Driven by prudent expense management, Wells Fargo & Company (WFC) earned $1.01 per share in second-quarter 2014, thereby surpassing 98 cents earned in the year-ago quarter. However, the reported figure was in line with the Zacks Consensus Estimate.
Despite positive market sentiment, shares of Wells Fargo fell more than 1% in the pre-market session, indicating that investors have been bearish on the results. The price reaction during the trading session will give a better sense about the extent of disappointment among investors.
Total loans and deposits grew and the company recorded reduction in non-interest expenses. Moreover, a strong capital position and returns on assets and equity acted as the positives.
Wells Fargo also reported $500 million in reserve release (pre-tax), attributable to its improved credit performance. However, the company experienced a fall in its top line owing to lower non-interest income.
Second-quarter net income applicable to common stock came in at $5.4 billion, up 3% year over year.
The quarter’s total revenue came in at $21.1 billion, outpacing the Zacks Consensus Estimate of $20.7 billion. However, revenues declined 1.4% year over year.
Furthermore, segment-wise, on a year-over-year basis, Community Banking and Wholesale Banking segments’ total revenue fell 2.3% and 3.3%, respectively, while the Wealth, Brokerage and Retirement segment reported a rise of 9.1%.
Performance in Detail
Wells Fargo’s net interest income for the quarter came in at $10.8 billion, up slightly on a year-over-year basis. Increased interest income from trading assets and investment securities, along with lower funding costs, aided the results. However, net interest margin decreased 32 basis points year over year to 3.15%.
Non-interest income at Wells Fargo came in at $10.3 billion, down 3% year over year, mainly due to a fall in mortgage banking revenues and reduced lease income along with lower insurance revenues. These negatives were partially mitigated by increases in net gains on debt securities, equity investments and trading activities, higher card fees as well as trust and investment fees.
As of Jun 30, 2014, total loans were $828.9 billion, increasing 3.6% on a year-over-year basis. Growth in commercial and industrial, auto, foreign and commercial real estate mortgage portfolio contributed to the rise. Average total deposits were $1.1 trillion, up 9% from the prior-year quarter. Strong commercial and consumer growth aided the positive results.
Non-interest expense at Wells Fargo was $12.2 billion, down around 1% from the prior-year quarter. The fall in expenses was primarily attributable to reduction in commission and incentive compensation, core deposit and other intangibles as well as FDIC and other deposit assessments, partially offset by higher salaries, employee benefits and other expenses.
The company’s efficiency ratio of 57.9% came in above 57.3% in the prior-year quarter but was within the targeted efficiency ratio range of 55%–59%. A rise in efficiency ratio indicates a fall in profitability. Wells Fargo hopes to maintain its targeted efficiency ratio range in the third quarter of 2014.
Credit Quality
Wells Fargo reported improved credit quality metrics in the quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $13.8 billion as of Jun 30, 2014, waning from $16.6 billion as of Jun 30, 2013.
Net charge-offs were $717 million or 0.35% of average loans in the reported quarter, down from the prior-year quarter net charge-offs of $1.2 billion (0.58%). Nonperforming assets fell 14.2% to $18.1 billion in the quarter from $21.1 billion in the prior-year quarter. Moreover, provision for credit losses were $217 million against $652 million in the prior-year quarter.
Capital Position
Wells Fargo has maintained a solid capital position. The company purchased 39.4 million shares of its common stock in the second quarter. The company also entered into a forward repurchases transaction for an additional estimated 19.4 million shares, which is anticipated to settle in third-quarter 2014.
Wells Fargo’s Tier 1 common equity under Basel III (General Approach) increased to $134.8 billion from $132.7 billion in the prior quarter. The Tier 1 common equity to total risk-weighted assets ratio was 11.31% under Basel III (General Approach) as of Jun 30, 2014.
The company’s estimated Tier 1 common equity ratio was an estimated 10.09% under Basel III (Advanced Approach). The Tier 1 leverage ratio was 9.86% as of Jun 30, 2014, up from 9.63% as of Jun 30, 2013.
Tier 1 capital ratio was 12.73% as of Jun 30, 2014 compared with 12.12% as of Jun 30, 2013. Book value per share increased to $31.18 from $28.26 in the prior-year quarter.
Our Viewpoint
The positive developments of the sector and a gradually improving macro economy helped the banking behemoth to post impressive earnings.
Looking at the fundamentals, Wells Fargo’s growth plans have historically included a large number of acquisitions, the Wachovia acquisition in Dec 2008 being the largest. Additionally, Wells Fargo announced consecutive dividend increases over the past few years with the latest hike of 17% being announced in Apr 2014.
Nevertheless, we expect top-line headwinds to persist, given the protracted economic recovery. Moreover, a low interest rate environment would keep Wells Fargo’s margins under pressure. Further, lower mortgage banking revenues remain a concern. With the thrust of banking regulations, there will be pressure on fees and loan growth. Moreover, higher legal costs could drive down profitability.
We believe that in the long term, investors will not be disappointed with their investment in Wells Fargo, given its diverse geographic and business mix, which enables it to sustain consistent earnings growth. Going forward, we believe that strategic acquisitions will help the company to expand its business and boost profitability.
In our view, long-term investors who can absorb risks related to economic and regulatory fluctuations can expect decent earnings growth for Wells Fargo in the future. Solid capital levels, disciplined expense management as well as expected improvement in credit quality will support its profit figures. Additionally, the company’s strong deployment activities raised investors’ confidence.
Wells Fargo, with exposure in almost all banking businesses, is the first among the banking majors to report second-quarter earnings. The earnings release of this banking major should be an indicator of the performance of the key banking sector.
Among other Wall Street giants, Citigroup Inc. (C) is slated to report earnings results on Jul 14, JPMorgan Chase & Co. (JPM) on Jul 15 and Bank of America Corporation (BAC) will report on Jul 16.
Currently, Wells Fargo carries a Zacks Rank #3 (Hold).
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