Wells Fargo a Penny Short - Analyst Blog

Wells Fargo & Company's (WFC) fourth quarter 2010 operating earnings came in at 61 cents per share, almost in line with the Zacks Consensus Estimate of 62 cents and slightly above the prior quarter's 60 cents though significantly higher than the year-ago quarter's earnings of 8 cents per share.

Quarterly results reflect a better-than-expected increase in revenues. Also, the company experienced a decent reserve release of $850 million as a result of improved portfolio performance. Yet an increase in expenses played the spoil sport and therefore the results did not impress.

However, for full year 2010, the company reported earnings of $2.21 per share, 3 cents below the Zacks Consensus Estimate of $2.24 but substantially above the prior year's earnings of $1.75 per share.

Fourth quarter net income applicable to common stock came in at $3.41 billion compared with $3.34 billion in the prior quarter and $2.82 billion in the prior-year quarter. Full-year net income reported was $12.4 billion, up from $12.3 billion in the prior year.

During the quarter, Wells Fargo earned $21.5 billion, up 2.9% sequentially and above the Zacks Consensus Estimate of $21.1 billion, helped by a broad-based revenue growth. Sequential growth was recorded in asset management, auto dealer services, brokerage, capital finance, commercial banking, commercial mortgage originations, commercial real estate, debit card, equipment finance, global remittance, insurance, international, investment banking, mortgage banking, real estate brokerage, shareowner services, SBA lending and wealth management.

Segment wise, Wholesale Banking results were strong and were up 11% from the prior quarter while Community banking results were almost flat compared with the prior quarter. Earnings from the Wealth, Brokerage and Retirement segment were however, down 23% sequentially.

Quarter in Detail

Wells Fargo's net interest income for the quarter came in at $11.06 billion, down 0.4% from $11.10 billion in the prior quarter. Net interest margin (NIM) decreased to 4.16% from 4.25% in the prior quarter and 4.31% in the year-ago quarter. Lower purchased credit-impaired (PCI) loan resolution income was attributed to a decline in NIM in the reported quarter.

However, non-interest income came in at $10.4 billion, up 6.7% from the prior quarter. The increase stemmed from growth in mortgage banking income, trust and investment fees, insurance and trading gains. However, the positives were partially offset by a decline in operating leases and deposit service charges mainly due to Regulation E impact.

Wells Fargo's non-interest expense was $13.3 billion, up 8.9% from the prior quarter. The increase reflects merger integration costs and seasonally higher year-end expenses, including higher advertising, equipment, software and travel costs.

As of December 31, 2010, total loans were $757.3 billion, up from $753.7 billion as of September 30, 2010, reflecting signs of increased lending activity. Average core deposits were $794.8 billion, up 3.0% from the prior quarter.

Credit Quality

Credit quality continued to improve during the reported quarter. Net charge-offs were $3.8 billion, or annualized 2.02% of average loans, down from third quarter net charge-offs of $4.1 billion or annualized 2.14%. Both consumer and commercial charge-offs declined from the prior and year-ago quarters.

Since the merger with Wachovia, for the first time nonperforming assets declined, ending the quarter at $32.4 billion, down 6% from $34.6 billion in the prior quarter. Non-accrual loans declined to $26.2 billion from $28.3 billion in the prior quarter.

Overall credit performance improvement was facilitated by slowly improving economy together with steps taken by Wells Fargo over the past several years to advance underwriting standards and exit portfolios with unattractive credit metrics. Wells Fargo reported reserve release of $850 million (pre tax) reflecting improved portfolio performance.

As of December 31, 2010, over 620,000 active trial or completed loan modifications had been initiated since beginning of 2009; of this total, 530,000 were through Wells Fargo's own programs, with the remaining 90,000 under the federal government's Home Affordable Modification Program (HAMP).

Evaluation of Capital

Wells Fargo reported an increase in capital ratios in the fourth quarter, attributable to the $3.5 billion of internal capital generation. As a percentage of total risk-weighted assets, Tier 1 capital increased to 11.3%, total capital to 15.1% and Tier 1 common equity to 8.4% as of December 31, 2010, up from 10.9%, 14.9% and 8.0%, respectively, as of September 30, 2010.

The Tier 1 leverage ratio was 9.2% as of December 31, 2010, up from 9.0% as of September 30, 2010. The company's estimated Tier 1 common ratio was 6.9% as of December 31, 2010, under the Basel III capital proposals.Book value per share improved to $22.49, from $22.04 in the prior quarter and $20.03 in the prior-year quarter.

Wachovia Integration Update

Wells Fargo completed the second year of Wachovia integration. Merger activities are on track. Conversion of retail banking stores in Georgia was completed while the replacements of Wachovia ATM network with Envelope-Free webATM machines were accomplished. By year end 2011, the company expects to convert the remaining eastern banking markets. In the weekend of January 15^th, Wells Fargo also converted the brokerage platform.

Competitor Performance

Wells Fargo's closest competitors –Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM) have reported mixed results. Citi's fourth quarter earnings came at 4 cents per share, lagging the Zacks Consensus Estimate of 8 cents. The lower-than-expected results were primarily due to a drop in revenues. Additionally, there was also an escalation in expenses. However, the decrease in loan loss provisions, which was pretty much expected, was the bright spot.

Unlike Citi, JPMorgan reported fourth quarter earnings of $1.12 per share, substantially ahead of the Zacks Consensus Estimate of $1.00. The better-than-expected fourth quarter earnings resulted from higher non-interest revenue and a slowdown in provision for credit losses.

Our Take

We believe that Wells Fargo with its diverse geographic and business mix, is well positioned compared to its peers. The Wachovia acquisition and the demise of some smaller players helped it garner a larger share in the mortgage markets. Yet, the recent financial regulations are expected to have a negative impact on both top- and bottom-line results of the company.

Wells Fargo shares maintain a Zacks #4 Rank, which translates into a short-term Sell recommendation.

With a not so impressive result from Wells Fargo, the market seems to be in a negative mood. Since the announcement of results, the share price of Wells Fargo has decreased 1.57%.

 
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