Today we look at another major U.S. bank in the wake of the Federal Reserve’s tighter restrictions. Wells Fargo gets a larger share of its revenue from retail banking than does Morgan. Retail banking tends to produce steady earnings, and Wells Fargo aims to increase those earnings with acquisitions like a recent deal with GE Capital. Future acquisitions should not hurt this blue chip stock’s ability to keep raising its dividend.
Following the 2008 financial crisis, the U.S. Federal Reserve ordered banks and other big lenders to boost the capital (cash, bonds and other securities) they hold. That put them in a better position to absorb future loan losses.
The Fed recently announced that starting in 2019, it will bring in tougher new capital requirements for the eight largest U.S. banks, including Wells Fargo. However, Wells Fargo has bolstered its balance sheet and tightened its lending policies. That should help it meet the new standards without having to issue new shares.
WELLS FARGO & CO. (New York symbol WFC; www.wellsfargo.com) operates through three divisions: Community Banking provides consumer mortgages, loans, credit cards and other financial services (57% of 2014 revenue, 59% of earnings); Wholesale Banking supplies business loans (27%, 32%); and Wealth, Brokerage and Retirement offers wealth management, brokerage and trust services to individuals and institutions, such as pension plans (16%, 9%). The U.S. supplies 95% of Wells Fargo’s revenue.
Weak loan demand and lower interest rates cut the bank’s revenue by 5.0%, from $85.2 billion in 2010 to $80.9 billion in 2011. Loan volumes improved in 2012, causing revenue to rise to $86.1 billion. Lower fee income cut the bank’s revenue to $83.8 billion in 2013. Revenue rebounded to $84.3 billion in 2014, thanks to gains at the bank’s wealth management business.
Earnings jumped 85.5%, from $2.21 a share (or a total of $12.4 billion) in 2010 to $4.10 a share (or $23.1 billion) in 2014.
The bank continues to refinance and restructure the subprime mortgages it acquired as part of its 2008 purchase of rival lender Wachovia Corp. At the end of 2014, these loans totalled $26.3 billion, or 3% of Wells Fargo’s total loan portfolio.
The bank also tightened its lending policies in the wake of the financial crisis. As a result, its loan-loss provisions fell 91.1%, from $15.8 billion in 2010 to $1.4 billion in 2014.
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Blue chip stocks: Wells Fargo expects to sell its services to newly-acquired GE Capital loan holders
Wells Fargo’s improving balance sheet puts it in a strong position to make acquisitions. It recently acquired $9 billion worth of commercial real estate loans from GE Capital, the financing division of General Electric (New York symbol GE).
Many of the businesses that hold these loans aren’t Wells Fargo clients, so the bank feels the deal gives it a chance to sell more of its services to them. Wells Fargo is now looking at buying more assets from GE Capital. If so, that could force it to slow down its share repurchase plan. In the first half of 2015, it bought back $6.2 billion of its shares.
Future acquisitions should not hurt the bank’s ability to keep raising its dividend. It recently increased its quarterly payout by 7.1%, to $0.375 a share from $0.35. The new annual rate of $1.50 yields 2.6%. Wells Fargo paid out 54% of its earnings through dividends and share buybacks in the second quarter of 2015. For the full year, it expects to pay out 55% to 75%.
The new GE Capital loans should help offset the impact of low interest rates on the bank’s revenue, and increase its earnings to $4.16 a share in 2015. The stock trades at an attractive 13.9 times that forecast.
Recommendation in Wall Street Stock Forecaster: BUY.
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