Wells Fargo Surprises Yet Again

Before the market opened this morning, Wells Fargo (WFC - Analyst Report) reported third quarter 2009 diluted earnings of 56 cents per common share, compared with 57 cents in the second quarter 2009 and 49 cents in the third quarter 2008.

Net income applicable to common shareholders came in at $2.6 billion, almost flat compared with the prior quarter and up 61.1% year-over-year. The results were substantially ahead of the Zacks Consensus Estimate of 35 cents per share.

Results were aided by strong top-line growth across all key business segments, strong deposits and a robust loan growth rate. Unlike its major peers, Wells Fargo witnessed strong growth in its traditional banking operations, especially in its mortgage business acquired from Wachovia. Net interest income of $11.7 billion climbed 83.1% year-over-year.

However, credit quality deteriorated further and losses rose sharply during the quarter. The bank expects credit losses and non-performing assets to increase further, though some moderation was visible. Net charge-offs rose to $5.1 billion (2.50% of average loans) from $4.4 billion (2.11%) in the prior quarter and $2.0 billion (1.96%) in the prior-year quarter. Non-performing assets grew to $23.5 billion (2.93% of loans) from $18.3 billion (2.23%) in the prior quarter and $6.2 billion (1.53%) in the prior-year quarter.

Credit-loss provisions were $6.1 billion, up 144.9% from a year earlier and 20.2% from the prior quarter. The allowance for credit losses totaled $24.5 billion at Sept. 30, 2009, compared with $23.5 billion at June 30, 2009 and $8.0 billion at Sept. 30, 2008.

Large banks including Wells Fargo, Bank of America Corporation (BAC - Analyst Report), Citigroup, Inc. (C - Analyst Report) and JPMorgan Chase & Co. (JPM - Analyst Report) have suffered from the increase in loan losses which were offset by strong growth in trading operations.

Due to its integration with Wachovia, Wells Fargo is heavily exposed to the still-deteriorating housing sector. As a result, we expect higher credit losses in the coming quarter. We also think that the reserve build by the bank should have been larger to cover the future losses, especially from the consumer portfolios.

Though the company transcended all estimates, it did not give any insights into repayment of the bailout funds. We suspect the company may not do this anytime soon. As such, we maintain our Neutral recommendation on the stock.

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