Wells Fargo’s Solid Q3 Results In Tough Environment Highlight Strong Business Model

Investors were initially not thrilled when Wells Fargo (NYSE:WFC) reported its performance figures for the third quarter early Wednesday morning (October 14), with the bank’s shares dropping by more than 2% following the release. Although the bank’s bottom line results were better than expected, news that its return on equity figure fell for the third consecutive quarter was not well received. Moreover, Wells Fargo’s loan provisions of $703 million for the quarter were the highest since Q1 2013, and its trading activities resulted in a net loss for the first time in four years.

But a more detailed look at Wells Fargo’s results reveals a fairly strong showing by the banking giant in a period that was difficult for banking activities. To begin with, the bank continues to grow its asset base rapidly enough to largely counter the negative impact of low interest rates on its revenues, which gives it a significant advantage relative to peers once the Fed hikes benchmark interest rates. While the bank’s efforts to grow its fee-based revenues have resulted in the highest non-interest income figure since early 2013, it has also done well to keep costs under check. These positive trends were enough to ensure that Wells Fargo’s share price regained almost all its lost value by the end of the day.

Given the better than expected increase in the size of its loans and deposits, we have increase our price estimate for Wells Fargo’s stock marginally from $60 to $61. The price estimate is around 15% higher than the current market price.

See our complete analysis of Wells Fargo here

Net Interest Margins Under Pressure, Expect Gains Once Rates Rise 

Wells Fargo’s biggest concern over the last few years has been its rapidly shrinking net interest margin (NIM) figure. While the current prolonged low-interest rate environment has hurt interest incomes for the banking industry as a whole, the impact is particularly evident in Wells Fargo’s results as net interest revenues are responsible for more than half of its total revenues. This is because Wells Fargo relies more on the traditional loans-and-deposits business model than competitors such as JPMorgan and Citigroup.

Wells Fargo’s NIM figure fell from 4.05% in Q1 2011 to 2.95% in Q1 2015. The figure appears to have bottomed out since then, with an uptick of 2 basis points in Q2 being followed by a 1 basis point decline in Q3. Notably, Wells Fargo has maintained its quarterly net interest income between $10.5 billion and $11 billion over the last five years thanks to a steady increase in interest-earning assets. With the interest-bearing assets comfortably outpacing growth in interest-bearing liabilities over recent quarters, the total interest income rose to almost $11.5 billion in Q3 2015. Assuming that the Fed hikes interest rates in the next few months, the existing asset base could easily churn out quarterly interest incomes in excess of $12 billion by early next year.

Mortgage Business Reported A Mixed Performance

Wells Fargo’s mortgage production unit reported a reduction in total origination volumes from $62 billion in Q2 2015 to $55 billion in Q3 2015 as a result of lower application volumes. This in turn resulted in a sharp reduction in mortgage production-related revenues from almost $1.2 billion in the previous quarter to $915 million – a reduction of 23%. Notably, these revenues were also lower than the $954 million figure for the year-ago period, despite the fact that originated volumes were just $48 billion then. While the market for both fresh mortgages and refinances have shown some improvement over recent quarters, volumes will be driven almost entirely by fresh mortgages once interest rates rise.

On the other hand, Wells Fargo’s mortgage servicing revenues improved considerably compared to the previous quarters, as they jumped from $514 million in Q2 2015 to $674 million in Q3 2015. The figure for this quarter was just marginally lower than the $679 million reported in Q3 2014. Adjusting the servicing fees for revaluations in mortgage servicing rights (MSRs) and for gains/losses on hedges, servicing fees improved from $919 million a year ago to $990 million in Q3.

Card Fees Helped The Top Line

Wells Fargo has done well in recent years to combat the pressure on its primary revenue streams – interest income from loans and fees from mortgage origination and servicing – by exploring other fee-based revenue sources. In particular, the bank has grown its asset management and card fees notably. Wells Fargo reported card fees in excess of $950 million for the first time this quarter since Q3 2011 – something that highlights the bank’s increased push in the card industry over recent quarters.

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research