Wells Fargo: Another Show of Strength

Wells Fargo keeps on trucking.

Anand Chokkavelu
Anand Chokkavelu, CFA
Apr 14, 2012 at 12:00AM
Other

Don't let their falling stock prices fool you. Despite being down 3.5% and 3.6% on Friday, Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM) started off bank earnings season on solid footing. (See my analysis of JPMorgan's quarter.)

Wells grew its revenue 6% and earnings per share 12% over last year's first quarter. Its EPS tally of $0.75, a share off $4.2 billion in net income, beat analyst expectations by two pennies.

It saw strong performance from its mortgage banking business. Although its total loan portfolio went down from running off its Wachovia loan portfolio, its core lending business increased. It was able to increase deposits and also increased non-interest income by 11%, largely because of the mortgage banking activity. All this led to a return on equity of 12.14% -- not great by Wells' lofty historical standards, but the best since Q2 2009.

Looking at the balance sheet, we see that Wells' charge-off percentage has gone down from an annualized 1.73% in last year's first quarter to just 1.25%, the best since 2007. That allowed it to release $400 million of its reserves for bad loans. Management expects that trend of releasing reserves and boosting net income to continue this year.

And when we turn to Wells' all-important capital position, we see its Tier 1 common equity ratio under the stricter Basel III accounting improving from 7.50% to 7.81% over Q4. We also see Wells employing a reasonable amount of leverage (about 11:1). This comes after Wells passed the Federal Reserve's recent stress tests, which deemed Wells' capital position strong enough to buy back shares and increase its dividend (it now yields 2.6%).

The takeaways
I was quite pleased with Wells' progress on all fronts. It seems to be growing wisely, and I think the upside on the Wachovia acquisition is being underestimated as Wells improves its cross-sell, frees itself from merger-related costs in Q2, and works through Wachovia's substandard portfolio of assets.

As we look forward to the earnings releases from laggards Bank of America (NYSE: BAC) and Citigroup (NYSE: C) next week, I think the solid releases from Wells and JPMorgan bode well. They may not do as well as Wells and JPMorgan, but expectations are also lowered.

Wells is a high-quality institution that had another high-quality quarter. For more analysis on high-quality companies, check out our brand-new free report: "5 Stocks Investors Need to Watch This Earnings Season." It details what to look for from Apple and four other must-watch companies as they report their latest results. Access it now.