Can Wells Fargo & Co (WFC) Make The Most of Higher Interest Rates?

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The much-awaited interest rate hike has at last happened. The Federal Reserve has taken a much longer time than one would have expected it to be. In fact, some analysts and billionaire investors viewed that the Central Bank should have hiked the interest rate at least six months in advance. The beneficiary would undoubtedly be the financial sector and some selected banks. Wells Fargo & Co (NYSE:WFC) is one among the banks to benefit from the rate hikes. The company was one of the selected few that came unscathed from the financial crisis or the least impacted by the crisis. None-the-less, the sentiments towards the financial sector, as well as, the Bank was subdued as the threat of the percolation loomed large. However, the bank did well to not only manage the credit crisis but is also looking to gain more than anyone else from the current rate hike.

Conservative And Consistent

Wells Fargo & Co (NYSE:WFC) past indicates one factor clearly. That is the company has been conservative and remains consistent in its performance. The bank is known to perform either in line with the expectations or slightly above. It was a rare phenomenon that its performance misses the Street analyst estimations. If it was able to survive the financial crisis without having to look for the bailout package, it was partly because of its conservatism and consistency. That said there was still enough scope for improving its performance. However, one could say that its upside potential might be limited compared its rivals like Bank of America Corp (NYSE:BAC). Let’s look at some of the factors behind it.

There is a strong belief that Wells Fargo & Co (NYSE:WFC) will witness a slower expansion of its net interest margin after the Central Bank hiked the interest rates. That was despite the fact about its overall asset sensitive positioning. There is no doubt that there would be an expansion, but such expansion might be slower than any investor would have imagined. The reason behind such an opinion was due to some of its recent actions. That included swap additions, as well as, the duration of extension through investment securities purchase. That was also reflected in the loans-to-earning-assets ratio in the third quarter. It was 57% compared to 62% some two years back. The company has also not revealed the changes in its composition interest rate derivatives.

How Much NIM Can Grow

Wells Fargo & Co (NYSE:WFC)’s net interest margin for the third quarter was 2.96%, which was down by ten basis points from the year-ago quarter’s 3.06%. It was a known fact that financial institutions were struggling for a better net interest margin in the absence of interest rate hike. Most recently, the company provided some hindsight of the impact due to interest rate hike. The bank expects its net interest margin (NIM) to expand 10 – 30 basis points. At the mid-point, the company is likely to gain about 20 basis points in NIM. The Fed is set to boost the interest rates at least by 75 basis points next year in three trenches.

Aside from NIM gain, Wells Fargo & Co (NYSE:WFC) has also been focusing on non-interest income. The bank is likely to continue its solid growth in fee-generating categories in the next year also. That included, service charges, card, Trust and investment management apart from other fee-based income. According to Jefferies analyst, Ken Usdin, the company could face some pressure from weaker mortgage banking revenue and equity and investment gains. His contention was that he sees lower originations reducing refinance volumes and that it could more than compensate the purchase volume growth. Also, he sees the continuous drop in servicing portfolio.

Some Key Factors To Look

There are some key factors in respect of Wells Fargo & Co (NYSE:WFC) that cannot be ignored. For instance, the bank was ranked as a number one in commercial real estate originator and middle-market commercial lender. Similarly, it occupied the numero uno status in residential mortgage origination and servicing portfolio. While the company was ranked number one in small business lender on other consumer lending, it was positioned number two in auto lending. The bank is among the top in getting retail deposits and ranked number three in total deposits. It has a balanced revenue stream with 52% of revenue coming from interest income and the rest from the non-interest category.

There are also factors that support its consistent performance. Wells Fargo & Co (NYSE:WFC) has set a target level for itself in achieving certain levels in different key parameters. Accordingly, it has set a target of 1.30 – 1.60% return on assets. In the third quarter, the company delivered 1.32% return on assets, which is only marginally better than its lower end. Similarly, it delivered 12.62% return on equity compared to its target of 12 – 15%. These two clearly suggested that there is enough room to improve its performance to reach at least the mid-point of its targeted level. The company has plans for the net payout ratio of 55 – 75%. However, its current ratio was only 60% leaving further scope to improve. The company pays a dividend regularly, and the yield worked out to 2.8%.

Conclusion

The Fed hiking rates would have a favorable impact on Wells Fargo & Co (NYSE:WFC) like any other bank. Therefore, there is bound to be upside potential. However, that might not match some of its rivals in the top four categories. But there is enough space for the company to expand its growth compared to its own target. For those who are looking for long-term, consistent, and steady growth, WFC is the right candidate. Also, its dividend yield provides an additional factor to look it as an attractive one.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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