) was one of the banks to emerge the strongest after the financial
crisis. As capital markets improve, we foresee Wells benefiting
from its expanded presence in many markets relative to peers like
Bank of America (
), Goldman Sachs (
), Citigroup (
) and UBS (UBS).
Below we look at the key factors to watch in the coming months that
our $33.81 price estimate
, which is around 10% ahead of the market price.
1. Rising Rates Will Lift Net Interest Income
As a result of the economic recession, the U.S. government
decreased the prime loan interest rate from high levels of around
8.25% in 2006-2007 to 3.25% in 2010. As the economic conditions
remain uncertain, the prime rate is expected to remain low through
However, as interest rates rise slowly back to historical levels
beyond 2011 with improvement in economic environment, Wells Fargo's
interest income will be positively impacted.
2. High Core Deposits and Low Cost of Funding
While an increase in prime loan rates will likely impact both
interest income as well as interest expense for Wells Fargo, the
fact that Wells Fargo derives the majority of its funding from low
cost core deposits will help the firm restrain its interest expense
even as interest rates increase and thus boost its net interest
margins. Wells Fargo has to pay lower interest rates on its
core deposits as compared to long term debt and short term
borrowings. Also Wells Fargo's average cost of deposits at 0.35%
was the lowest in the industry and half of the peer average of
0.70% in 2010 making its cost of funding the lowest in the
Wells Fargo's net interest margin (interest earned on earning
assets minus interest paid on funding sources as a percentage of
interest earning assets) of 4.86% (10 year average 2001-2010) has
been significantly higher than the peer group average of 3.39% in
the banking industry. The peer group includes banks like Citigroup,
JPMorgan Chase, Bank of America, etc. The high net interest margins
at Wells Fargo have, in large part, been attributed to its large
low cost average core deposits (which include non-interest-bearing
deposits, interest-bearing checking, savings certificates, market
rate and other savings, and certain foreign deposits).
In Q4'10, nearly 67% of Wells Fargo's funding comes from
deposits which again is way higher than peer average of only 49%.
In 2009, nearly 93% of Wells Fargo's total average loans were
funded from its average core deposits.
As such while we forecast the net interest yield on home
mortgage loans to remain constant going forward (see rationales), a
gain of 1% in net interest yield over our forecast period driven by
the above factors could result in an upside of 5% to our $33.81
Trefis price estimate for Wells Fargo's stock. The upside will be
even more pronounced if the increase in net yield occurs across
Wells Fargo's different loan segments and asset classes.
3. Expanded Customer Base
Wells Fargo's cross-sell, meaning number of products sold to a
banking customer, has risen historically. The cross-sell increased
from 4.8 in 2005 to nearly 6 in 2009 for the old Wells Fargo (or
5.47 from combined Wells Fargo and Wachovia). In 2010 cross-sell
further increased to 5.70.
A direct positive correlation exists between cross-sell and
revenues for banks. As such while the cross-sell for Wells Fargo's
wholesale and retail banking increased at annualized rate of ~6%,
Wells Fargo's revenues increased at an annualized rate of ~9%
(excluding the increase in revenue due to Wachovia acquisition). As
the industry recovers and following the Wachovia acquisition, we
believe there are fresh cross-selling opportunities for Well Fargo
that will help support revenue growth.
You can drag the trend lines above to see the impact of
various scenarios of home mortgage loans' net interest yield and
outstanding loans on Wells Fargo's stock.
complete analysis of Wells Fargo