Wells Fargo’s Record Q3 Results Mask Concerns

by Trefis Team
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Wells Fargo & Co.
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The slowing mortgage industry could not prevent Wells Fargo from churning out record-breaking performance figures for Q3 last Friday, with the mortgage-focused banking giant making up for declining revenues by slashing expenses and releasing a chunk of its loan provisions. [1] And while falling costs is a good sign and is a sustainable way to improve profits in the long run, the steep reduction in total provisions for the bank is likely a temporary phenomenon which will reverse in a quarter or two. Provisions for this quarter, at $75 million, were a fraction of what the bank had set aside in any quarter since the economic downturn of 2008. To put things in perspective, Wells Fargo’s average quarterly provisions figure last year was $1.8 billion, whereas the figure is $649 million for year-to-date 2013.

While the two problems which have been plaguing the bank’s performance over the recent quarters – falling demand for new mortgages and declining net interest margin (NIM) – remain a cause for concern, we do see some promise in the strong non-interest income figures for the bank. If you ignore mortgage banking fees, this is only the third time ever that the bank has generated adjusted non-interest fee revenues in excess of $8 billion in a quarter (besides Q2 2011 and Q4 2012). This points to increasing diversification within Wells Fargo’s risk-averse business model – no doubt a desirable condition.

In view of the bank’s worse-than-expected mortgage banking performance, we have reduced our price estimate for Wells Fargo’s stock marginally from $46 to $45. This revised price is still about 10% ahead of its current market price.

See our complete analysis of Wells Fargo here

Net Interest Margin Concerns Remain For Now

The biggest concern for investors in Wells Fargo over the recent quarters has been the steady decline in the bank’s net interest margin (NIM). Due to the extended low interest rate environment, safe investment options with reasonably high rates of return have been difficult to come by.

The table below summarizes Wells Fargo’s reported net NIM figures for each of the last eleven quarters:

Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013
4.05% 4.01% 3.84% 3.89% 3.91% 3.91% 3.66% 3.56% 3.48% 3.46% 3.38%

While we expected a 1-2 basis point (0.01-0.02%) decline at most in NIM margin figures this quarter (and even a possible reversal in trend), the actual figure fell by another 8 basis points (0.08%). This has had a rather pronounced impact on top-line figures for Wells Fargo, and it looks like we will have to wait a couple of quarters more for interest margins to begin improving.

Mortgage Origination Revenues Tank, But Mortgage Servicing Fees Jump

Wells Fargo originated $80 billion in mortgages this quarter – the first time since Q4 2011 that the figure has fallen below $100 billion. This is a good 29% below the $112 billion in mortgages the bank handed out in Q2. The resulting impact on revenues has been more drastic, with mortgage origination & sales revenue sinking from $2.4 billion in Q2 to $1.1 billion in Q3 – a 54% decline.

On the other hand, Wells Fargo’s mortgage servicing revenues have grown steadily over the last five quarters – increasing from under $200 million in Q3 2012 to above $500 million in Q3 2013. The total size of mortgage servicing portfolio, however, has remained almost flat at around $1.9 trillion, which indicates that the losses linked to underlying mortgages have fallen over the period.

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Notes:
  1. Wells Fargo Reports Record Quarterly Net Income, Wells Fargo Press Releases, Oct 14 2013 []
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