Tuesday, October 18, 2011

Wells Fargo - Q3 Earnings Release

Wells Fargo announced earnings yesterday that misses somebody’s “target” by $0.01/shr.  Earnings were $0.72/shr.  The company subsequently sheds $12 billion in market capitalization in one day or down 8.5% (It recovered some today). 

Who says the market is rational?

I find it humorous, these types of market swings.  Obviously the concern is that revenue isn’t growing and was in fact down.  I then got an email news alert that said the following (I added some emphasis, & my comments are in brackets):

U.S. bank top lines aren't growing at all

Three of the four big U.S. banks have reported their third-quarter earnings, and the big story so far has been that accounting gains are boosting their bottom lines.

But the more important story centres on the other end of the income statement: revenue. Over the past two years, the top lines at Citigroup , JP Morgan Chase  and Wells Fargo  has barely moved. They can play with accounting gains all they want, but if their top lines don't grow, they're eventually going to run out of ways to re-jig their earnings.

Dating back to 2009, these banks' quarterly earnings have shown almost no trend (I believe he means revenue, not earnings). They've flatlined (Think dead). Looking at earnings over the last twelve months at each quarterly reporting date, Citi has averaged about $80-billion for the last two years (or about $20-billion per quarter over the last twelve months). JP Morgan's growth is also flat, though it's at least generating more revenue, with a LTM average of about $100-billion each quarter.  

Wells Fargo, on the other hand, is actually seeing its top line trend down. In 2010 it had a LTM average of about $87-billion each quarter. That's fallen to $81-billion.

On of that, revenue prospects aren't promising. All their exotic business lines are being curtailed by Dodd-Frank, and core business lending isn't expected to ramp up any time soon, because even the Fed expects weak economic growth for the next two years (The same Fed that forsaw the recession, right?).

That's why the banks rely on accounting gains, like debt valuation adjustments. Yet once credit spreads move the other way, these adjustments will come back to haunt.


I almost don’t know where to start with my knife to dissect this nice piece of work.  First I believe the writer is referring to revenue not quarterly earnings as stated in third paragraph.  Secondly, Wells Fargo didn’t rely on any accounting gains in their reported earnings.  Third, what investor uses one time gains and losses to value a company?

I’m not ignorant of the fact that revenue isn’t growing and that eventually profits can’t grow if revenue doesn’t grow.  The question I asked myself if this… If Wells Fargo didn’t increase revenue what could earnings be in a normal charge off environment?  I ran my estimates and believe they can earn around $3.50/shr.  That assumes no revenue growth. 

Wells Fargo can be purchases for a 12% earnings yield (annualized quarterly profit/stock price).  If the Fed wasn't interfering, the normal dividend yield could be 5.3% (45% of current earnings).  Similarly, based on my normalized earnings Wells Fargo is selling for a 14.3% yield with no assumed revenue growth.  Dividends yield would be 6.4% normalized with now revenue growth. 

Does anyone really think that revenue (think loans) will never increase at Wells Fargo?  The have some huge capacity to increase lending today, but they are having trouble finding credit worthy borrowers. 

The hatred for the banks has to be reaching a tipping point.  The banks have been accused of a lot of things, so add “re-jiged earnings” to the list.   

Does anyone else find it contradictory that Citi and other banks are being accused of “creative accounting” by recording these credit valuation charges on a mark to market basis while out of the other side of the mouth the banks are accused of using changes to fair value accounting (FASB 157) to juice their balance sheets?  By the way, mark to market account never went away.  Fair value accounting allows for alternate valuation methods to be used when the market for the security is illiquid or non existent. 

In other news, earnings at Wells Fargo were up 20% year over year (in case anyone was interested).   


Best Regards,

Kevin

Disclosure - Long WFC

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