Following yesterday’s stronger than expected results from JPM, today Wells Fargo – America’s largest bank by market cap – is having a far less pleasant day, trading down 3%, on what superficially was disappointing earnings.
What was the problem? There were several.
First, net income slid to $5.6 billion, or $1.01 a share, from $5.72 billion, or $1.03, a year earlier despite a nearly $1 billion increase in revenue to $22.2 billion. While matching the consensus estimate, the number wasn’t exactly true. As Macquarie’s David Konrad calculates, when one excludes $447 MM in securities gains, a $154 million MSR hedging benefit, $290 million gain from sale of health services business, one gets a bottom line result of $0.90, a 10% miss to the consensus $1.00 estimate.
Another problem: loan growth was lower than expected, as total loans climbed 7.7% to $957.2 billion, well below the loan machine that JPM has unleashed in recent quarters, while fees collected from cards rose 7.2% to $997 million. Other segments of the business were in outright decline, with profit from wholesale banking down 5.4% to $2.07 billion from a year earlier, while community bank earnings declined 1.2% to $3.18 billion. Wealth-management net income slid 1% to $584 million.
Just as disappointing was that mortgage banking revenue for the largest US lender declined by 17% from a year earlier to $1.41 billion, falling well short of the $1.8 billion estimates of Oppenheimer & Co.’s Chris Kotowski and Jefferies Group’s Ken Usdin.
Even more disappointing was the bank’s continuously declining Net Interest Margin: for a pure-play bank like Wells (which unlike JPM and BofA does not have extensive sales and trading ops to buffer earnings), NIM is the bread and butter of the business. As such, the NIM decline to new all time lows of 2.86%, “on growth in long-term debt, deposits and lower income on investment securities reflecting accelerated prepayment”, below the expected 2.90%, was an even bigger red flag, as it shows that Wells is having major trouble adapting to record low yields (and neither we, nor Deutsche Bank can blame it).
Finally, we get to the real meat – Wells’ Oil and Gas loan portfolio and total exposure. Here are the details:
Oil and gas loan portfolio of $17.8 billion, or 1.9% of total loan outstandings
The total outstanding amount was up $474 million, or 3%, from the $17.4 billion in 4Q15 on drawn lines and the acquisition of $236 million in loans from GE Capital.
Outstandings include $819 million second lien and $374 million of mezzanine loans.
Wells reports that ~7%, or $1.2 billion, of outstandings to investment grade companies. This means that $16.6 bilion of Wells’ outstanding loans are to junk-rated companies, something we flagged four months ago.
On the other hand, total exposure of $40.7 billion was down $1.3 billion, or 3%, reflecting declines across all 3 sectors from reductions to existing credit facilities and net charge-offs. As expected, Wells has decided to start trimming it overall exposure by collapsing credit lines.
But the punchline once again, is in the reminder of just how generous Wells has been in lending to junk-rated oil and gas companies in the recent past to compensate for its declining NIM: Wells reported that ~22%, or $8.8 billion, of exposure to investment grade companies, which means $32 billion is to junk-rated companies.
It also means that much more pain is in store for Wells in the coming quarters unless oil stages a dramatic comeback.
Oil did not stage a dramatic comeback. In fact, after tentatively dipping above $50, it is almost back to levels where it was three months ago. Which means that Wells’ exposure is only going to sour even more, forcing the bank to keep reserving increasingly more for future credit losses.
Which brings us to the final point. As we concluded three months ago: “here is the recap: $1.1 billion in reserves provisions (an increase of only $200MM in the quarter), a total of $1.9 billion in non-performing Oil and Gas assets, a $1.7 billion allowance for Oil and Gas credit losses, and a total of $32 billion in junk rated oil and gas exposure? Something tells us that top chart showing Wells Fargo’s declining net income will not get much better any time soon…”
We were right. In fact, as Bloomberg writes today, “provisions for credit losses more than tripled to $1.07 billion from a year earlier, tied largely to the bank’s oil and gas portfolio, while net write-offs rose about 42 percent to $924 million.” As a result, net interest income, including the loan-loss provision, declined 2.8% to $10.7 billion from a year earlier.
And the chart that ties it all together: Wells’ long overdue admission that it is woefully under-reserved for what may be a deluge of loan defaults should oil fail to rebound strongly… and certainly if oil continues to decline, has finally arrived in the form of this chart showing its LTM loan loss provision expense. It is, in a word, soaring.
We continue to expect far more pain for the bank which continues to have the biggest exposure – that we know of – to oil ang gas.
By Tyler Durden