Wells Fargo (NYSE:WFC), along with other "super-regionals," such as U.S. Bancorp (NYSE:USB), PNC (NYSE:PNC) and BB&T (NYSE:BBT), occupies appealing real estate. The firms are big enough to secure cheap credit and massive operating scale, but they don't engage in the same level of volatility-inducing investment banking or proprietary trading as the big money center banks, nor do they carry quite the same regulatory burdens.
All of that said, performance still drives ultimate valuation, and Wells Fargo took a little stumble in the third quarter. One quarter is not enough data to make sweeping judgments about market share or management's strategy, but it may be enough to threaten what has been a premium-to-peers valuation.
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A Small Miss, but a Broad One
Relative to average sell-side expectations, Wells Fargo's bottom-line performance wasn't bad, but investors and analysts may be concerned that it was, by and large, uniformly unimpressive.
Operating revenue was down just slightly from the second quarter, with pre-provision net revenue (PPNR) down about 2%. Net interest income fell 4%, despite a 2% improvement in earning assets, as net interest margin contracted by a worse-than-expected 25 basis points. Within that, loan yields fell about 18bp, while security yields dropped about 34bp - JPMorgan (NYSE:JPM) fared relatively better in terms of the NIM decline, but all banks are facing lower security yields.
Credit quality wasn't bad. Although reported non-performing assets (NPA) rose 1% (due to new guidelines), core NPAs fell about 4%. Likewise, the company's charge-off ratio was solid this quarter. Stable non-interest operating expenses are slightly disappointing, though the bank's 57.1% efficiency ratio is not bad.
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The Core Business Seems Soft
Wells Fargo's period-end loans rose just 1%, with consumer loans up 4% and commercial down 1%. That weakness in commercial lending is a little surprising (especially given JPMorgan's report on the same day), and it arguably calls into question what other large commercial lenders such as U.S. Bancorp and BB&T can be expected to report in the coming weeks.
The mortgage business also seemed a little soft. Originations were up 6%, but mortgage fee income declined about 3% from the second quarter. Applications were down 10% in dollar terms, though, and the gain on sale margin declined about 20bp sequentially. Wells Fargo also elected to keep more mortgages on the books this quarter (forgoing the fee revenue from selling/securitizing them).
Core community bank operations are still doing all right. The cross-sell ratio improved by 14bp to 6.04 from last year, and there remains a sizable gap between the products used per-customer in the West (where the company has a long operating history) and the East. Deposits did increase a bit, but it seems as though overall customer/account growth slowed some.
The Bottom Line
Wells Fargo is still a high-quality bank, and one quarter isn't going to shake my feelings on that point. What's more, I believe the company has the opportunity to use its capital to expand into additional business lines, such as insurance (it's already a large crop insurer) or overseas banking.
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This bank has enjoyed a premium within the sector for a little while, and with a strong low-teens return on equity that valuation isn't unreasonable. That said, I see less opportunity in these shares at current prices than other high-quality banks. Wells Fargo is still a fine bank and a fine bank stock investment, but investors looking to put new money into the sector should shop around a bit more.
At the time of writing, Stephen D. Simpson owned shares in WFC and BBT.