Wells Fargo (WFC) Q2 Earnings Miss Estimate, Expenses Up

Impacted by higher expenses, Wells Fargo & Company 's WFC second-quarter 2016 earnings recorded a negative surprise of about 1%. Earnings of $1.01 per share missed the Zacks Consensus Estimate by a penny. Moreover, it compared unfavorably with the prior-year quarter's earnings of $1.03 per share.

Shares of Wells Fargo decreased more than 1% in the pre-market session, indicating that investors are bearish on the results. The price reaction during the full trading session will give a fair idea about the extent of disappointment.

Wells Fargo witnessed organic growth aided by higher revenues along with strong loans and deposit balances. Moreover, a strong capital position along with returns on assets and equity acted as the primary drivers. However, higher provisions and expenses were a concern.

Notably, reserve build of $150 million was recorded in the quarter driven by loan growth. Second-quarter net income applicable to common stock came in at $5.2 billion, down 3.7% year over year.

The quarter's total revenue came in at $22.2 billion, in line with the Zacks Consensus Estimate. Revenues inched up around 4.2% on a year-over-year basis.

Furthermore, on a year-over-year basis, revenue generation at the business segments was impressive. Community Banking and the Wholesale Banking segments' total quarterly revenue jumped around 1.7% and 10.6%, respectively, while Wealth, Brokerage and Retirement segment's revenues decreased 2.5%.

Wells Fargo & Company (WFC) EPS BNRI & Surprise Percent - Last 5 Quarters | FindTheCompany

Loans and Deposits Rises, Costs Surged

Wells Fargo's net interest income in the quarter came in at $11.7 billion, up 4% on a year-over-year basis. Increased interest income from trading assets and loans drove the results. However, net interest margin decreased 11 basis points year over year to 2.86%.

Non-interest income at Wells Fargo came in at around $10.4 billion, up 4% year over year, mainly due to elevated lease income and net gains from debt securities and trading activities. These positives were partially mitigated by reduced net gains from equity investments, insurance and mortgage banking revenue.

As of Jun 30, 2016, total loans were $957.2 billion, increasing 7.7% on a year-over-year basis. Growth in both the commercial and consumer portfolios contributed to the rise. Total deposits were $1.2 trillion, up 5% from the prior-year quarter.

Non-interest expense at Wells Fargo was $12.9 billion, up 3% from the prior-year quarter. The rise in expenses was primarily due to higher salaries and equipment expenses along with elevated employee benefits.

The company's efficiency ratio of 58.1% was below 58.5% recorded in the prior-year quarter and within the targeted efficiency ratio range of 55%-59%. A fall in efficiency ratio indicates a rise in profitability. Wells Fargo hopes to operate at the high end of its targeted efficiency ratio range in 2016.

Credit Quality: A Cause of Concern?

Wells Fargo's credit quality metrics deteriorated in the quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $12.7 billion as of Jun 30, 2016, increasing from $12.6 billion as of Jun 30, 2015.

Provision for credit losses was $1.07 billion, significantly up year over year from $300 million. Net charge-offs were $924 million or 0.39% of average loans in the reported quarter, up from the prior-year quarter net charge-offs of $650 million (0.30%). Non-performing assets fell 9% to $13.1 billion in the quarter from $14.4 billion in the prior-year quarter.

Strong Capital Position

Wells Fargo has maintained a solid capital position. The company purchased 44.8 million shares of its common stock in the second quarter.

Wells Fargo's Tier 1 common equity under Basel III (fully phased-in) increased to $145.6 billion from $139.9 billion in the prior-year quarter. The Tier 1 common equity to total risk-weighted assets ratio was estimated at 10.6% under Basel III (fully phased-in) as of Jun 30, 2016, in line with the prior quarter.

Book value per share increased to $35.38 from $32.96 in the prior-year quarter.

Our Viewpoint

Though Wells Fargo has reported decent revenue growth, we expect top-line headwinds to persist, given the prolonged economic recovery and further interest rate hike uncertainty. With the thrust of banking regulations, there will be pressure on fees and loan growth. Moreover, rise in expenses and higher provisions were a major drag.

We believe that in the long term, investors will not be disappointed with their investment in Wells Fargo, given its diverse geographic and business mix, which enables it to sustain consistent earnings growth. Going forward, we believe that strategic acquisitions will help the company expand its business and enhance profitability.

WELLS FARGO-NEW Price, Consensus and EPS Surprise

WELLS FARGO-NEW Price, Consensus and EPS Surprise | WELLS FARGO-NEW Quote

Currently, Wells Fargo carries a Zacks Rank #4 (Sell).

Meanwhile, banking major - JPMorgan Chase & Co. JPM - which kicked started the second-quarter earnings, driven by improved trading revenues, reported earnings of $1.55 per share, neatly outpacing the Zacks Consensus Estimate of $1.43. Also, the figure reflects a 1% rise from the year-ago period. Notably, the results included a legal benefit of $430 million.

Among the other Wall Street giants, Bank of America Corporation BAC is scheduled to report second-quarter 2016 earnings on Jul 18, while Comerica Incorporated CMA will report on Jul 19.

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

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

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