Wells Fargo Continues to Show Earnings Strength - Analyst Blog

Driven by prudent expense management, Wells Fargo & Company WFC earned $1.05 per share in first-quarter 2014, thereby achieving earnings growth for the 17th consecutive quarter. Results improved from $1.00 earned in the prior quarter and 92 cents in the year-ago quarter. The reported figure also beat the Zacks Consensus Estimate by 8 cents.

Despite negative market sentiment, shares of Wells Fargo increased marginally in the pre-market session, indicating that investors have been bullish on the results. The price reaction during the trading session will give a fair idea whether Wells Fargo has been able to meet market expectations.

Total loans and deposits grew and the company recorded reduction in non-interest expenses. Moreover, a strong capital position and returns on assets and equity acted as the positives.

Wells Fargo also reported $500 million in reserve release (pre-tax), attributable to its improved credit performance. However, the company experienced a fall in its top line owing to lower non-interest income.

First-quarter net income applicable to common stock came in at $5.6 billion, up 14% year over year.

The quarter's total revenue came in at $20.6 billion, outpacing the Zacks Consensus Estimate of $20.5 billion. However, revenues declined 3.3% year over year.

Furthermore, segment-wise, on a year-over-year basis, Community Banking and Wholesale Banking segments' total revenue fell 2.3% and 8.2%, respectively, while the Wealth, Brokerage and Retirement segment reported a rise of 9.4%.

Performance in Detail

Wells Fargo's net interest income for the quarter came in at $10.6 billion, up 1% year over year. Increased interest income from trading assets and investment securities, along with lower funding costs, aided the results. However, net interest margin decreased 29 basis points year over year to 3.20%.

Non-interest income at Wells Fargo came in at $10.0 billion, down 7% on a year-over-year basis, mainly due to a fall in mortgage banking revenues and reduced net gains from trading activities along with lower other income. These negatives were partially mitigated by increases in net gains on debt securities and equity investments, card fees as well as trust and investment fees.
 
As of Mar 31, 2014, total loans were $826.4 billion, increasing 3.3% on a year-over-year basis. Growth in commercial and industrial, auto, foreign and commercial real estate mortgage portfolio contributed to the rise. Average total deposits were $1.1 trillion, up 9% from the prior-year quarter. Strong commercial and consumer growth aided the positive results.

Non-interest expense at Wells Fargo was $11.9 billion, down 4% from the prior-year quarter. The fall in expenses was primarily attributable to reduction in employee benefits, core deposit and other intangibles, FDIC and other deposit assessments as well as commission incentive compensation and other expenses.

The company's efficiency ratio of 57.9% came in below 58.3% in the prior-year quarter and was within the targeted efficiency ratio range of 55%–59%. A fall in efficiency ratio indicates rise in profitability. Wells Fargo hopes to maintain its targeted efficiency ratio range in the second quarter of 2014.

Credit Quality

Wells Fargo reported improved credit quality metrics in the quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $14.4 billion as of Mar 31, 2014, waning from $17.2 billion as of Mar 31, 2013.

Net charge-offs were $825 million or 0.41% of average loans in the reported quarter, down from the prior-year quarter net charge-offs of $1.4 billion (0.72%). Nonperforming assets fell 17.9% to $18.8 billion in the quarter from $22.9 billion in the prior-year quarter. Moreover, provision for credit losses were $325 million against $1.2 billion in the prior-year quarter.

Capital Position

Wells Fargo has maintained a solid capital position. The company purchased 33.5 million shares of its common stock in the first quarter.

Further, during the quarter, the company received the Fed's approval for its 2014 Capital Plan under the Comprehensive Capital Analysis and Review (CCAR).

The capital plan for the company included a dividend hike of 16.7% to 35 cents per share for second-quarter 2014, subject to the board's approval along with an increase in common stock repurchase activity compared with 2013. Notably, Wells Fargo's board of directors approved an additional repurchase of 350 million shares.

Wells Fargo's Tier 1 common equity under Basel III (General Approach) increased to $132.7 billion. The Tier 1 common equity to total risk-weighted assets ratio was 11.36% under Basel III (General Approach) as of Mar 31, 2014.

The company's estimated Tier 1 common equity ratio was an estimated 10.04% under Basel III (Advanced Approach). The Tier 1 leverage ratio was 9.83% as of Mar 31, 2014, up from 9.53% as of Mar 31, 2013.

Tier 1 capital ratio was 12.63% as of Mar 31, 2014 compared with 11.80% as of Mar 31, 2013. Book value per share increased to $30.48 from $28.27 in the prior-year quarter.

Our Viewpoint

The positive developments of the sector and a gradually improving macro economy helped the banking behemoth to maintain its impressive track record.

Looking at the fundamentals, Wells Fargo's growth plans have historically included a large number of acquisitions, the Wachovia acquisition in Dec 2008 being the largest. Additionally, Wells Fargo announced consecutive dividend increases over the past few years with the latest hike of 20% being announced in Apr 2013.

Nevertheless, we expect top-line headwinds to persist, given the protracted economic recovery. Moreover, a low interest rate environment would keep Wells Fargo's margins under pressure. Further, lower mortgage banking revenues remain a concern. With the thrust of banking regulations, there will be pressure on fees and loan growth.

We believe that in the long term, investors will not be disappointed with their investment in Wells Fargo, given its diverse geographic and business mix, which enables it to sustain consistent earnings growth. Going forward, we believe that strategic acquisitions will help the company to expand its business and boost profitability.

In our view, long-term investors who can absorb risks related to economic and regulatory fluctuations can expect decent earnings growth for Wells Fargo in the future. Solid capital levels, disciplined expense management as well as expected improvement in credit quality will support its profit figures.

Additionally, the company's stress test clearance in March and the subsequent expected dividend hike, along with its strategy to increase share buybacks raised investors' confidence.

Wells Fargo and JPMorgan Chase & Co. JPM, with exposure in almost all banking businesses, are the first among the banking majors to report first-quarter earnings. The earnings releases of these banks should be an indicator of the performance of the key banking sector.

Among other Wall Street giants, Citigroup Inc. C is slated to report earnings results on Apr 14 while Bank of America Corporation BAC will report on Apr 16.

Currently, Wells Fargo carries a Zacks Rank #2 (Buy).