NEW YORK - Wells Fargo gave the kiss of death to its earnings results today when they said in their release when they the company said they recorded "solid results." Investors fret when a company says its results were solid they don't like being told whats good and usually choose the irrational opposite of what a company says. WFC seen as the banking superpower of the U.S.A for being one of the banks which does not have a huge business in trading and is known as more of a vanilla plain bank and simple to understand along with PNC and USB. However this bank saw its stock crushed today.
All the bank did was record, record results. The company earned $4.1 billion or $3.8 billion after preferred dividends. The company said it has called back $5.6 billion of preferred shares with a coupon of 8.45%. This means the company will add another $122 million to net income in future quarters just by the redemption of these shares. The company also purchased $600 million of common shares and paid around that amount in dividends giving the company a payout ratio of close to 30% in the quarter.
The Tier 1 ratio improved to 9.35%: Wells is quickly becoming a leader in Tier 1 capital after being behind banking peers last year. The company is doing it by record capital generation through earnings. By keeping all this capital the bank is exploding its capital base.
Net charge-offs declined to $2.6 billion. Charge-offs are loans that the bank has already written down the value off and has officially declared these loans unrecoverable and completely writes off the loans off their balance sheet and takes it out of their allowance. Nonperforming loans dropped to $26.8 billion this is down from $27.9 billion in the prior quarter. The company has $20.4 billion in allowances to cover this amount. An extremely high amount since usually a bank recovers a high portion of their nonperforming assets. However there is a time discount to the collectability and the cost of collecting this amount.
Investors focused on the drop in revenue in the quarter. The company dropped its revenue to $19.6 billion from $20.4 billion. A revenue drop is concerning since a company can grow profits through top line growth and expense cuts. Its harder to grow profits when top line falls. However revenue also drops when bad loans run off and they are invested in better assets in lower rates. Consider this a Wachovia loan may have been written down by 30% and yield lets say 15% a year. The provision on this loan may have been a high amount each quarter. This means while revenue on a $1000 loan may be $150 a year the company may earn $0 in profit. Now the loan expires and Wells makes a new loan at 5% but takes no provisions. So Earnings can increase simply by making better loans. These gains are called purchase accounting accretion. This is when a bank buys another bank and marks down the loans lets say $1000 to $600. This decrease increases the yield on loans and hence raises revenue. But expenses also go up when you mark the loan down because they usually have large losses attached to them. This is why investors should not be to concerned with a revenue drop in Wells and strong banks such as PNC. It was going to happen especially in a low interest rate environment. Lower revenue is likely attributable to run-off of high yielding high loss Wachovia loans.
Wells dramatically decreased costs by $800 million. The banks efficiency ratio which is non interest expense divided by revenues declined to 59.5% from 61.2%. Unlike most ratios the lower the better for this one. Loans impressively rose by $8.9 billion to $760 billion. The bank is only behind BAC in terms of total loans outstanding. BAC had $940 billion in loans in their latest quarter. This is well above J.P. Morgan which has $696 billion in loans. Wells is simply becoming the banking leader in the United States.
Tangible book value per share jumped to $17.7 from $17.33. Wells is now trading at a mere 37% premium to its tangible equity. The bank is also earning 17.5% on tangible equity a truly great return. PNC trades at an even cheaper 1.1 to tangible book value on a ROTE (Return on Tangible Equity) of 16.5%. US Bancorp trades at 2.1 to 1 on a ROTE of 22%. How long can U.S. Bancorp keep this premium to PNC and WFC?
Wells also had $442 million in trading losses in the quarter compared to $470 million gain last year. Obviously the bank will return back to profitability in the next quarter and over time. Meaning Wells easily can easily add another $.7 billion to its earnings power.
One disappointing note in the quarter was the drop in Wells' investment values. Wells' investments dropped by $1.6 billion in value. This drop doesn't go straight to earnings due to an accounting peculiarity. However in the last quarter Wells real income made was $4.5 billion when you add in the real change of investments compared to the $3.7 billion reported. In the current quarter. Wells adjusted net income in the current quarter was $2.8 billion. This includes $1.6 billion in investment losses that go through other comprehensive income but not net income. This accounting rule is expected to be changed by 2014. It will lead to more volatility in earnings but likely only during volatile times. The large swings in investment values are only caused in this ridiculous trading environment.
However this $2.8 billion is not that important since bond values usually show much higher gains than losses but due to current volatility the value of some assets have dropped.
Wells stock dropped 8.5% on a fairly excellent quarter. The stock is now only 9% of its 52 week low. Warren is likely licking his chops at the hacks currently trading this stock. The Oracle of Omaha like stocks when they are cheap.
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