According to Wells Fargo (NYSE:WFC) CEO John Stumpf, the bank's third-quarter results reflected its diversified business model's ability to "generate consistent financial performance in an uneven economic environment." It's a good way to summarize the challenges that Wells Fargo has been meeting this year within a difficult trading environment. That said, let's take a look at the key themes in the earnings report and what the bank has been doing to generate earnings growth.
Net interest margin declines
You can think of the bank as generating two income streams. The first is net interest income and the second is, unsurprisingly, non-interest income. The former is somewhat dependent on interest rate movements.
The key metric to follow with net interest income is net interest margin, or NIM, which is simply the difference between the interest its investments generate and interest expenses, divided by its average interest earning assets.
Unfortunately, Wells Fargo's NIM has been in decline since 2012 as deposits have increased strongly while the moderate pace of economic growth has held back loan growth. The following chart shows how NIM stayed flat in the third quarter -- further evidence of a moderately growing economy. However, the good news is that net interest income rose 4.7% in the third quarter compared to the same period last year.
The second income stream has also faced some challenges in recent quarters as Wells Fargo has struggled to grow non-interest income -- which comprises things like service charges on deposit accounts, trust and investment fees, card fees, and mortgage banking fees -- more than non-interest expenses. The result has proved a growing drag on overall profits.
However, as you can see graphically below, non-interest expenses rose at the same rate as non-interest income did in the quarter. Both increased at a rate of 1% in the quarter compared to the same period last year, an indication that Wells Fargo is getting its non-interest expenses under control.
The bank is widely regarded as a proxy for the housing market due to its importance as a mortgage originator, and observant readers will have noted that I've included mortgage banking fees in the chart above. In fact, the chart shows that Wells Fargo's mortgage banking revenue fell 7% compared to the same period last year. According to management, "Mortgage banking is down $116 million on 11% lower residential origination volumes and lower commercial mortgage activity."
Moreover, home lending originations were only $55 billion in the third quarter compared to $62 billion in the second quarter, with applications of $73 billion in the quarter compared to $81 billion in the second quarter. Ultimately, Wells Fargo's home lending application pipeline declined from $38 billion at the start of the quarter to $34 billion at the end. The housing market, at least in terms of mortgage originations, appears to be slowing.
All told, overall net income increased just 1% in the third quarter compared to last year and diluted earnings per share rose just 3%. Given the difficult trading environment outlined above -- NIM declining, mortgage origination declining, organic loan growth not as much as hoped, and rising non-interest income expenses -- it's incumbent upon Wells Fargo's management to adjust to circumstances.
In a sense, this is what Stumpf is referencing in the statement I opened this article with. Indeed, management is finding ways to diversify its income stream and grow its loan book, and one of them is through the purchase of assets from General Electric Company.
In fact, the current results contain some benefit from the $9 billion worth of commercial real estate mortgages it bought earlier in the year from GE. Moreover, on Tuesday GE announced the sale of commercial lending and leasing business with $32 billion in assets to Wells Fargo. Completion is expected in the first quarter of 2016.
The bottom line
All told, it was a mixed quarter for the bank. NIM continues to decline, however the acquisition of assets from GE helped net-interest income rise. Meanwhile, non-interest expense growth has slowed -- a good sign.
On the other hand, mortgage origination slowed compared to the previous quarter and Wells Fargo made less money from mortgage banking fees. The ongoing purchase of GE's financial assets is a sign that Wells Fargo continues to seek to find ways to grow its loan book -- a good thing in a difficult market environment.