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.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

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.

SEE: Understanding The Income Statement

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.

SEE: 5 Must-Have Metrics For Value Investors

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.

Related Articles
  1. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  2. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  7. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  8. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  9. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  10. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  1. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  2. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  3. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  4. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  5. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  6. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>

You May Also Like

Trading Center