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Wells Fargo & Company (WFC - Analyst Report) achieved the fourteenth consecutive quarter of growth in earnings per share by reporting earnings of 98 cents per share in second-quarter 2013. Results improved from earnings per share of 92 cents in the prior quarter and 82 cents in the year-ago quarter. Also, it beat the Zacks Consensus Estimate by a nickel.

Results at Wells Fargo reflected growth in total loans and deposits amid a challenging economy and prudent expense management. Moreover, a strong capital position and returns on assets and equity acted as positives. It also reported $500 million in reserve release (pre-tax), attributable to improved credit performance. However, the company experienced a fall in non-interest income.

Second-quarter net income applicable to common stock came in at $5.5 billion, up 5.8% sequentially and 19.6% year over year.

The quarter’s total revenue came in at $21.4 billion, outpacing the Zacks Consensus Estimate of $21.3 billion. Revenues also surged 0.5% both sequentially and year over year.

Furthermore, segment-wise, on a sequential basis, Community Banking, Wholesale Banking and Wealth, Brokerage and Retirement segments reported rises of 0.3%, 0.8% and 2.0% in total revenues, respectively.

Performance in Detail

Wells Fargo’s net interest income for the quarter came in at $10.8 billion, up 2.9% sequentially, mainly due to increased interest income from the available for sale (AFS) securities portfolio. However, net interest margin dipped 2 basis points sequentially to 3.46%.

Non-interest income at Wells Fargo came in at $10.6 billion, down slightly on a sequential basis. Reduced trading income including lower deferred compensation gains and dip in other income were on the downsides. However, the decline was partly offset by higher service charges on deposit accounts, elevated trust and investment fees along with high mortgage banking and insurance revenues.
 
As of Jun 30, 2013, total loans were $802 billion, ascending slightly on a sequential basis. Growth in commercial and industrial, auto, foreign, credit card, and non-conforming first mortgage portfolios contributed to the rise. However, it was partially offset by continued reduction in the non-strategic/liquidating portfolio. Average total deposits were $1.0 trillion, up 10% (annualized) from the prior quarter.

Non-interest expense at Wells Fargo was $12.3 billion, down 0.8% from the prior quarter. The fall in expenses was primarily due to lower employee benefits expense.

The company’s efficiency ratio of 57.3% was below 58.3% reported in the prior quarter, and it remained within the targeted efficiency ratio range of 55% – 59%. Wells Fargo anticipates expenses to decline sequentially in the third quarter of 2013, which will maintain the target efficiency range.

Credit Quality

Wells Fargo reported improved credit quality metrics in the quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $16.6 billion as of Jun 30, 2013, waning from $17.2 billion as of Mar 31, 2013.

Net charge-offs were $1.2 billion, or 0.58% of average loans in the reported quarter, down from the prior-quarter net charge-offs of $1.4 billion (0.72%). Nonperforming assets dipped to $21.1 billion in the quarter from $22.9 billion in the prior quarter. Moreover, provision for credit losses decreased 41.7% sequentially to $0.7 billion in the reported quarter.

Capital Position

Wells Fargo has maintained a solid capital position. The company purchased 26.7 million shares of its common stock in the quarter. Moreover, an additional purchase of estimated 13 million shares was conducted through a forward repurchase transaction, anticipated to settle in third-quarter 2013.

Wells Fargo’s Tier 1 common equity under Basel I increased $4 billion sequentially to $117.6 billion. The Tier 1 common equity to total risk-weighted assets ratio was 10.73% under Basel I as of Jun 30, 2013 compared with 10.39% in the prior quarter.

The company’s estimated Tier 1 common equity ratio was an estimated 8.54% under the latest Basel III capital proposals, compared with 8.39% in the prior quarter. The Tier 1 leverage ratio was 9.63% as of Jun 30, 2013, up from 9.53% as of Mar 31, 2013.

Tier 1 capital ratio was 12.14% as of Jun 30, 2013 compared with 11.80% as of Mar 31, 2013. Book value per share decreased slightly to $28.26 from $28.27 in the prior quarter but increased from $26.06 in the prior-year quarter.

Our Viewpoint

The positive developments of the sector and gradually improving macroeconomic elements helped the banking behemoth to maintain its illustrious track record.

On the fundamental side, Wells Fargo’s growth plans have historically included a large number of acquisitions, Wachovia being the largest addition in Dec 2008. Notably, last year, the company completed 3 acquisitions with combined total assets of $4.5 billion. Further, on Aug 1, 2013, the company completed the acquisition of a prime brokerage and technology provider with assets of approximately $280 million.

Also, it announced consecutive dividend increases over the past few years with the latest hike of 20% being announced in Apr 2013.

Though there are concerns related to the impact of legal issues, equity-centric activities in the U.S. are expected to support Wells Fargo’s results in the upcoming quarters with continued recovery in the capital markets.

We believe that over the long term, investors should not be disappointed with their investments in Wells Fargo, given its diverse geographic and business mix, which enable it to sustain consistent earnings growth. Going forward, we believe that strategic acquisitions will help Wells Fargo expand its business and improve its profitability.

We believe that long-term investors who can absorb the risks related to economy and regulations can expect decent growth in Wells Fargo’s earnings in the future. Solid capital levels, prudent expense management as well as expected improvement in credit quality, will support its profit figures. Its stress test clearance in the prior quarter and the subsequent dividend hike as well as its strategy to increase share buybacks also boost investors’ confidence.

Yet, we believe the top-line headwinds would persist, given the protracted economic recovery. Plus, a low interest-rate environment would keep Wells Fargo’s margins under pressure. Wells Fargo’s unrelenting legacy mortgage issues also remain a concern. With the thrust of banking regulations, there will be pressure on fees and loan growth could remain feeble.

Wells Fargo and JPMorgan Chase & Co. (JPM - Analyst Report), with exposure in almost all banking businesses, are the first among the banking big shots to report second-quarter earnings. Their earnings releases should be a significant indicator of the performance of the key banking sector.

Among other Wall Street big shots, Citigroup Inc. (C - Analyst Report) will report on Jul 15 and Goldman Sachs Group, Inc. (GS - Analyst Report) on Jul 16.

Wells Fargo currently carries a Zacks Rank #3 (Hold).

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