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Encouraging Earnings for Wells Fargo

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Wells Fargo & Company (WFC - Free Report) earned 99 cents in third-quarter 2013, achieving the fifteenth consecutive quarter of earnings per share growth. Results improved from 98 cents earned in the prior quarter and 88 cents in the year-ago quarter. Also, the results beat the Zacks Consensus Estimate by 2 cents.

Total loans and deposits grew amid economic challenges and disciplined expense management. Moreover, a strong capital position and returns on assets and equity acted as positives.

Wells Fargo also reported $900 million in reserve release (pre-tax), attributable to improved credit performance. However, the company experienced a fall in top line due to reduced non-interest income.

Third-quarter net income applicable to common stock came in at $5.6 billion, up 1.8% sequentially and 14.3% year over year.

The quarter’s total revenue came in at $20.5 billion, lagging the Zacks Consensus Estimate of $20.9 billion. Revenues also declined 4.2% sequentially and 3.3% year over year.

Furthermore, segment-wise, on a sequential basis, Community Banking and Wholesale Banking segments fell 5.4% and 3.3% in total revenue, respectively, while the Wealth, Brokerage and Retirement segment reported a rise of 1.2%.

Performance in Detail

Wells Fargo’s net interest income for the quarter came in at $10.7 billion, almost in line with the prior quarter. Increased interest income from the available for sale (AFS) securities portfolio, lower funding costs, organic growth in commercial and consumer loans, commercial real estate loan acquisitions, and one additional business day in the quarter aided the results.

However, these positives were offset by reduced interest income from mortgages held for sale and lower income from variable sources. Further, net interest margin decreased 8 basis points sequentially to 3.38%.

Non-interest income at Wells Fargo came in at $9.7 billion, down 8.5% on a sequential basis, mainly due to reduced mortgage refinance volume and lower gain on sales margins. Moreover, trust and investment fees also declined. These negatives were partially compensated by elevated debt and equity gains, mortgage banking servicing income and trading revenues.
As of Sep 30, 2013, total loans were $812.3 billion, ascending 1.3% on a sequential basis. Growth in commercial and industrial, auto, foreign, credit card and commercial real estate mortgage portfolio 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 6% (annualized) from the prior quarter.

Non-interest expense at Wells Fargo was $12.1 billion, down 1.6% from the prior quarter. The fall in expenses was primarily attributable to lower incentive compensation.

The company’s efficiency ratio of 59.1% was above 57.3% in the prior quarter, and slightly outpaced the targeted efficiency ratio range of 55–59%. Wells Fargo anticipates expenses to decline sequentially in the fourth quarter of 2013, which will help in maintaining 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 $15.6 billion as of Sep 30, 2013, waning from $16.6 billion as of Jun 30, 2013.

Net charge-offs were $975 million, or 0.48% of average loans in the reported quarter, down from the prior-quarter net charge-offs of $1.2 billion (0.58%). Nonperforming assets dipped to $20.7 billion in the quarter from $21.1 billion in the prior quarter. Moreover, provision for credit losses decreased 88.5% sequentially to $75 million in the reported quarter.

Capital Position

Wells Fargo has maintained a solid capital position. The company purchased 50.9 million shares of its common stock in the quarter. Moreover, an additional purchase of estimated 9.8 million shares was conducted through a forward repurchase transaction, anticipated to be settled in fourth-quarter 2013.

Wells Fargo’s Tier 1 common equity under Basel I increased $2.7 billion sequentially to $120.3 billion. The Tier 1 common equity to total risk-weighted assets ratio was 10.64% under Basel I as of Sep 30, 2013 compared with 10.71% in the prior quarter.

The company’s estimated Tier 1 common equity ratio was an estimated 9.54% under the latest Basel III capital proposals, compared with 8.54% in the prior quarter. The Tier 1 leverage ratio was 9.76% as of Sep 30, 2013, up from 9.63% as of Jun 30, 2013.

Tier 1 capital ratio was 12.15% as of Sep 30, 2013 compared with 12.12% as of Jun 30, 2013. Book value per share increased to $28.98 from $28.26 in the prior quarter and $27.10 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 in Dec 2008. Notably, last year, the company completed three acquisitions with combined total assets of $4.5 billion.

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 enables 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 March and the subsequent dividend hike as well as its strategy to increase share buyback also lifted 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.

Wells Fargo and JPMorgan Chase & Co. (JPM - Free Report) , with exposure in almost all banking businesses, are the first among the banking big shots to report third-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 - Free Report) will report on Oct 15 and Goldman Sachs Group, Inc. (GS - Free Report) on Oct 17.

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

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