Wells Fargo (NYSE:WFC) deserves credit for the extent to which it has cleaned up its messes from the housing crash. Not only does Wells Fargo enjoy a pretty attractive risk exposure, but the company has multiple avenues for future growth. The question for investors is how quickly those avenues can lead to actual increased returns.

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A Pretty Solid Second Quarter
Although there are a few nits to pick, Wells Fargo announced solid second quarter results. Operating revenue did fall 1% sequentially, but rose about 7% from last year, while pre-provision revenue rose about 2% sequentially.

The rate environment hasn't made life easy for banks like Wells Fargo, U.S. Bancorp (NYSE:USB) or PNC (NYSE:PNC), but the company is holding its own. Net interest income ticked up about 1% sequentially, with net interest margin holding steady. Credit also continues to improve, and the company's non-performing assets ratio was back down to a level not seen since the third quarter of 2009.

But the quarter was not perfect. Loan demand remains pretty soft, and about half of the company's reported loan growth came from acquired loans. Wells Fargo is also a little behind schedule with its expense reductions, and although mortgage banking revenue grew, it was a little softer than I would have liked to see.

SEE: The Banking Industry In 2012

Mortgages Drive the Bus
There's not much question that Wells Fargo is a huge player in residential mortgages, with no plans to shrink that exposure. In the first quarter of the year, Wells Fargo was responsible for a whopping one-third (33.9%) of national mortgage originations, leaving rivals like JPMorgan (NYSE:JPM) (10.6%), U.S. Bancorp (5.2%) and Bank of America (NYSE:BAC) (4.2%) in the dust.

That's not to say that everything is perfect in the mortgage business. The company did see almost a quarter-billion dollars more mortgage repurchase expense this quarter (up to almost $700 million), and the company's reserve for future repurchases is up to $1.8 billion.

SEE: Requirements For A Post-Housing-Bust Mortgage

Multiple Opportunities to Grow the Business
I can see four major avenues for Wells Fargo to grow significantly over the next three to five years. First, as the largest mortgage originator, it should have quite a lot to gain from a healthier housing market, though government-funded subsidies like HARP will go away.

Second, I think the company can benefit from continued up-selling efforts directed at the Wachovia customer base. I've mentioned this opportunity before, and it's relevant as there is a meaningful gap between the number of services that traditional Western customers use and the number that Eastern customers use. At the same time, if Wells Fargo pushes too far too fast they run the risk of alienating customers and pushing them towards SunTrust (NYSE:STI), PNC and Bank of America.

Third, Bank of America is no different than any other large retail bank in that it should benefit from increased interest rate spreads over time. While this seems like a very promising avenue for improved per share performance, there have been expectations for higher rates for multiple years now and even if it's a "when, not if" question, there's still a lot of uncertainty around the when.

Last and not least is the opportunity for Wells Fargo to expand or enter other non-banking lines of business. While the company has openly discussed growing its wealth management operations, that's a very crowded market. The company is more likely to find better prospects in European banking or expanding its existing insurance operations ((with ACE (NYSE:ACE), it is one of the country's largest crop insurance companies)).

SEE: How Your Credit Score Will Affect Your Mortgage Rate

The Bottom Line
Using an excess returns model with a 10% discount rate and an estimated long-term return on equity of 13.5%, fair value on Wells Fargo is in the low $40s. That doesn't leave an enormous appreciation potential in the stock, but a 13.5% return on equity is well below long-term historical averages. Moreover, even if the return prospects at Wells Fargo aren't the highest, the quality of the business is quite high and less aggressive investors may appreciate the net balance of risk and reward that its shares offer.

At the time of writing, Stephen Simpson, CFA has owned shares of JP Morgan since January of 2006.

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