Wells Fargo (NYSE:WFC) is among a small handful of banks that seem to do everything right, from keeping expenses low to investing in digital technology to conservatively managing credit risk. As a result, when its executives talk, bank stock investors would be smart to listen.
The chief financial officer of Wells Fargo, John Shrewsberry, spoke at last week's Barclays Global Financial Services Conference. Here are the three most important things he had to say:
1. Net interest income
Low interest rates are the bane of the bank industry's existence. While they keep funding costs low, they also weigh on a bank's yield from earning assets. The net result is that most banks have seen their net interest margins, calculated by dividing a bank's net interest income by its average earning assets, plummet over the past few years.
Wells Fargo is no exception to this. Since the beginning of 2010, its net interest margin has fallen from 4.27% down to 2.97% in the second quarter of the current year. This means that its portfolio of loans and securities is earning roughly two-thirds of what it was generating in the immediate aftermath of the financial crisis.
Wells Fargo has nevertheless been able to expand its net interest income, which is the amount of money it generates from its interest-earning assets less the bank's cost of funds. As Shrewsberry explained:
While the interest rate environment and strong deposit growth have reduced our net interest margin by 104 basis points over the last five years, we've been able to grow net interest income since 2011, while maintaining strong [return on asset] levels as we've benefited from growing loans and securities. Obviously, the subject of interest rates remains very topical and, in our own view, has evolved over the last year to more of a lower for longer expectation than in prior periods for both short-term and for long-term rates.
As a result, we've been adding duration to our balance sheet over the last few quarters, both through the purchase of securities as well as the use of interest rate swaps and some of our floating rate portfolios. We still remain asset-sensitive and we'll benefit from higher rates, but we stopped waiting for higher rates in order to grow net interest income. In fact, we expect to grow net interest income right through '15 compared to '14 even if rates remain low after what happens tomorrow.
2. Benefits of diversification
Wells Fargo has long appreciated the benefits of a widely diversified business model, claiming to have more than 90 separate business lines. Shrewsberry offered a tangible example of why this matters:
Mortgage Banking contributed 28% of our fee income in 2009 as the low-rate environment drove high levels of refinancing activity, which we're all very happy about at the time and servicing results were also very strong. While mortgage volume continued to benefit from [refinancing activity] and the stronger purchase market during the first half of this year, Mortgage Banking, overall, has declined to be 16% of fee income.
On the other hand, trust and investment fees, which include retail brokerage, asset management, and Investment Banking, have benefited from stronger equity markets, new customer growth, and better penetration among existing retail and commercial customers, and are now 36% of fee income, up from
3. Credit quality at a two-decade low
Finally, while credit quality is something that investors should always keep in the back of their heads, it isn't an issue right now. Even the least prudent banks in the lead-up to the financial crisis have since cleaned up their acts from a credit quality perspective. Thus, given that Wells Fargo has consistently been one of the industry's best managers of credit risk, it should come as no surprise that its loan book is in better shape than it's been in for multiple decades.
Again, according to Shrewsberry:
At $888 billion, our loan portfolio is now slightly larger than it was at the time of our merger with Wachovia on Jan. 1, 2009. However, the quality of the portfolio has improved significantly. We have reduced our liquidating portfolio, 70% from $191 billion to $56 billion, while we've been growing our core high quality portfolio.
Our net charge-off rate declined to 32 basis points for the first half of 2015 and was 30 basis points in the second quarter, our lowest level in at least 20 years. Nonperforming assets have declined for 11 consecutive quarters and are down $17 billion or 54% from their peak in 2010.
In sum, while Shrewsberry offered a number of interesting tidbits for investors to sink their teeth into, his presentation also made it clear that Wells Fargo is sticking to its tried and true business model that's served it so well throughout the years.