Wells Fargo Earnings Will Set The Tone For Big Banks

by Trefis Team
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Wells Fargo & Co.
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Wells Fargo (NYSE:WFC) is set to kick off the earnings season for banks this Friday, and although investors would love to see the country’s fourth largest bank extend the record earnings streak it has been on, Q4 2012 results are expected to be lukewarm for the bank. While Wells Fargo’s dominance in the mortgage industry is undisputed, its almost complete reliance on the traditional loans & deposits banking model are simultaneously its biggest strength and weakness, especially given the record low interest rates prevalent in the economy.

As we had detailed in a recent article, titled Banks Feel The Pinch From Low Interest Rates, banks’ interest incomes have been squeezed over recent quarters. And there really isn’t much Wells Fargo can do in this matter, making it the bank’s single, biggest concern even as it continues to focus on growing its mortgage business and shrinking its costs. Fourth quarter 2012 figures would also be dragged down by the $644 million pre-tax charge the bank incurred in relation to the foreclosure settlement with regulatory bodies. [1]

We maintain a $38 price estimate for Wells Fargo’s stock, which is about 10% above the current market price.

See our complete analysis of Wells Fargo here

Wells Fargo’s Net Interest Margin Figures Highest On Our Watch List

When Wells Fargo reported its record performance figures for Q3 2012, the one thing that stood out like a sore thumb was the sharp decline in interest income for the quarter – from $11.04 billion in Q2 2012 to $10.67 billion. This figure was also the lowest since Q3 2011, with the net interest margin (NIM) falling to the unprecedented 3.66% from the normal level of 3.8-3.9%.

And while the bank’s top management has been optimistic about its ability to improve interest margins despite the Fed’s decision to keep interest rates at the 0 to 0.25% range over the foreseeable future, what really matters is whether the optimism translates into actual numbers. After all, a fall in the NIM represents a significant downside to Wells Fargo’s share price, something you can gauge to a good extent by making changes to the chart above that represents Wells Fargo’s NIM on outstanding mortgages.

Followed By Its Operating Expenses

The other significant aspect of Wells Fargo’s business is its operating (non-interest) expenses. In Q1 2012, the bank reported its highest ever non-interest figure of $12.99 billion, owing to a significantly high employee benefit payout for the quarter. But this figure improved for Q2 and Q3, reducing to $12.4 billion and $12.1 billion respectively.

However, operating expenses would be well over $13 billion for Q4 2012, as a result of the bank’s foreclosure settlement which will take out $644 million from the bank’s pre-tax income figure. This will drag down operating margins for the bank over the entire year, with expenses likely to go higher than the ~60% in revenues, we forecast for the year as shown in the chart above.

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Notes:
  1. Wells Fargo Provides Statement on Independent Foreclosure Review Agreement Reached Today, Wells Fargo Press Releases, Jan 7 2013 []
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