The 10-Q for Wells Fargo Bank was just released. Let’s take a look under the hood and see what this report from the country’s largest mortgage lender tells us about the housing market and the business trends affecting the largest banks.
The first thing you’ll notice is that revenue was down small YOY (-2%) and that pre-tax, pre-provision profit was likewise down a similar amount. Loans were up about the same amount, not typical for banks broadly, but the AFS securities account was up 8% or twice the rate of growth for the loan book. Despite the happy talk coming from the latest Fed survey on lending conditions, lenders are having an increasingly difficult time finding acceptable assets for the credit book. While the average loan book grew $30 billion YOY, WFC’s deposits grew $55 billion or 2x. Keep in mind too that credit cards, non-agency RMBS and leases are the highest yielding asset sub-classes for WFC.
Allowances for loan losses were down 11% YOY as WFC, like the industry as a whole, continued to reserve less for future losses than was charged off in the current period. To understand how WFC made its earnings number in Q1 2013, ponder the following. Revenue was down $300 million YOY to $21.3 billion, but WFC put aside $800 million less in provisions in Q1 2013 vs. the same period in 2012. Non-interest expense was cut by another $600 million, resulting in net income of $5.2 billion in Q1 2013 or $1 billion above the same period last year. There is no growth here per se. WFC is a cost reduction story, plain and simple.
One of the reasons that WFC and the banking industry generally are able to pad earnings with lower provisions for loan losses is because the 0-89 day past due loan category is continuing to fall. The dirty little secret in the banking industry is that the +90 day and non-accrual categories are not falling (see chart below). Indeed, it might surprise many bank investors to know that there are some $190 billion in +90 days and non-accrual 1-4 family loans on the books of US banks. This is a pile of lovely distressed assets equal to nearly 8% of the $2.4 trillion in 1-4s held in portfolio by all FDIC insured banks. Sell Side analysts never look at this data, you understand, because it would detract from the bull case. But for those of us who know and love the NPL trade, suffice to say that the proverbial ice cube is not melting nearly as fast as regulators and the Big Media like to believe.
In terms of net interest margin, the bank’s cost of fund from all sources was just 0.38% while the yield on earning assets was 3.86%. Net interest margin was 3.48%, down half a point YOY from 3.91%. About half of WFC’s revenue dollar comes from non-interest sources, much higher than most banks, but NIM is a vital part of the overall business. In dollar terms, the Q1 2013 NIM was $10.8 billion vs. $11.1 billion last year. Again, this illustrates the fact that the Fed’s QE is no longer propping up NIM and in fact is starting to accelerate NIM compression.
What are the big areas of growth in terms of income? Well, service charges on deposit accounts were up 12% YOY. Brokerage and advisory fees were also up 12% vs. last year. And investment banking fees were up 37% to $357 million in Q1 2013. Trust and investment fees were also up 13% YOY. Credit card fees were also up 13%. Most significant, mortgage banking fees were down 3% YOY as markedly higher servicing fees (+25%) were swamped by falling gain on sale.
Yes, even though the bond market has rallied due to QE and the monetary lunacy in evidence at the Bank of Japan, gain on sale in the mortgage sector is shrinking. Again, the diminishing returns of QE are very evident in the WFC results. With prime lending customers available in dwindling numbers and spread tightening in the agency TBA market, is there any surprise that gain on sale for WFC and other mortgage banks is falling? If you are surprised, please don't admit it.
With all of the effort in terms of increased fees to boost non-interest income, the net, net for WFC's non-interest income in Q1 2013 was flat, around $10.8 billion. Such is the large impact of changes in the mortgage sector. As time goes on and spreads in the TBA market revert to the mean, it is possible that we may see actual declines in non-interest income at WFC and other banks that operate in the agency TBA market. At one quarter of non-interest income for WFC, gain on sale is the first thing to look for in earnings results.
The key takeaway from the Q1 2013 results for WFC and the industry as a whole is that US banks are not a growth opportunity at the present time. Mortgage applications may be up, this according to the Mortgage Bankers Association, but precious few 1-4 family mortgage loans are actually being closed and those which are closing are refinancing of existing loans by a 3:1 ratio, according to the MBA. Get used to it.