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Wells Fargo Earnings Report: Stagecoach is on schedule

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July 21, 2007 – Comments (0)

Three weeks ago Wells Fargo was my blog subject and I wanted to update that post by going over some of the highlights of the recent earning report. And, after 'Dumpster Diving', I felt like I owed TMF a serious blog.

Wells Fargo reported second quarter earnings of 67 cents per share on Tuesday the 17th, up from 61 cents in 2nd quarter ’06 and in line with analysts’ estimates. In addition to the earnings, several things in the recorded comments caught my attention.

Quotes from the comments transcript are in italics, bold highlighting is mine.

“Businesses that generated double-digit year-over-year revenue growth included asset management, business direct, capital markets, corporate trust, credit and debit cards, global remittance services, home equity, consumer finance, insurance, international, personal credit management, real estate brokerage and wealth management.”

A broad range of WFC businesses contributed to the 13 percent revenue growth. I was surprised to see home equity and real estate brokerage in that list.

“We continued to have the highest net interest margin among our peers at 4.89 percent, up 13 basis points from a year ago.”

“At 1.82 percent our return on assets - after all expenses and credit costs – remained one of the highest among large banks and improved 11 basis points from second quarter 2006 despite the increase in charge-offs from a year ago. At 19.6 percent, our ROE remained one of the highest in the industry …”

A couple of reasons to consider owning this company.

“While we maintained one of the highest ratios of non-interest bearing deposits to total deposits among large banks in the U.S.....”

Don’t know who has non-interest bearing deposits these days, but thanks for the free money.

“Our Wealth Management group once again had a strong quarter with 17 percent revenue growth and 23 percent earnings growth from a year ago. Revenue from brokerage increased 31 percent and earnings were up 91 percent from a year ago driven by an increase in productivity from our financial consultants. This productivity lift helped brokerage assets under administration reach record levels, up 19 percent from second quarter 2006. WellsTrade, our on-line brokerage service, introduced new pricing during the first quarter which offers 100 commission-free online trades per year for Wells Fargo PMA customers. Since the new pricing in February, new account openings have increased almost 100 percent over the same period last year.”

Free trades won't generate revenues, but WFC now has a new, affluent customer base for other financial services.

“Mortgage applications in second quarter were running at relatively high levels, up 6 percent from a year ago. Despite the increase in mortgage rates from last year, mortgage refi applications were up 24 percent from a year ago. At $68 billion, purchase mortgage applications were close to the $71 billion in purchase applications taken during the homebuying season last spring.”

I was surprised the mortgage business was holding up this well. Maybe things aren't quite as bad as is being reported, apparently someone is still buying houses.

“The anticipatory actions we took in February to further strengthen our residential real estate underwriting standards, and some pricing improvements on these loans in the second quarter, resulted in only $35 million of revenue reduction on nonprime loans reflected in net gains on mortgage loan origination/sale activities, compared to $90 million in revenue reduction taken in the first quarter. Total nonprime residential real estate secured originations were down $2.7 billion from second quarter 2006.”

“While delinquencies andforeclosures are increasing, only 0.56 percent of our servicing portfolio – in other words,less than 1 percent - is in foreclosure, which is below the industry average.”

“We have very little ARM reset risk across our loan and servicing portfolios.”

“We have never offered or retained negative AM or option ARMs with low initial teaser rates, which is where the greatest risk exists for other providers in the industry.”

“We have negligible direct exposure to hedge funds. Lending directly to private equity sponsors is immaterial and not a strategic focus of our business. … We have consciously avoided participating in high profile or controversial financings of this type.”

“Weakness in the home equity portfolio is particularly apparent in the 2006 vintage sourced through third party channels where current CLTVs have risen above 90 percent in part due to the decline in local home values. This particular segment represents only about 3 percent of the total home equity portfolio.”

“Given current trends in many residential housing markets, we expect higher but manageable losses throughout 2007 in the home equity portfolio.”

WFC has done a decent job of managing risk, tightened standards, cut back on subprime and generally avoided flashy, high risk investment banking ventures. It’s not all good news, but is better than I had expected/feared.

I was a little surprised by the mortgage business. Given all news about subprime spreading, hedge fund collapses and mortgage companies going out of business, I was surprised to see WFC mortgage business holding steady. The mortgage business still has problems, but like many things, the press may be over-emphasizing the problem areas. Moderate earnings hits from subprime may turn out to be a trend across the banking industry. Fellow Fool DoEddi noted the same thing in Citi’s earnings call.

The relative strength, if you can call it that, in purchase mortgage applications was one of the reasons I ended my under perform picks on a couple of the homebuilders. Recovery is still a ways off, but many of the homebuilders stock prices have taken a beating and much of the bad news is probably already in the stock price. Still way too early to think about going long.

I continue to believe the share price of all financial firms with mortgage exposure is being marked down by the mess in subprime, whether they deserve it or not. WFC’s earnings comments indicate they're handling the problems pretty well. This mark down presents a nice opportunity to accumulate shares of quality financial firms at a discount to the market.

And, the dividend hike should be announced next week.

Disclosure: I own shares of Wells Fargo.

Still no sign of the elusive blogging charm, but 'popular' joined the collection.  My humble thanks. 

Thanks for reading. As always, your opinions and comments are welcome.

Fool On! 

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