Thursday, July 23, 2009

Wells Fargo 2Q09 Results

Wells Fargo has once again defied expectations, coming in much strong than was expected. The Street expected 34 cents on average, while Wells Fargo earned 57 cents for the quarter. But yet, the stock took a beating - down by more than 7% at one point, before ending down about 3.5%. The worry is the quality of the earnings and more importantly, the worry on its worsening credit quality.

Let's touch on the earnings quality, the Street is worried that the company will not be able to reproduce the high revenue in the future quarters, especially on the contribution of $3B from Mortgage Banking alone. Well, even Mortgage Banking may not be as high in the next few quarters, it won't be zero for sure - perhaps maybe half of the $3B of revenue. But what is interesting is the company improved on its net interest margin (NII) to 4.3%. In the event that Mortgage Banking revenue decreases, the improvement in NII will help to offset it - not all but some as least. In the quarter, the company pretax preprovision for income came to $9.8B.

Now, the other worry is what spoked the market more than the revenue in my view - credit quality. But let's go through the numbers and comparison with how it came about to extract the reality behind it.

Prior to the merger, below are some numbers of the two companies as at end Dec 08 as if each is a separate entity:

1) Wachovia
  • Total loans = $484.1 billion (When Wells bought over, only $446.1b was carried over)
  • Nonperforming loans = $20.1 billion (When WFC bought over, only $97m is carried over)
2) Wells Fargo
  • Total loans $418.7 billion
  • Nonperforming loans = $6.7 billion
Now here is how the loan portfolio looks like as at end Dec 2008 with the merged entity.

Wachovia loans 476.6
Less Purchase Accounting & Write offs -30.5
Plus WFC loans 418.7


Essentially, after the application of Purchase Accounting and Write Off, the remaining loan applicable to Wachovia's legacy loans is all free from nonperforming loans.

Of the $864.8b loans, $446.1b is attributed to Wachovia and $418.7b is attributed to Wells Fargo.

As at December 31, 2008, the nonperforming loans left at Wachovia is $97 million, and $6.7 billion at Wells Fargo, for a total of $6.8 billion in nonperforming loans. Had Wells Fargo not acquired Wachovia, its ratio of nonperforming loans to total loans is 1.6% ($6.7b/$418.7b). But since both are merged, the nonperforming loans is $6.8b over a combined loan portfolio of $864.8B, which brings the ratio of nonperforming loans to total loans down substantially to 0.79%.

Below is a table on nonperforming loans numbers:

2Q09 4Q08 Difference
Legacy Wells Fargo nonperforming loans 11.0 6.7 4.3
Wachovia nonperforming loans 4.8 0.1 4.7
Total nonperforming (legacy WFC & WA) loans 15.8 6.8 9.0
Legacy Wells Fargo total loans 398.7 418.7 -20.0
Wachovia total loans 422.9 446.1 -23.2
Total legacy WFC & WA loans 821.6 864.8 -43.2
NPL as a % of total loans

- Legacy Wells Fargo 2.76% 1.60% 1.16%
- Wachovia 1.13% 0.02% 1.11%
- Total loans 1.92% 0.79% 1.14%

Although, the Street worries about the huge quarter to quarter jump in nonperforming loans (50% increase), the increase for the past half a year isn't so bad at all as you can glean from the table. The rise in NPL as a % of total loans for this period is about 1.1%, whichever way you look at it - either solely by legacy WFC, Wachovia or as a total. This ratio is not that far off with all of the rest of the banks - JPM at 0.97%, USB at about 0.8%, BAC at 1.35%, STI at 1.38%, Citi at 1.19%. So, the increase in NPL seems somewhere in the middle of the pack when compared to its peers.


Frank said...

Good analysis. I will add on to my position if they dump WFC further to USD20.
It is quite interesting that the market players make their forecast base on short term results.

Berkshire said...

Hi Frank,

Thanks. I did some adjustment to my portfolio. Sold some AXP and bought WFC, hoping the two will converge. Sort of an arbitrage play but even if it doesn't converge, WFC is still cheap for the long run. I just think that WFC can ride out of this credit crisis with its superior earning powers.

The last 2 quarters, WFC earned Pretax preprovision income of $9.2b and $9.8b, even if it drops to $8b, this $8b can cover for a worsening of credit quality of losses up to $32b annually. That means if WFC bad loans ends up at a nonperforming assets/loan ratio of 3.9%. Now is 2.2% or so, moreover there is already $23.5b in the coffer provided for loan losses. What they earn in future, only enhanced it. When the economy turns, WFC earning power would spike.

Frank said...

That is what i plan to do too. Quite interesting that we have some similar thinking. But my average cost of axp is at 31, and i do not want to lose any money. So, i have to wait first. Since coke new ceo is pretty good and earning increase, i buy ko too

Penny Stock Blog said...

I believe that every single bank with the exception of maybe some small town ultra conservative bank that only loans money to very very credit worthy customers. Never puts itself in any kind of situation where it might lose any money at all on any sort of loan. Every other bank under the sun Will in time get in trouble it always seems to happen regardless of the bank.