It’s the end of the year, and real gross domestic product is down 5 percent in 15 months, while stocks have been halved, the Dow gamely trying to find a bottom above 7000. Unemployment’s at 12 percent, housing prices are in the middle of a 20 percent correction, and the severe recession has spread around the globe while the financial markets are going completely haywire. Meanwhile, central banks are sitting on their thumbs so credit spreads have blown out, pushing mortgage rates and corporate bond yields much higher.
Fortunately this isn’t a forecast but rather the “severely adverse scenario” devised by the Federal Reserve to test the soundness of the balance sheets of the largest banks as required by the Dodd-Frank financial reform legislation.
The results from the latest such annual exercise came late Thursday, and they showed that while the banks would rack up huge losses once again, the vast majority would end up with satisfactory capital ratios even if they continued to boost dividends and/or share buybacks.
The point of this oddly familiar vision of financial apocalypse is to reassure the taxpayers that they wouldn’t end up on the hook for another bailout and, more importantly for our purposes here, to allow the banks to continue to return capital as they approach the sweet spot of the credit cycle.
So yeah, let’s put aside the question of whether four years of negligible interest rates is really all it takes to fix bank balance sheets to the extent where even a depression won’t shred them. Focus instead on the 20 percent dividend hike Wells Fargo (NYSE: WFC) has just promised, and the fact that its shares are challenging a record high after breaking above a multi-year trading range.
To get paid, “as long as the music is playing you’ve got to get up and dance,” in the immortal words of former Citigroup (NYSE: C) CEO Chuck Prince. Chuck got paid and we can too, with the added satisfaction of knowing, thanks to the Fed, that we won’t maim the banking system with our dancing.
Wells Fargo’s new quarterly dividend of 30 cents a share works out to an annual dividend yield of 3.2 percent, and will cost the bank $6 billion this year. Wells will spend at least another $4 billion, and possibly considerably more, on share buybacks, which it has said will exceed last year’s.
All of this is very affordable considering Wells Fargo earned $18 billion of net income in 2012, and should approach nearly $20 billion this year. The bank passed the Fed’s stress test by a comfortable margin, and looks to be among the exercise’s biggest winners.
Bank of America (NYSE: BAC) shares are actually up a little more in the early going, after the Fed approved a surprisingly generous $5 billion share buyback. (We reviewed that bank’s bullish prospects at the end of last year, when the stock was 10 percent cheaper, and it was even lower two weeks ago before a 14 percent uphill sprint.)
But Bank of America, with its piddly $4.2 billion 2012 profit on revenue comparable to Wells Fargo’s, is years away from catching its healthier rival. So is Citi, whose shares, like Bank of America’s, have run some 30 percent in the last year while Wells Fargo’s ticked up less than 10 percent. Year to date, Citi’s stock has been leading the charge, followed by JPMorgan Chase (NYSE: JPM).
And while JPMorgan Chase received approval for a $6 billion share buyback and a 27 percent hike in dividend, it will have to take a “make-up” exam in the fall alongside Goldman Sachs (NYSE: GS) to allay the Fed’s concern about these firms’ ability to estimate potential losses.
And meanwhile JPMorgan’s top executives are tied up once again on Capitol Hill explaining how they countenanced, and briefly concealed, the multi-billion “London whale” trading losses. The bank’s own report on that fiasco as well as a congressional follow-up have revealed that its internal controls are sorely lacking, especially given the mind-boggling complexity of the business.
So Wells Fargo is not rebuilding the franchise like Bank of America or Citi, and it’s not still enmeshed in global trading with all its financial and regulatory pitfalls like JPMorgan or Goldman, nearly three years after passage of the Volcker Rule that was supposed to curtail the gambling.
Instead, Wells Fargo is the strongest big bank with the greatest exposure to the reviving real estate market. More than $10 billion of last year’s income came from the booming mortgage loan origination business, which doubled its 2011 gain without taxing the capital ratios. Wells Fargo originated mortgages worth $524 billion last year, yet retained just $19.4 billion for investment.
Its net interest rate margin, the spread between the bank’s cost of funds and return on those funds, remains the envy of the industry at 3.56 percent, but has declined modestly over the last three years as investing yields fell, deposits rose and the bank remained cautious about taking on assets.
This caution may now be dissipating somewhat as longer-term rates and loan demand perk up alongside housing. Certainly, Wells has plenty of other people’s money to invest if and when it should judge the potential returns worthwhile: core deposits increased 8 percent to $946 billion last year.
Those deposits tend to bring other business: Wells leads the industry by cross-selling six products to the average customer, everything from credit cards to financial advice. The bank also knows how to milk deposits for fees: last year it earned an extra $403 million for a total of $4.7 billion in deposit service charges, partially reversing the hit from stricter regulation of such fees the prior year. Wells Fargo also earned $4.2 billion in trust, investment and IRA fees, $1.4 billion from mortgage servicing and $470 million in ATM network fees last year.
Meanwhile, non-interest costs rose just 2 percent, mostly from extra commissions and expenses, thanks to cost savings in the wake of the Wachovia acquisition. That deal, struck in the dark days of 2008, certainly hurt the balance sheet in the near term. But it also turned Wells into a truly national bank with a strong presence on both coasts, and gave it lots of extra deposits to milk and lots of branches to bring up to the Wells marketing standards.
The Fed’s stress test didn’t say that Wells Fargo is the strongest and best US bank with a stock that’s due to do some catching up to peers after finally breaking out. But the market appears to have read between the lines and traded accordingly.
Igor Greenwald is an investment analyst with The Energy Strategist.
1 Comment So Far
Leave a Reply
Our comments section is reserved for productive dialogue pertaining to the content and portfolio recommendations of this service. We reserve the right to remove any comments we feel do not benefit other readers. If you have a personal question about your subscription or need technical help, please contact our customer service team. Thank you.
You must be logged in to post a comment OR register below.