Improvement in Loan Portfolio Could Spell Upside for Wells Fargo

February 15th, 2011 by Trefis Team
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Wells Fargo

Wells Fargo (NYSE:WFC) is a diversified financial services company headquartered in San Francisco. It is the fourth largest bank in the U.S. by assets and the second largest bank by market cap. It is also the second largest bank in deposits, home mortgage servicing, and debit cards in the United States. Wells Fargo’s competitors include banks such as Bank of America (NYSE:BAC), Goldman Sachs (NYSE:GS), JP Morgan (NYSE:JPM), Citigroup (NYSE:C) and UBS (NYSE:UBS).

We estimate that the mortgage business is the largest contributor of value to Wells Fargo, accounting for 28% of our $33.81 price estimate for the company’s stock. Other divisions contributing significantly to Wells Fargo’s value include asset management & brokerage and securities & trading, each making up about 19% of the company’s equity value.

See our full analysis and $33.81 price estimate for Wells Fargo

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Decreased Net Charge-Offs

During its Q4 2010 earnings call in mid-January, Wells Fargo reported a significant improvement in the performance of its loan portfolio (including both loans and mortgages) as lending increased. The result was driven by strong loan demand (particularly from business owners) and decreased net charge-offs (loans lenders don’t think are collectible), largely due to better than expected performance of the acquired Wachovia loan portfolio. Net charge-offs declined to 2.02% of average loans in the fourth quarter, considerably lower than the 2.71%  observed a year earlier and the 2.14% seen in Q3 2010. [1]

Just to give you an idea of the sensitivity of Wells Fargo stock price to loan losses, a 1% increase in the provision for credit losses as a percentage of average home mortgage loans in 2011 (vs. our base forecast of a 0.5% decline, as shown above) would imply downside of nearly 20% to our $33.81 price estimate for Wells Fargo stock.

However, we are optimistic that provisions for credit losses across the various loan segments (including commercial, commercial real estate and home mortgage) will continue to decline in the future as economic conditions improve, resulting in fewer defaults and lower net charge-offs.

Notes:
  1. Wells Fargo’s Results Show More Benefits of Wachovia Deal, Wall Street Journal [↩]