Encouraging Outlook if Wells Fargo Can Reduce Non-Interest Expense

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Wells Fargo ( WFC ) is a diversified financial services company headquartered in San Francisco. It is the fourth largest bank in the U.S. by assets and the second largest bank by market cap. It is also the second largest bank in deposits, home mortgage servicing, and debit cards in the United States. Wells Fargo's competitors include banks such as Bank of America ( BAC ), Goldman Sachs ( GS ), JP Morgan ( JPM ), Citigroup ( C ) and UBS (UBS).

We estimate that the mortgage business is the largest contributor of value to Wells Fargo, accounting for 28% of our $33.81 price estimate for the company's stock. Other divisions contributing significantly to Wells Fargo's value include asset management & brokerage and securities & trading, each making up about 19% of the company's equity value.

See our full analysis and $33.81 price estimate for Wells Fargo

Rising Non-Interest Expenses

During its Q4 2010 earnings call in mid-January, Wells Fargo highlighted an emphasis on "reducing expenses, being more efficient and nimble" and "limiting the impact of regulatory reform costs on our customers".

We recently discussed the improvement in Wells Fargo's loan portfolio observed during Q4 2010, which was driven in part by strong loan demand and decreased net charge-offs. Net charge-offs declined to 2.02% of average loans in the fourth quarter, considerably lower than the 2.71% observed a year earlier and the 2.14% seen in Q3 2010.

Despite optimism following strong top line growth and a decline in net charge-offs during Q4 2010, we believe that non-interest expenses still pose a concern for Wells Fargo's outlook. In 2010, Wells Fargo's non-interest expense as a percentage of total revenues increased to 59.2% (up 4.4% from a year earlier), driven by increases to salaries, compensation & incentive expenses, foreclosed assets expenses and operating losses.

We currently estimate that Wells Fargo's non-interest expense will remain at these current high levels going forward. However, a decline in non-interest expenses as a percentage of revenues back to 2009 levels would imply roughly 13% upside to our $33.81 price estimate for Wells Fargo stock. Below are a some factors that could contribute towards lower non-interest expense for Wells Fargo.

1. Salary Cost Reductions

With cost reduction a high priority, Wells Fargo is planning to take measures that could result in employee terminations. While the size of the potential layoffs is unclear, the reduction in salary and incentive-based expenses, currently more than 40% of the company's non-interest expenses, could present upside.

2. Fewer Merger-Related & Other Expenses Going Forward

While Wells Fargo will witness fewer merger-related expenses going forward, it will enjoy cost saving arising from merger synergies. Also, costs like foreclosed asset expenses are likely to decline significantly in the future as economic conditions improve. These developments should pave the way for a reduction in non-interest expenses as a percentage of revenues.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas , Stocks , US Markets
Referenced Symbols: BAC , C , GS , JPM , WFC

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