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Wells Fargo Earnings: 3 Numbers to Watch

By John Maxfield - Apr 2, 2016 at 8:20AM

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There’s every reason to believe that Wells Fargo will turn in another impressive quarterly performance.

Image source: Wikimedia Commons.

When Wells Fargo (WFC 0.64%) reports earnings on April 14, there are three numbers that investors will want to watch.

1. Average loans/deposits
Although Wells Fargo boasts roughly 90 business lines, it's fundamentally a consumer and commercial bank. This differentiates the California-based lender from the likes of JPMorgan Chase and Bank of America. While these banks have substantial commercial lending operations as well, their business models also encompass activities associated with investment banking.

Wells Fargo's emphasis on traditional banking -- taking deposits and originating loans -- means that those two figures should be watched particularly closely by investors. In the latest quarter, its total average loans added up to $912.3 billion. That was $63 billion, or 7%, higher than the year-ago period. Total average deposits, meanwhile, came in at $1.2 trillion, up $67 billion, or 6%, on a year-over-year basis.

Investors will accordingly want to see these figures continue to increase -- albeit at a steady pace. This follows from the simple fact that Wells Fargo's net interest income, which accounts for a little more than half of its net revenue, is only likely to expand if the size of its loan portfolio grows. This will change once interest rates start to climb, but until that happens the only realistic way for a bank to earn more interest income is to bolster its earning assets.

2. Energy sector loans
Of the many problems facing the bank industry right now -- including heightened regulations and the ultra-low interest rate environment, among others -- few are as acute as the decline in the quality of oil and gas loans. Since energy prices plummeted last year, energy companies have been under increasing pressure to service their debts. Because Wells Fargo is a major lender to the industry, this is starting to produce higher loan losses for the nation's third largest bank.

All told, Wells Fargo has $42 billion worth of exposure to the oil and gas industry. Though, to be clear, this doesn't mean that Wells Fargo's has $42 billion worth of oil and gas loans outstanding. It instead has only $17.4 billion worth in actual loans, with the remaining $25 billion being made up of unused credit lines. The first thing that investors will want to watch when it comes to Wells Fargo's energy portfolio, then, is whether or not these credit lines are starting to be used, as that could be an indication that its borrowers are grasping at any remaining sources of capital that they have left.

The second thing to watch in this regard is the direction of nonaccrual loans -- that is, loans which are unlikely to meet all of the terms of payment. In the fourth quarter of last year, Wells Fargo's energy-related nonaccrual loans increased by $277 million to a total of $843 million. It's widely assumed that the latter number will continue higher this quarter, but it remains to be seen just how much higher it's likely to go.

3. Efficiency ratio
Last but not least is Wells Fargo's efficiency ratio. This measures the percentage of a bank's net revenue that's consumed by operating expenses. The lower the number, the better. Most banks shoot for efficiency ratios below 60%.

Wells Fargo has long been one of the most efficient banks in the industry. Its efficiency ratio last year was 57.8%, comfortably below the 60% threshold. For context, Bank of America spent 68.6% of its net revenue on operating expenses in 2015. This gives Wells Fargo an advantage over less efficient peers, as it means that it can often underprice its competitors' loan terms while still earning above-average margins.

With added compliance costs and the continued low interest rate environment, however, it isn't unreasonable to think that this figure could at some point go in the wrong direction. Investors should accordingly watch to see that Wells Fargo's famously efficient operations remain on track.

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