Earnings season for banks kicks off on Friday, October 11, with the country’s biggest bank by assets – JPMorgan Chase (NYSE:JPM) – and the country’s biggest bank by market capitalization – Wells Fargo (NYSE:WFC) – reporting their third quarter results before the market opens. And while the former’s diversified business model will provide investors a good idea of how good or bad the quarter was for nearly every financial service provided by banks, the latter’s figures should give an idea of the various retail banking services over the period.
Expectations from Wells Fargo remain high as usual, thanks to the string of record earnings it has churned out over several quarters now. The bank, however, continues to deal with the problems of shrinking net interest margins and declining mortgage origination figures. And it is only due to a steady improvement in fee revenues generated by its asset management and investment banking operations that the bank will be able to meet these expectations this time around.
We maintain a $46 price estimate for Wells Fargo’s stock, which is about 10% ahead of its current market price.
- A Look At Outstanding Loans For The U.S. Banking Industry, And How They Have Changed Since 2012
- How Have Price-To-Book Ratios For The Country’s Biggest Banks Changed In The Last 5 Years?
- Weak Mortgage Activity, One-Time Charge Hurts Wells Fargo’s Q4 Results As Bank Braces For Additional Headwinds
- Post-Election Rally Helps U.S. Bank Shares End 2016 On A High Note, With JPMorgan Leading The Pack
- How Are Net Interest Margins Going To Change For U.S. Banks Going Forward?
- Wells Fargo’s International Ambitions Will Have To Wait
Decline In Net Interest Margins Likely Arrested In Q3
As we have pointed out on numerous occasions over the past two quarters, Wells Fargo’s biggest concern is its rapidly shrinking net interest margin (NIM) figure. While the current prolonged low-interest rate environment has impacted interest incomes for the banking industry as a whole, the impact on Wells Fargo is aggravated due to its reliance on the traditional loans-and-deposits banking model.
The table below summarizes Wells Fargo’s reported net NIM figures for each of the last ten quarters:
|Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013|
Wells Fargo did well to arrest the sharp decline in the NIM last quarter and to restrict the fall to just 2 basis points (0.02%) compared to falls of 25 basis points (0.25%) in recent quarters. And with interest rates being nudged higher in the third quarter from rising expectations that the Fed will begin tapering its asset purchase program, the NIM figure may actually reverse the trend it has displayed for well over two years now.
You can better understand the partial impact of changing net interest margins on the bank’s total value by making changes to the chart above, which represents Wells Fargo’s NIM on outstanding mortgages.
Fees From Other Operations Should Make Up For Declining Mortgage Revenues
Wells Fargo is the undisputed leader in the country’s mortgage industry with a share of nearly one-third of the market. The importance of the business to the bank’s overall value becomes evident from the chart below which shows that mortgage banking contributes to more than a quarter of its total share value.
But the mortgage industry has been in a state of flux recently. Up until three quarters ago, mortgage origination volumes were at record levels due to a large number of home owners opting to refinance their existing mortgages, to benefit from record low mortgage rates and also from government-led initiatives. But this mortgage refinancing wave began dying down in Q4 2012, and has been reduced to a trickle now. At an investor event last month, Wells Fargo CFO Tim Sloan estimated a 30% decline in mortgage origination volumes this quarter compared to the same period last year – stemming from a 63% reduction in number of refinancing applications. 
There are other products that should fill in the gap left from the falling demand for mortgages, however. More specifically, Wells Fargo’s trust and investment fees – which contributed a strong $3.5 billion to the top line in Q2 2013 – should help this quarter too. These fees have grown at nearly 10% quarter-on-quarter in recent quarters to reach levels well above the total mortgage-banking related fees for Wells Fargo, which were $2.8 billion last quarter.Notes: