Wells Fargo (NYSE:WFC) continued its strong run with yet another record performance in the first quarter of the year, as the bank reported a sequential 4.5% improvement in net income for the period even though its revenues shrank marginally.  Compared to the same period last year, the bank reported a 14% jump in net income despite a 3% reduction in total revenues. Wells Fargo has reported an increase in its bottom line for each of the last sixteen quarters since Q1 2010 – a formidable effort considering that the period has seen significant changes in the country’s economic conditions and the regulatory framework for big banks. Even though the bank has seen revenues shrink from the peak figure of almost $22 billion in Q4 2012 – when the mortgage refinancing wave died – to the current figure of $20.6 billion, effective expense management has ensured that the bottom line continues to improve.
The strong Q1 results coupled with Wells Fargo’s plans to return as much as $24 billion in cash to investors over the next four quarters (see Fed Approves Wells Fargo’s $24 Billion Capital Return Plan For 2014) led us to revise our price estimate for Wells Fargo’s stock upwards from $50 to $54. The updated price is roughly 12% ahead of its current market price.
Mortgage Business Not Paying Well For The Time Being
Wells Fargo originated just $36 billion in mortgages this quarter – a figure far below the bank’s quarterly mortgage origination figure for any period since its acquisition of Wachovia. The slowdown in the mortgage industry is demonstrated by the fact that the bank originated mortgages worth $139 billion in the third quarter of 2012. The situation is not likely to improve considerably over the next several quarters, as the bank has just about $27 billion worth of mortgage applications pending in its pipeline, and fresh applications have already fallen to their lowest level since 2009 (including refinancing applications).
The resulting impact on revenues has understandably been drastic, with mortgage origination & sales revenue sinking from $2.5 billion in Q1 2013 to $572 million in Q1 2014 – a 77% decline. Fortunately, the bank’s mortgage servicing unit continues to report strong growth in revenues. Servicing revenues have grown three-fold from $314 million in Q1 2013 to $938 million now. The total size of the 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.
Increasing Focus On Other Revenues, Cutting Costs
There are two primary reasons that Wells Fargo’s mortgage-focused business model has been able to churn out record earnings despite the mortgage industry going through a slump: the bank’s ability to refocus on other sources of revenue, and its cost-cutting measures. Over the last two years, the bank has grown its asset management, card usage and investment banking fees quite notably, and has also stepped up its equity investments. Equity investment gains added $847 million to Wells Fargo’s top line this quarter – the highest since at least 2009.
Also, the bank reported total non-interest expenses of less than $12 billion this quarter for the first time since Q3 2011, with expenses clubbed under the “Other” category falling to their lowest values ever. The impact of falling expenses on the bank’s total share value can be understood by making changes to the chart below.Notes: