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
),
JPMorgan Chase
(
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. This represents a slight premium of 5% to
the market price. Below we show the main drivers of Wells Fargo's
mortgage business and the factors that affect them.
Average outstanding balance on home mortgage loans will
increase
Wells Fargo home mortgage portfolio includes family first
mortgages and family junior lien mortgages. The graph above
represents the average annual outstanding balance on Wells Fargo's
home mortgage loan portfolio on which the firm earns interest
income. The average outstanding balance on home mortgage loans has
increased significantly from $122 billion in 2006 to $337 billion
in 2010. The sharp increase in 2009 was due to acquisition of
Wachovia's home mortgage portfolio.
We forecast a sharp increase in outstanding balance on home
mortgage loans going forward driven by the following factors:
1. Wachovia acquisition provides new opportunities
With the acquisition of Wachovia, Wells Fargo will now have
access to newer households. Since the cross-sell (number of
banking products sold per customer) at Wachovia has been
traditionally lower than that at Wells Fargo, this will provide
additional opportunities for expansion. These factors will
positively impact average outstanding balance on home mortgage
loans in the future.
2. Loosening of lending standards will boost demand
Following the economic downturn in 2008-09, the average 30-year
fixed-rate mortgage dropped to the lowest levels on record. As the
economic conditions improve and assuming rates on mortgages remain
low, in an effort to boost demand, home sales will increase back
leading to new mortgage originations and higher average outstanding
balance on home mortgage loans in the future.
Fewer writedowns in the future will increase
profitability
Provisions for credit losses is a charge to income which
represents an expense given the composition of a bank's credit
portfolios, the probability of default, the economic environment
and an allowance for credit losses already established. The chart
above represents the provisions for credit losses on home mortgage
loans as a percentage of average home mortgage loans
outstanding.
Provisions as a percentage of mortgage loans outstanding
increased sharply to 4.6% in 2008 primarily due to sub-prime
mortgage mess in the U.S. which resulted in high default rates and
hence increases in net charge offs on home mortgage loans.
It declined back in 2009 to 3% despite an increase in net
charge offs as the average home mortgage loans more than doubled
due to Wachovia acquisition. In 2010, it declined further to
2.4% as there were fewer defaults on loans and thus fewer write
downs with the improvement in the economic environment.
Going forward, we expect, the provisions for losses on home
mortgage loans will decline even further dropping slowly back to
historical levels of 0.2%-0.4%. Below are some of the factors that
will lead to a decline in provision for credit losses on home
mortgage loans outstanding:
1. Lower charge-offs as economy recovers
Charge-offs for home mortgage loans were 2.35% at the height of
the economic recession in 2009 which were much higher than
historical level of around 0.18%. Trefis forecasts charge-off
rate will decline in the future as economic conditions in the U.S.
improve.
2. Stricter regulations on banking industry
Due to the economic recession of 2008-2009, regulations on the
banking industry have increased and lending requirements have
become stricter. Also, banks have become more conservative in
lending. These factors will lead to a decline in home loan defaults
and thus provision for credit losses on home mortgage loans in the
long run.
You can drag the trend lines above to see the impact of
various home mortgage outstanding loan balance and credit losses
scenarios on Wells Fargo's stock.
See
complete analysis of Wells Fargo's stock
.