Like it's larger rival JPMorgan (NYSE:JPM), Wells Fargo (NYSE:WFC) delivered a solid, better-than-expected second quarter on Friday morning. Clearly there is still pressure on the business, as loan growth is faint and yields are low, but lower credit costs are helping underpin earnings. Wells Fargo and JPMorgan seem virtually equally undervalued, and both offer investors a quality play on the banking sector. With JPMorgan's greater exposure to trading and investment banking, as well as further regulatory changes, Wells Fargo is arguably the better play for investors looking to benefit from an eventual improvement in loan growth and yields.
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Q2 Comes In With A Solid Top Line And Good Credit
Wells Fargo delivered a fairly straightforward good quarter, as both revenue and credit costs were stronger than expected and the company once again beat the estimate for the period.
Operating revenue rose 1%, as net interest income rose 3% (sequentially) and offset a 1% decline in fee income that was smaller than expected. Looking at the components, Wells Fargo saw a 3% increase in average earning assets, but a 45-point year-on-year decline in net interest margin (NIM was close to flat sequentially, and slightly better than expected). Within the fees, mortgage banking was basically flat, while trust and credit card fees grew more than expected.
With expenses down slightly on a sequential basis, operating income rose 3% sequentially. It is worth noting, though, that the non-interest expense line was something of a disappointment. I would have expected expenses to decline more given that a lot of the compensation in mortgage banking is commission based, but this isn't the first time a major bank has found it hard to reach Wall Street's expense targets.
On the credit side, the non-performing asset and non-performing loan ratios continue to decline, each down a little more than 20bp sequentially. Net-charge-offs were also lower than expected (with the ratio declining about 13bp sequentially), and the loan loss provision was nearly cut in half. With both Wells Fargo and JPMorgan reporting strong credit trends in housing and cards, I think there's reason for optimism about credit performance at other banks like PNC Financial (NYSE: PNC) and U.S. Bancorp (NYSE:USB) at this point.
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Core Business Still Sluggish
It's well worth noting, though, that Wells Fargo's loan growth is still sub-optimal. Wells Fargo did better than JPMorgan this quarter (and not as well as two smaller banks that have reported, Commerce Bancshares (Nasdaq:CBSH) and Bank of the Ozarks (Nasdaq:OZRK), and commercial lending was up nearly 2% on a sequential basis, but it's still very much a low-growth environment.
The mortgage business, which is a significant one for Wells Fargo, is also pretty mixed at this point. Given the company's market share, it isn't surprising that JPMorgan appears to be outgrowing them and it's well worth remembering that the bank did do better than expected. Even so, this doesn't look like an accelerating growth driver at this point.
The Bottom Line
Although they're very different businesses, JPMorgan and Wells Fargo look strangely similar from a valuation standpoint. I use a higher expected long-term ROE in my Wells Fargo model (14% now), but the resulting fair value of about $47.50 suggests similar appreciation potential as for JPMorgan (about 10%). Likewise, while I believe Wells Fargo's much higher return on tangible assets merits a much higher multiple to tangible book value (2.3x versus 1.6x), the resulting fair value of about $50.50 is, like JPMorgan's TBV-based target, about 18% higher than today's price. Incidentally, they're both also yielding 2.8% at present.
All things considered, I think Wells Fargo is still a stock worth considering today for long-term investors.
Disclosure: As of this writing, the author owns shares of JPMorgan.