at 1:42PM

Wells Fargo & Co. (NYSE:WFC) reported 2014 first-quarter earnings last Friday. Reading beyond the headlines, management described a banking institution with a business model and strategies that have the potential to make investors happy for a long time.

Wells is a "Main Street" bank. The business model is simple: take in customer deposits, make wise mortgages/community loans, and generate a margin on the difference. In addition, management emphasizes cross-selling, where bank employees encourage existing customers to utilize the company for additional products and services: auto loans, credit cards, business products, and retirement accounts. Traditional expense management is front and center. Investment banking, overseas exposure, and marketing financially engineered products are not part of the core business.  

Earnings, deposits and loans
Wells Fargo's earnings per share of $1.05 marked the 12th consecutive record quarter and represented a $0.09 beat on the Wall Street analyst consensus -- a remarkable achievement. Customer deposits were up 5%, and total loans grew 3% -- par for the course in recent years. 

Credit quality and reserve release
Disciplined loan management, even prior to the financial crisis, has lead to a long string of improvements in credit quality. The first quarter of 2014 continued the trend. Provision for credit losses and net charge offs were down once again, while a $500 million reserve release provided about $0.09 a share to the bottom line. There's more to come. During the earnings conference call, CEO John Stumpf commented:

When you think about the quality of the loans that we have originated post-crisis, the loan losses, credit quality are very, very good. And so our expectation is that while our loan loss reserve release was down this quarter from the prior quarter and from the prior quarter before that, we do anticipate future releases...

Capital returns
Wells Fargo is a shareholder-friendly bank, which should come as little surprise, given legendary Warren Buffett is its biggest investor. The upcoming dividend is expected to be $0.35, thereby eclipsing the pre-crisis mark. Management confirmed the company will repurchases 350 million shares in coming months, providing a meaningful reduction in total diluted shares outstanding. CEO Stumpf highlighted this during the conference call Q&A session:

...we would tell you that we think our shares are on sale every day and we are going to repurchase more shares this year than we did last year and you are going to see that share count go down in the second quarter, in the third quarter and in the fourth quarter.

Adding gloss to the report, nearly every standard bank return metric improved. Return on assets, return on equity, Common Equity Tier 1 ratio, and the expense efficiency ratio all bested prior quarter results. Investors saw record exceptional results in nearly every major banking return measure.   

Flat revenue growth is perhaps the lone area for concern. Mortgage refinancing has effectively dried up, drilling a hole in top line comparisons. However, bank management acknowledges the challenge and procedes to explain what they are planning to do about it. 

Premising that the gradual improvement in the U.S. economy will translate to community lending growth, Wells' senior staff has especially concentrated resources on two specific areas: credit cards and auto loans. EVP Tim Sloan offered the following encouraging remarks:

Our credit card business grew balances and fee income compared with a year ago, reflecting record new account growth up 6% from the first quarter of 2013. Purchase volume grew 14% from a year ago and household penetration increased to 38%, up from 34% a year ago. We continue to be the number one auto lender in the country, with record originations in the first quarter of $7.8 billion, up 15% from a year ago.

Valuation and prognosis
Despite a choppy market, Wells Fargo stock moved up about 1.6% post-earnings. Despite the bevy of good news, the shares still appear undervalued. Over the past three years, the bank has grown operating earnings 11% annually. Despite the improvements in financial strength and operating results, the current price to tangible book ratio is still hovering around 2.2; prior to the financial meltdown, the marker clocked consistently above 4.

An investment in Wells Fargo is an investment in the future of the economy of the United States. CEO Stumpf summed it all up nicely in his remarks to analysts and shareholders:

I am optimistic about future economic growth, because consumers and businesses have continued to improve their financial conditions. Households have reduced their leverage to the lowest level since 2001 and the burden of their financial obligations is lower than at any time since the mid-1980s. Also businesses are well-positioned to hire and invest with ample supplies of cash. As always, Wells Fargo is ready to help all of our customers to meet their financial needs through our diversified product line and financial advice.

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Raymond Merola is long Wells Fargo and Wells Fargo warrants. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of 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.

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