Written by Pankaj Kumar
Wells Fargo & Co’s (WFC) better-than-expected 2Q FY08 results show that WFC is better positioned than its peers to withstand the rigors of real-estate asset write downs. WFC soothed worried bank-stock investors by increasing dividend even as peers are cutting dividend.
We looked up some key real estate loans (REL) data of WFC and its peers on the Gridstone platform. Besides WFC, we picked up Washington Mutual (WM) and Wachovia Bank (WB) in the peer set. A quick analysis of past data and SEC filings of this group shows that WFC has been managing its loan portfolio more smartly than its peers.
As seen in Exhibit I, WFC has slightly increased its REL portfolio whereas WM has maintained its REL portfolio and WB has slightly decreased it. Considering that WM’s REL portfolio accounts for 95% of its total loan, the bank is most sensitive to sub-prime mortgages.
Average yield on REL for all the three banks has fallen in 1QFY08, with WB showing the sharpest decline. WFC, however, has maintained the highest average yield in its peer group.
Exhibit 1
Source: Gridstone Research
As seen in Exhibit 2, net charge offs / average loans ratio (NCO ratio) has increased for all the three banks. WFC has always had a higher NCO ratio than its peers, and has been aggressively charging off more than 1% of its average loans in the past many quarters. Its NCO ratio increased to 1.3% in 4QFY07 and to 1.6% in 1Q and 2Q of FY08. WFC’s REL yield is the highest among the three and it has been able to earn high interest margin due to its low cost deposit mix; moreover, WFC has been prudent to use this margin to weed out NPAs regularly. In 2QFY08, WFC’s total revenue (before provision) increased 16% y/y vs. only 2% increase in expenses, which helped it digest a 318% y/y increase in provision for loan losses.
The same is not true for WB and WM, which have been trying to catch up with charge offs when they have been hit, but didn’t have the providence to build that cushion earlier on. WB is still managing to keep its NCO ratio under 1% but rising NPA might force them to increase charge offs significantly in 2QFY08. Both WB and WM are due to release their 2QFY08 results this week, and it would be interesting to see whether their struggle is over or there is more to come.
Exhibit 2
