Wells Fargo New $30 Price Estimate: Mortgage Concerns Overdone

December 13th, 2011 by Trefis Team
-8.27%
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Wells Fargo

Wells Fargo (NYSE:WFC) holds the distinction of being the country’s largest bank by market cap and the fourth largest bank by assets – after competitors JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C). The bank’s shares have taken a hit this year much like its competitors despite its significantly lower European exposure compared to its peers. No doubt the size of Wells Fargo’s huge mortgage operations at a time when there are concerns regarding the quality of banks’ mortgage portfolios has contributed to this nervousness. Wells Fargo’s shares currently trading below $27, have lost more than 15% of their value at the market since the beginning of the year. We believe that this decline is a result of negative investor sentiment regarding the European debt situation and overall macroeconomic conditions as opposed to anything specific to Wells Fargo.

We recently revisited our forecasts for the bank and revised our price estimate from $32 to $30, and detail below the reasons for these revisions. See our complete analysis of Wells Fargo here

Mortgage Business Expected to Remain Weak

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Wells Fargo has the largest portfolio of interest-earning mortgages in the U.S. – with $337 billion worth of mortgages at the end of 2010 in comparison to $186 billion for Bank of America and less than $130 billion for Citigroup. Wells Fargo’s portfolio was significantly boosted in 2009 with the acquisition of Wachovia. As the nation’s largest mortgage originator, the bank funded one of every four mortgages in the U.S. in 2010.

The mortgage division is undoubtedly the most important business for the bank. Our analysis estimates that mortgage operations contribute just under a quarter of Wells Fargo’s value. However the global economic slowdown will take a toll on the bank’s mortgage business in several ways. With the housing market still hurting and likely not bouncing back in a meaningful way in the next year or two, we expect that the mortgage portfolio will not expand to the extent that we had initially projected.

Moreover, the decline in economic growth as well as elevated unemployment will likely lead to more defaults on mortgages – accordingly we have modified our estimates for provisions for losses.

Trading Yields Expected to Suffer

Wells Fargo’s securities & trading division is the second most important business for the bank, which we estimate contributes to more than a quarter of its value.

We expect that current macroeconomic conditions will continue to impact the bank’s sales and trading operations. The introduction of regulations such as the Volcker Rule will also put additional pressure on top-line figures for Wells Fargo’s securities & trading business. Consequently, we have lowered our forecast for the bank’s trading yields.

With these adjustments, our intrinsic value estimates based on discounted cash flows are still around $30 implying around 15% upside once markets calm down.

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