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On a day in which the Dow Jones Industrial Average opened down 400 points, it was hard to find any good news Friday. In the financial sector, earnings reports from major U.S. banks are trickling in, and the results are actually quite positive. But the stock market is moving on geopolitical concerns, so even good earnings are being ignored.
Wells Fargo (NYSE: WFC) is widely regarded as a best-of-breed bank stock, and last quarter the company lived up to its reputation. But the stock fell more than 4% at Friday’s open anyway, before paring its losses to finish the day down 1.8%.
Improving Loan Portfolio Boosts Profit
In the Wells Fargo earnings report, the bank reported $1.03 per share last quarter in diluted earnings, on $21.6 billion in revenue. Net income came in at $5.7 billion, unchanged from the previous year, while sales grew 1% year over year.
Analysts projected the bank to earn $1.02 per share on $21.8 billion. As a result, while Wells Fargo earnings beat expectations, revenue fell slightly short.
That was enough to send the stock down at the open, and shares of Wells Fargo are down 8% year-to-date.
The major contributors to the Wells Fargo earnings beat were a strict focus on cost controls, as well as an improving loan and deposit portfolio. Average deposits rose 6% year over year, while average loans increased 7%. The increased activity for both deposits and loans signals the U.S. consumer is still in relatively good financial shape.
The Wells Fargo earnings report said the bank ended the quarter with a solid 10.7% Tier 1 ratio.
Still, investors are once again worried about net interest margin, and the prospect of slower-than-expected rate hikes from the Federal Reserve going forward.
Why Investors Are Running Scared
Investors are afraid that a continued slowdown in U.S. economic growth, exacerbated by the extreme volatility in emerging markets and the rising U.S. dollar, will compel the Federal Reserve to postpone its interest rate hikes.
The Fed raised interest rates in December for the first time in nearly a decade. That is seen as a tailwind for the U.S. financial sector, because banks are one of the few industries that benefits from higher interest rates. That’s because banks earn a spread between the interest paid on short-term deposits versus the interest earned on longer-dated loans.
That metric is referred to as net interest margin. For most major U.S. banks, net interest margin contracted over the past few years due to the ongoing zero interest rate policy employed by the Fed to stimulate the U.S. economy.
Wells Fargo’s net interest margin contracted from 3.04% in the fourth quarter 2014, to 2.92% last quarter. For the full year, net interest margin was 2.95%, down from 3.11% the previous year.
If U.S. economic data disappoints in the first half of 2016, the Fed may decide not to increase rates again this year. That would delay further Wells Fargo’s net interest margin expansion.
This Too Shall Pass
Investors are very negative on Wells Fargo, and judging by the stock market performance to start 2016, it is clear that the bears are in control.
But the good news is that Wells Fargo is still a strong company. The underlying business itself is healthy. Although the company is not reporting huge growth, it is still highly profitable, its balance sheet is improving, and investors could view this current period as a buying opportunity.
Shares of Wells Fargo are cheap. The stock trades for a modest 11 times 2015 earnings per share, as well as 10 times forward EPS estimates. In addition, Wells Fargo stock offers a nice 3% dividend yield, which is attractive in this low-rate environment. Wells Fargo returned more than $12 billion to investors last year through combined dividends and share repurchases.
There is no guarantee that the short-term pessimism will fade and the selling pressure will ease, but long-term investors are likely to be rewarded for their patience.
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