Wells Fargo & Company’s (WFC) second quarter 2011 earnings of 70 cents per share were a penny ahead of the Zacks Consensus Estimate.
Results improved from earnings of 67 cents in the prior quarter and 55 cents in the year-ago quarter.
Quarterly results reflect a decent reserve release and a decrease in expenses.
Wells Fargo’s second quarter net income applicable to common stock came in at $3.7 billion, compared with $3.6 billion in the prior quarter and $2.9 billion in the prior-year quarter.
The quarter’s revenue came in at $20.4 billion, in line with the Zacks Consensus Estimate and up 0.3% sequentially. On a sequential basis, Wells Fargo’s corporate banking, commercial real estate, debit card, insurance, international, merchant services, retirement services and SBA lending reported revenue growth.
Segment wise, on a sequential basis, Wholesale Banking reported a 17% growth in revenues while the Community Banking and Wealth, Brokerage and Retirement segments reported declines of 4% and 2%, respectively.
Wells Fargo reported a reserve release of $1.0 billion (pre tax), attributable to improved portfolio performance. The company also expects future reductions in the allowance should the economy improve significantly.
Behind the Headline Numbers
Net interest income for the quarter came in at $10.7 billion, up 0.3% from the prior quarter, primarily attributable to lower cost funding. However, net interest margin dropped 4 basis points (bps) sequentially to 4.01% as a result of higher short-term investment balances.
Wells Fargo’s non-interest income came in at $9.7 billion, up 0.3% from the prior quarter. The sequential increase in card fees, other fees, deposit service charges, trust and investment fees, as well as insurance fees were partially offset by a drop in mortgage banking income.
As of June 30, 2011, total loans were $751.9 billion, up $766 million from $751.2 billion as of March 31, 2011. While the company continued with its planned reduction in the non-strategic/liquidating portfolios, it was more than offset by increased balances in many commercial loan portfolios. Average core deposits were $807.5 billion, up 5% (annualized) from first quarter 2011 and 6% from a year ago.
However, non-interest expense at Wells Fargo was $12.5 billion, down 2% from the prior quarter. The decrease reflects lower operating losses, substantially all for litigation accruals for mortgage foreclosure-related matters, reduced expenses on commission and incentive compensation, employee benefits, equipment, net occupancy, core deposit and other intangibles. However, the decrease was partially offset by slightly higher merger integration costs, salaries as well as FDIC and other assessment expenses.
Credit Quality
Credit quality continued to improve during the reported quarter. Net charge-offs were $2.8 billion or annualized 1.52% of average loans, down $372 million from prior quarter net charge-offs of $3.2 billion or annualized 1.73%.This reflected improved net charge-offs across all major portfolio segments. Delinquency trends continued to show improvement as well.
Nonperforming assets (NPAs) continued to decline with Wells Fargo reporting NPAs of $27.9 billion, down 8% sequentially. Nonaccrual loans decreased to $23.0 billion from $25.0 billion in the prior quarter.
Wells Fargo’s allowance for credit losses, including the allowance for unfunded commitments, totaled $21.3 billion as of June 30, 2011, down from $22.4 billion as of March 31, 2011. Provision for credit losses decreased to $1.8 billion from $2.2 billion in the prior quarter.
As of June 30, 2011, around 695,000 active trial or completed loan modifications had been initiated since the beginning of 2009. Of this total, 85% were through Wells Fargo’s own modification programs and the remainder were through the federal government’s Home Affordable Modification Program (HAMP).
Capital Position
Wells Fargo reported an increase in capital ratios in the second quarter. The company redeemed $3.4 billion of trust preferred securities and restarted the open market common stock repurchase program. It purchased 35 million shares in the reported quarter.
The Tier 1 leverage ratio was 9.4% as of June 30, 2011, up from 9.3% as of March 31, 2011. The Tier 1 common equity ratio was an estimated 7.4% as of June 30, 2011 under the Basel III capital proposals. Tier 1 capital ratio improved to 11.7% as of June 30, 2011 from 11.5% as of March 31, 2011. Book value per share improved to $23.84 from $23.18 in the prior quarter and $21.35 in the prior-year quarter.
Wachovia Integration Update
Wells Fargo’s Wachovia merger integration remained on track with the company converting 2,215 Wachovia stores to date. The company converted Wachovia banking stores in Pennsylvania and Florida during the quarter. The remaining Eastern banking markets are planned to convert by year end. Around 83% of banking customers across the company are on a single system.
Competitive Landscape
Similar to Wells Fargo, results at JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) benefited from credit quality improvement. These banks have reduced their loan provisions and results exceeded market expectations.
We believe lower credit costs will be the trend in second quarter results. However, we do not expect a significant turnaround in revenues in the near term.
Recent Acquisitions
Recently, Wells Fargo also completed the acquisition of its strategic partner, Castle Pines Capital. The buyout was a part of Wells Fargo’s effort to expand its business and add channel financing capabilities.
In May, Wells Fargo announced that it would acquire substantially all of the US-based operating assets of Foreign Currency Exchange Corporation, a wholly owned subsidiary of the Bank of Ireland Group (IRE), in an effort to expand its international banking capabilities. The deal would substantially strengthen Wells Fargo’s foreign currency exchange capabilities for domestic correspondent banks.
Our Take
Strategic acquisitions have been part of Wells Fargo’s endeavor to strengthen its business model, expand its capabilities and diversify its footprint. This has been the driving force behind its growth in recent years.
With cross-selling as its key strength, Wells Fargo’s diverse geographic and business mix provides a solid leverage for consistent earnings growth. Capital ratios are strong, and the dividend as well as share buyback initiatives inspire investors’ confidence in the stock.
Yet, we believe that a substantial improvement in revenue will remain elusive. In addition, regulatory issues also pose as headwind to the company’s top line.
Wells Fargo currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.
