Insights From Wells Fargo Q3 2012 Earnings & Conference Call


Wells Fargo & Co [WFC] is a long time holding of mine, and there are some insights from its Q3 2012 earnings & conference call that I think deserve some attention. I’m going to highlight a few, as well as some that didn’t get noticed or talked about as much.

The items will show you a bit of why I like this bank so much, and likely some of the same reasons why it is Warren Buffett’s favorite bank to invest in. Many of the points discussed can be applied to other banks, especially when reviewing them as potential investment candidates.

Wells Fargo kicked off the third quarter earnings season with solid Q3 profit numbers. To summarize, they had record earnings of $4.9 billion, which was up 7% from the prior quarter, and 22% YoY. Revenue remained relatively stable at $21.2 billion.


Return On Equity

ROE came in at 13.38%, and increased 52 basis points QoQ. This number is also higher than its closest peers.
Bank of America [BAC] = 9.47%
JP Morgan Chase [JPM] = 12%
Citigroup [C] = 8.4%

I like seeing double digit ROE numbers, but since it can be manipulated in many different ways. I also like to look at expenses, efficiency ratio (how effective they are at using their assets), leverage ratio, as well as capital position. This ensures that the high ROE is not boosted by questionable financial maneuvers or increased risk & leverage.


Expenses & Efficiency Ratio

Wells Fargo saw expenses in Q3 decline by $285 million YoY. Their efficiency ratio improved and declined from 58.2% in Q2 to 57.1%. In Q3 2011, it was 59.5%. However, management still feels that expenses can be improved upon. Remember that efficiency ratio is obtained by dividing expenses by revenue, and shows effective use of assets.
[BAC = 84.93%, JPM = 61%, C = 59.8%]

Capital Position

WFC also continues to maintain a very strong capital position and is very well capitalized:
• Tier 1 common equity (Basel I) = $105.8 billion (increase of $4.1 billion).
• Tier 1 common equity ratio (Basel I) = 10.06%.
• Estimated Tier 1 common equity ratio (current Basel III capital proposals) = 8.02%.


Leverage Ratio

Wells Fargo’s Tier 1 leverage ratio is 9.45%, which is much higher than the 3% and 4% FDIC minimum requirements for banks, as well as in comparison to its peers.
[BAC = 7.84%, JPM = 7.1%, C = 7.4%]

The better leverage ratio also indicates that leverage isn’t the factor behind the higher profit numbers or used to make other metrics better than they really are.


Growth – Deposits & Loans

During the third quarter the bank saw strong deposit & loan growth. Total avg core checking & savings deposits increased $16.9 billion from the prior quarter. Total loans increased by $7.4 billion, and the core loan portfolio increased by $11.9 billion from the prior quarter.

This is significant because it shows that Wells Fargo’s record quarterly profit is due to growth in their core business, which is traditional banking services. The core business is also something that is sustainable, and is in contrast to large profits that could have come from riskier assets & investments. Riskier assets may boost profits in the short term, but would likely lead to disastrous results in the long term (something we’ve seen during the build up to the financial crisis by less conservative institutions). Record quarterly profits from loan & deposit growth means they are attracting more business away from their peers!


Credit Quality

Credit quality is another area that I like to focus on. Non-performing loans were 1.21% of average loans. This is a very good number and is quite low especially when compared to its peers. Considering that Wells Fargo acquired troubled bank Wachovia, and the bank’s current size, it is a big indicator of the bank’s strength.
[BAC = 2.77%, JPM = 2.33%, C 2.0%]


Lowered Revenue & NIM

Not everything is rosy though. Revenue did decline slightly during the quarter to $21.2 billion, from the $21.3 billion in Q2. The cause was that higher non-interest income was offset by lower net interest income.

NIM declined to 3.66%, which was impacted by lower income from variable sources, and management’s cautious stance on investment portfolio growth in the low rate environment.

These items are not show stoppers, but are good to be aware of. Management continues to take a cautious stance, even if it means lower profits in the short term. Caution also means a lower chance of things going bad. Remember when banks tried to increase profits with riskier assets and higher yields?


Earnings Call Insights:

Earnings calls usually provide a deeper level of insight directly from the management team themselves, that often do not appear in quarterly or annual reports. This insight is often qualitative in nature and is not something that can be seen through numbers themselves. Such items include vision, strategy, leadership, perspective, approach, assessments of risk, business outlook, and decision making abilities.

WFC’s mortgage business has grown substantially, and they had set out to grow the mortgage business. They currently originate 1 out of 3 mortgages in the country.

Tim Sloan (CFO) – “It’s competitive but is a very attractive business for us to be in. We’re really pleased that we are originating 1 of every 3 mortgages that’s done in the country.”
NIM has declined, but the strong deposit flows are perhaps a bigger positive for the bank.
Tim Sloan- “A big reason for the net interest margin decline was because of the strong deposit flows particularly what we saw in September.”

WFC’s management is known for their conservative nature. During the financial such conservatism allowed them to remain financially superior and take advantage of opportunities. They sought quality & low risk, over quantity, yield, & higher risks. The management team still remains conservative.

Tim Sloan – “We decided to hold $9.8 billion of our confirming first mortgage portfolio primarily because we viewed it as a good investment opportunity for us given the risk reward of holding those mortgages which were very high quality vs buying a similar duration MBS at a big premium. We were very cautious this quarter in terms of how we thought about our investment alternatives because we are thinking about the investment portfolio for the long term.”
John Stumpf (Chairman & CEO) – “We are going to be very careful at this point in time not to just go out there and stretch for yield, and take on a lot of interest rate risk”

NIM in a low rate environment will continue to be under pressure, but quarterly NIM not representative of future results.

Tim Sloan – “In this low rate environment the NIM will continue to be under pressure. We don’t believe that the 25 basis point decline we saw this quarter is representative of what we’ll see in the future. But what we do believe is that our performance is going to be representative of what we are going to see in the future because we’ve got a very strong diversified model.”

Even though NIM has come under pressure in recent quarters, and looks to continue coming under pressure. Management’s decisions are not influenced by the NIM, nor do they feel pressured to necessarily make decisions just to improve that number. They continue to take a conservative stance and look towards the long term aspects of the business.

Tim Sloan – “We focus on not managing to the net interest margin and the reason for that is the following, we could have easily increased our net interest margin by making some bad short term decisions. For example, we could increase the duration of our investment portfolio, we could go out and buy a lot of securities that have good short term yield but higher credit risk. That’s maybe a good short term decision in terms of managing the net interest margin. It could be a bad long term decision in terms of how we’re managing this company for the long term, which why we don’t spend a whole lot of time being focused on managing that margin.”

Again, the management team’s conservative & disciplined approach. extends towards acquisitions as well. The bank is selectively looking for good opportunities that fit, rather than just any opportunity.

Tim Sloan – “We’re not necessarily holding cash to make sure that we’ve got the ability to do it, because even if we had $20 or $30 billion less cash we would be more than liquid enough to be able to accomplish an acquisition. We continue to be very focused on looking at good acquisition opportunities.”

John Strumpf – “The risk reward is not the right kind of thing and we haven’t found anything that makes sense for us”.

Management’s approach to running the company.

John Strumpf – We’ve got to make good long term decisions everyday as opposed to let’s make a good short term decision that doesn’t have a good long term benefit.”


Insights Lead To Returns

Wells Fargo is one of the best run banks in the world, due to their conservative nature and smart decision making capabilities. That in-turn has resulted in continued capital strength, profitability, and sustainable growth in their core business. I hope the insights have provided a glimpse into why I find this bank to be such a great investment, and some of the reasons Buffett does too!

It isn’t a question of whether Wells Fargo is a good investment or solid bank, it is a question of what role/function would it play a in your long term investment plan, and what other capital priorities you may have that take precedence over it. WFC has risen 24.53% this year, and at current prices it’s still attractively valued, which is likely why Buffett continued to add to his position.

If you missed seeing similar insights from reading Wells Fargo’s Q3 report and listening to their earnings call, try to look for insights in the company’s next quarterly results. This insight searching activity can be applied to any company, and is not limited to the banking industry. Do it for all the companies you hold to gain more investing success!



Wells Fargo Q3 2012 Earnings:

Wells Fargo Q3 2012 Webcast:

For more information on valuation & evaluating bank stocks see the Bank Valuation Series.


DISCLOSURE: I am long Wells Fargo, and do not plan to sell or acquire any shares within the next 3 trading days.

Thanks & Happy Investing! — The Investment Blogger © 2012


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