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Wells Fargo & Company has achieved its twelfth consecutive quarter of growth in earnings per share by reporting earnings of 92 cents per share in fourth quarter 2012. Results improved from earnings per share of 88 cents in the prior quarter and 73 cents in the year-ago quarter. Also, it beat the Zacks Consensus Estimate by 5 cents.

For the year ended 2012, earnings per share were $3.36, significantly up by 54 cents compared with the prior-year. Results also outpaced the Zacks Consensus Estimate by 3 cents.

Fourth quarter net income applicable to common stock came in at $4.9 billion, up 4.3% sequentially and 25.6% year over year. For the year ended 2012, net income applicable to common stock stood at $18 billion, up 19% year over year.

Results at Wells Fargo benefited from improvement in top line, aided by rise in all segments’ revenue. It also reported $250 million in reserve release (pre-tax), attributable to improved portfolio performance. However, the company experienced rise in non-interest expenses.

The quarter’s total revenue came in at $21.9 billion, beating the Zacks Consensus Estimate of $21.3 billion. Revenues also advanced 3.3% sequentially and 6.3% year over year.

Revenues for the year ended 2012, came in at $86.1 billion, up 6.0% year over year. Also, it beat the Zacks Consensus Estimate of $85.7 billion.

Furthermore, segment-wise, on a sequential basis, Community Banking, Wholesale Banking and Wealth, Brokerage and Retirement segments reported rise of 5.3%, 1.7% and 3.3%, respectively.

Performance in Detail

Wells Fargo’s net interest income for the quarter came in at $10.6 billion, down 0.9% sequentially. Net interest margin dipped 10 basis points sequentially to 3.56%. With the pressure of low interest rate environment, income and margin were affected by continuing repricing of the balance sheet, partially offset by increased variable income.

Non-interest income at Wells Fargo came in at $11.3 billion, up 6.6% from the prior quarter. Higher equity gains, driven by improved private equity businesses primarily led to the augmentation in non interest income. Moreover, the rise was supported by higher deposit service charges, trust and investment fees and mortgage banking income.
 
As of December 31, 2012, total loans were $799.6 billion, ascending 2.2% sequentially. Growth in credit card, mortgage, and commercial and retail brokerage loan balances contributed to this increase. However, it was partially offset by continued reduction in the non-strategic/liquidating portfolio. Average core deposits were $928.8 billion, up 15% (annualized) from the prior quarter.

Non-interest expense at Wells Fargo was $12.9 billion, up 6.6% from the prior quarter. Higher operating losses and increased salaries led to the rise in total expenses. These were partially mitigated by lower advertising costs. Though the company’s efficiency ratio of 58.8% was above 57.1% reported in the prior quarter, yet it remained within the targeted efficiency ratio range of 55% to 59%.

Credit Quality

Wells Fargo reported mixed credit quality trends in the quarter, affected by the completion of the implementation of the Office of the Comptroller of the Currency (OCC) guidance, issued in the prior quarter. The guidance demanded write-down of performing consumer loans restructured in bankruptcy to collateral value.

Wells Fargo’s allowance for credit losses, including the allowance for unfunded commitments, totaled $17.5 billion as of December 31, 2012, waning from $17.8 billion as of September 30, 2012. Net charge-offs were $2.1 billion, or 1.05% of average loans in the reported quarter, down from the prior quarter net charge-offs of $2.4 billion (1.21%). Nonperforming assets dipped to $24.5 billion in the quarter from $25.3 billion in the prior quarter.
 
However, provision for credit losses increased 12.5% sequentially to $1.8 billion in the reported quarter.

Capital Position

Wells Fargo maintained a solid capital position. The company purchased 42 million shares of common stock in the quarter. Moreover, it opted for an additional estimated 6 million shares through a forward repurchase transaction, which is expected to be settled in the first quarter of 2013.

As a result, Wells Fargo’s Tier 1 common equity under Basel I increased $3.3 billion sequentially to $109.1 billion, with Tier 1 common equity to total risk-weighted assets ratio of 10.12% under Basel I as of December 31, 2012. Moreover, its estimated Tier 1 common equity ratio was 8.18% under the latest Basel III capital proposals.

The Tier 1 leverage ratio was 9.47% as of December 31, 2012, up from 9.40% as of September 30, 2012. Tier 1 capital ratio was 11.75% as of December 31, 2012 compared with 11.50% as of September 30, 2012. Book value per share improved to $27.64 from $27.10 in the prior quarter and $24.64 in the prior-year quarter.

Other Developments

Earlier this week, Wells Fargo along with nine other mortgage servicers announced settlement agreements with the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Board (FRB) to close their Independent Foreclosure Review (IFR) programs.

Wells Fargo’s agreed to pay $766 million in cash. Therefore, the company recorded a pre-tax charge of $644 million in fourth quarter 2012 as full reserve for its cash payment part of the settlement and additional remedial costs. The company has also announced an additional $1.2 billion to foreclosure prevention.

Our Viewpoint

The positive developments of the sector and gradually improving macroeconomic elements helped the banking behemoth to keep up 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 December 2008. Notably, in the first half of 2012, the company completed three acquisitions with combined total assets of $4.5 billion. Further, on August 1, the company completed the acquisition of a prime brokerage and technology provider with assets of approximately $280 million.

Also, it has announced consecutive dividend increases over the past three years with the latest hike of 83.3% being announced in March 2012.

Though there are concerns related to the impact of legal issues and its exposure to the European economy, 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 though at a slower pace, will support its profit figures. Its stress test clearance and 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 its 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.

Among the two most important bankers to kick start the results, Wells Fargo, with exposure in almost all banking businesses, is the first, while JPMorgan Chase & Company has delayed its earnings release this quarter. Wells Fargo’s release should be a significant indicator of performance in the key banking sector.

Among other Wall Street big shots, The Goldman Sachs Group Inc. will report on January 16, while Citigroup, Inc. and Bank of America Corporation on January 17.

Wells Fargo currently retains a Zacks Rank #3 (Hold). We believe such strong results might lead to positive earnings estimate revisions.

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