July 15, 2010
Wells Fargo & Company
Current Recommendation Prior Recommendation Date of Last Change Current Price (07/14/10) Target Price
SUMMARY Wells Fargo is scheduled to announce its second quarter earnings on July 21. The company s first quarter earnings came in significantly ahead of the Zacks Consensus Estimate, aided by a higherthan-expected growth in revenues. Capital ratios improved significantly in the quarter with the raising of fresh equity. We think that the company is well positioned compared to its peers as the Wachovia acquisition and the demise of some smaller players helped it garner a larger share in the mortgage markets. However, higher credit losses resulting from a continued deterioration in the housing markets and weak consumer trends will impact earnings in the upcoming quarters. We reiterate our Neutral recommendation on the stock.
N/A 04/07/2000 $27.66 $29.00
SUMMARY DATA 52-Week High 52-Week Low One-Year Return (%) Beta Average Daily Volume (sh) Shares Outstanding (mil) Market Capitalization ($mil) Short Interest Ratio (days) Institutional Ownership (%) Insider Ownership (%) Annual Cash Dividend Dividend Yield (%) 5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%) P/E using TTM EPS P/E using 2010 Estimate P/E using 2011 Estimate Zacks Rank *: Short Term 1 3 months outlook
* Definition / Disclosure on last page
$33.88 $22.87 14.08 1.34 38,010,888 5,210 $144,109 1.26 71 1 $0.20 0.72
Risk Level * Type of Stock Industry Zacks Industry Rank *
Below Avg., Large-Value Banks-Major Reg 119 out of 291
ZACKS CONSENSUS ESTIMATES
(In millions of $)
11,460 A 22,507 A 21,381 E
10,377 A 22,466 A 21,292 E
9,477 A 22,696 A 21,400 E
41,877 A 88,686 A 85,521 E 88,426 E
2008 2009 2010 2011
10,563 A 21,017 A 21,448 E
18.8 -15.5 -30.4 15.9 13.9 9.4
Earnings Per Share Estimates
(EPS is operating earnings before non-recurring items, but including employee stock options expenses)
$0.53 A $0.60 A $0.49 E
$0.49 A $0.56 A $0.52 E
-$0.84 A $0.08 A $0.48 E
$0.78 A $1.83 A $1.99 E $2.94 E
2008 2009 2010 2011
$0.60 A $0.59 A $0.50 A
3 - Hold
Projected EPS Growth - Next 5 Years %
© 2010 Zacks Investment Research, All Rights reserved.
111 North Canal Street, Chicago IL 60606
Wells Fargo & Company is one of the largest financial services company in the U.S. (in terms of assets) with $1.2 trillion in assets and over $800 million in deposits. The company provides retail and wholesale banking, mortgage banking, consumer finance, equipment leasing, insurance brokerage, agricultural finance, securities brokerage, trust, investment banking and other financial services through banking stores, the internet and other distribution channels to individuals, businesses and institutions in all 50 states, the District of Columbia (D.C.) and in other countries. The San Francisco-based company, as it stands today, is the result of the 1998 merger between Norwest Corporation and the former Wells Fargo (founded in 1852), as well as the recent merger with Wachovia Bank. Wells Fargo is also the premier institution in the U.S. in community banking, small business lending, middle market commercial banking, agriculture lending, commercial real estate lending, commercial real estate brokerage and bank-owned insurance brokerage. Wells Fargo acquired Wachovia Bank in December 2008, thereby being transformed into a premier coast-to-coast financial services franchise providing banking, insurance, investments, mortgage and consumer finance through almost 10,000 stores, over 12,000 ATMs and 267,300 team members across North America and other continents. In December 2009, Wells Fargo exited the Troubled Asset Relief Program (TARP) after a full repayment of its $25 billion loan along with cash dividends of $1.44 billion to the U.S. Treasury while maintaining strong capital levels. The company had entered the TARP in October 2008. The company also purchased Prudential Financial s non-controlling interest in securities brokerage joint venture, assuring itself 100% of the future earnings. The company provides its services through three broad segments: Community Banking (65% of 2009 revenue), Wholesale Banking (22%), and Wealth, Brokerage and Retirement (13%). Community Banking offers a complete line of diversified financial products and services for consumers and small businesses including investment, insurance and trust services in 39 states and D.C. It also offers mortgage and home equity loans in all 50 states and D.C. Wachovia has added product offerings as well as expanded channels to better serve customers. The segment now includes the Wells Fargo Financial division. Wholesale Banking provides financial solutions to businesses across the U.S. with annual sales generally over $10 million and to financial institutions globally. It provides middle market banking, corporate banking, commercial real estate, treasury management, asset-based lending, insurance brokerage, foreign exchange, correspondent banking, trade services, specialized lending, equipment finance, corporate trust, investment banking, capital markets and asset management. Wachovia expanded product offerings across the segment, including investment banking, mergers and acquisitions, equity trading, equity structured products, fixed-income sales and trading and equity and fixed income research. Wealth, Brokerage and Retirement provides a full range of financial advisory services to clients. The Wealth Management division provides affluent and high-net-worth clients with a complete range of wealth management solutions. Retail Brokerage division s financial advisors cater to the customers advisory, brokerage and financial needs as part of one of the largest full-service brokerage firms in the United States. The Retirement division provides retirement services for individual investors and is a national leader in 401(k) and pension record keeping. The Wachovia takeover added the following businesses to this segment: Wachovia Securities (retail brokerage),
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Wachovia Wealth Management, including its family wealth business and Wachovia s retirement and reinsurance business.
Full Year 2009 Revenue (Business Segm ents) Wealth, Brokerage and Retirement 13% Full Year 2009 Net incom e (Business Segm ents)
Wealth, Brokerage and Retirement 7%
Wholesale Banking 22%
Community Banking 65%
Wholesale Banking 29%
Community Banking 64%
REASONS TO BUY
Wells Fargo has well justified reputation as a growth stock among the large-cap banks, with crossselling as its key strength. Despite the ongoing weakness in housing, periodic dislocation in the secondary mortgage capital markets and the overall challenging environment in the U.S., the company has consistently achieved strong revenue growth in the past several quarters. Wells Fargo has a diverse geographic and business mix that enables it to sustain consistent earnings growth, while its strong consumer franchise allows it to offer a vast range of products to households. Wells Fargo s growth plans have historically included a large number of acquisitions, Wachovia being the largest addition in December 2008. The company has demonstrated its ability to assimilate local franchises offering a wider range of products than the acquired company could have had, thus increasing the number of options for customers to choose from. This has been the driving force behind its growth in the recent years. The Wachovia merger is expected to generate an internal rate of return (IRR) of about 20% and be accretive to earnings starting from the third year of its acquisition, without any adjustments. As a result of the merger, Wells Fargo has substantially expanded its distribution network and has a Community Banking presence for the first time in Alabama, Connecticut, Delaware, Florida, Georgia, Kansas, Maryland, Mississippi, New Jersey, New York, North Carolina, Pennsylvania, South Carolina, Tennessee, Virginia and Washington D.C. During the first quarter of 2010, the company converted 20 Wachovia banking stores in Arizona, Nevada and Illinois to Wells Fargo. The Wachovia merger integration remained on track and is expected to realize $5 billion of annual merger-related savings upon completion of the integration process in 2011. The company has achieved 70% of this targeted consolidated run-rate savings. Wells Fargo s ongoing focus on producing high risk-adjusted returns helps it to maintain strong capital ratios. Its absolute and relative liquidity position it above its peers to take advantage of opportunities arising from the changing market environment. Moreover, the timely exit from TARP has helped the company save the annual preferred stock dividend payment of $1.25 billion to the government. This is expected to be slightly accretive to earnings in 2010.
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With a view to conserve capital in a very challenging operating environment, Wells Fargo has slashed the quarterly common stock dividend from $0.34 to $0.05 per share on March 6, 2009. The move will help retain an additional $5 billion in common equity each year. The company aims to reinvest this amount in its businesses in order to gain a profitable market share in the long term while creating a larger capital cushion in the near term against a potentially more adverse credit cycle.
REASONS TO SELL
The combination of solid business growth, strong revenue growth and impressive operating margins is somewhat masked by higher impairment charges as a result of continuing write-downs to the securities portfolio and higher credit reserve builds. Following the trends in 2009, the latter is expected to continue to be high in the coming quarters as the industry position will remain challenging in the rest of 2010 as well. Wells Fargo continues to experience higher credit losses as a result of its initiative to de-risk the combined new balance sheet after the Wachovia acquisition. This strategy is aimed at reducing the likelihood of losses in the future. We expect these factors to continue to prevail in the short-tomedium term and hurt the earnings. Wells Fargo s significant mortgage banking operations and considerable variability in mortgage servicing operations may hamper P/E expansion. On the expense front, the company continues to push for growth across the franchise by adding to its existing number of stores and team members. These initiatives are keeping expense growth at a high level. The company may not be able to accomplish any positive leverage in the long run if it is not able to significantly control expenses. Credit quality continues to deteriorate though the rate of deterioration has moderated of late. During the first quarter of 2010, nonperforming assets increased to $31.5 billion or 4.00% of total loans compared with $27.64 billion or 3.12% of total loans in the prior quarter. The majority of losses stem from the consumer loan portfolios as the customers continue to be negatively impacted by the downturns in residential real estate, higher unemployment and weakening economy. Given the continued weakness in housing and broader market, charge-offs are expected to continue to rise through the remaining of 2010. Further, until home prices stabilize, the company will continue to a bear huge amount of losses in the home equity portfolio.
Wells Fargo s Beats Estimates April 21, 2010
Wells Fargo's first quarter 2010 operating earnings were $0.50 per share, well above the Zacks Consensus Estimate of $0.42. Net income applicable to common stock came in at $2.55 billion or $0.45 per share compared to $3.05 billion or $0.56 in the prior-year quarter. This included after-tax integration expenses of $247 million or $0.05 per share. During the quarter, Wells Fargo earned $21.4 billion (up 2% year over year) of combined revenue, driven primarily by 20% growth in trust and investment fees, 7% growth in insurance fees and14% growth in processing and other fees. While total mortgage banking remained flat, results for mortgage hedging reduced drastically.
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Net interest income for the quarter came in at $11.1 billion, down from $11.5 billion in the prior quarter. While earning assets were down at $1.07 trillion, the decline in core loans, reduction in non-strategic assets and mortgage-backed securities reduced net interest income growth although net interest margin (NIM) increased to 4.27% from 4.16% year over year. However, these declines were offset by significant growth in non-interest-bearing checking and savings deposits and wider new lending spreads, which are expected to be beneficial for net interest income over the long term. Total non-interest income came in at $10.3 billion, up 7% year over year, primarily due to continued strength in trust and investment fees and insurance revenue. This was partially offset by a decline in mortgage banking, card and deposit service charges. Non-interest expense for the quarter came in at $12.1 billion, down from $12.8 billion in the prior quarter. Total core deposits of $759.2 billion as of March 31, 2010 were down from $770.8 billion as of December 31, 2009. Growth in low-cost savings accounts and consumer checking accounts were offset by a decline in mortgage escrow deposits. Credit quality continued to deteriorate although improvement was witnessed in net charge-offs that declined to $5.3 billion or 2.71% of average loans compared with $5.4 billion or 2.71% of average loans in the prior quarter. However, nonperforming assets increased to $31.5 billion or 4.00% of total loans compared with $27.64 billion or 3.12% of total loans in the prior quarter. Allowance for credit losses was $25.7 billion as of March 31, 2010 compared with $25.0 billion as of December 31, 2009. Net unrealized gains on securities increased to $7.4 billion from $5.6 billion as of December 31, 2009. Wells Fargo s total assets as of March 31, 2010, were $1.22 trillion and total loans were $781.4 billion. As of March 31, 2010, Wells Fargo shareholders equity was $116.1 billion, compared with $111.8 billion as of December 31, 2009. Capital ratios remained strong with Tier I capital and total capital ratio at 10.0% and 13.9%, respectively, compared with 8.3% and 12.3% respectively, year over year. Book value per share improved to $20.79, up from $20.03 in the prior quarter and $16.28 year over year. Business Update On July 7, Wells Fargo announced a restructuring of its consumer finance unit. The company would close 638 Wells Fargo Financial stores across the U.S., stop originating non-prime portfolio mortgage loans and lay off 3,800 positions as part of this restructuring. According to the company, the requirement for a separate network of Wells Fargo Financial local offices no longer exists, following the company s 2008 merger with Wachovia. This merger has enabled customers to have access to the company s 6,600 Wells Fargo and Wachovia community bank stores and its 2,200 Wells Fargo Home Mortgage locations. Wells Fargo also pointed out that its financial stores have originated less than 2% of all its real estate loans in the first quarter of 2010. As a result of this restructuring, Wells Fargo would incur pre-tax charges of approximately $185 million in total. Of this, around $137 million, or $0.02 per share, would be incurred in the second quarter while the remaining charges would be reflected in the second half of the year, primarily in the third quarter. As part of the restructuring process, the company would also shed 3,800 positions within Wells Fargo Financial. This unit currently has 14,000 team members. Of this, Wells Fargo will abolish 2,800 positions in the next 60 days and another 1,000 positions within a year. The other employees will be absorbed in other Wells Fargo businesses.
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Dividend update On April 27, 2010, Wells Fargo declared its quarterly dividend of $0.05 per share. The dividend was paid on June 1, 2010, to stockholders of record as on May 7, 2010. On March 6, 2009, the company reduced its quarterly dividend by 85.3% to $0.05 per share versus $0.34 per share paid earlier.
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The Wachovia merger has transformed Wells Fargo into the fourth largest bank in the country with an impressive geographic diversification and a sturdy balance sheet. The company is on track with the Wachovia merger that is expected to realize $5 billion of annual merger-related savings upon full integration in 2011. However, the combined entity s large exposure to mortgage/real estate loans and the integration costs associated with the merger will continue to impact its earnings throughout 2010, even though Wells Fargo has not suffered as much from the current mortgage crisis as some of its peers due to its disciplined lending approach. Although there is a lot of uncertainty regarding the commercial sector especially due to the credit crunch, regulatory and fiscal policy issues in the near term, we believe that Wells Fargo s profitability ratios, cross selling ability, strategic Wachovia cost integration and a diverse business portfolio along with better-thanexpected growth in investment banking will drive long-term growth and add to the investors confidence. Wells Fargo shares currently trade at 13.9x our 2010 earnings estimate, a 50% discount to the industry average. On a price-to-book basis, the share currently trades at 1.3x which is at an 18% premium to the industry average. The valuation on a price-to-book basis looks attractive, given a trailing 12-month ROE which is significantly above the industry average. Our six-month target price of $29.00 per equates to about 14.6x our earnings estimate for 2010. This price target implies an expected return of 4.8% over that period. This is consistent with our long-term Neutral recommendation. The quantitative Zacks Rank for Wells Fargo is currently 3 , indicating no clear directional pressure on the shares over the near term.
P/E 5-Yr High (TTM) P/E 5-Yr Low (TTM)
Est. 5-Yr EPS Gr%
Wells Fargo & Company (WFC)
Industry Average S&P 500
13.9 27.6 13.8
9.4 13.4 12.0
10.0 5.7 10.7
9.3 16.0 12.4
15.9 19.2 19.3
35.5 40.7 27.7 N/A N/A 32.7 29.8
10.7 8.2 13.8 9.5 5.7 8.5 8.7
8.0 12.9 8.5 10.7 15.8 6.0 N/A 15.8 8.3 12.2 Citigroup Inc. (C) 13.2 9.5 -1.5 N/A N/A US Bancorp (USB) 15.3 10.9 6.3 16.6 23.0 TTM is trailing 12 months; F1 is 2010 and F2 is 2011, CF is operating cash flow
JPMorgan Chase & Co. (JPM) Bank of America Corporation (BAC)
P/B Last Qtr.
P/B 5-Yr High
P/B 5-Yr Low
D/E Last Qtr.
Div Yield Last Qtr.
Wells Fargo & Company (WFC)
Industry Average S&P 500
1.3 1.1 3.2
2.9 1.1 10.0
0.7 1.1 2.9
12.1 3.4 21.4
0.8 0.9 2.2
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Earnings Surprise and Estimate Revision History
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The Online Stock Research Community
Discover what other investors are saying about Wells Fargo (WFC) at: WFC Profile on StockResearchWiki.com
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of WFC. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1020 companies covered: Outperform - 12.8%, Neutral - 80.5%, Underperform 6.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each th stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.
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