Wells Fargo’s Positive Earnings Benefit From Wachovia Acquisition And Accounting Changes

Wells Fargo & Co. (WFC) reported its 1Q09 results (for the newly combined Wells Fargo-Wachovia) Wednesday morning. Net income applicable to common stock was $2.38 billion or $0.56 per common share. The results were in-line with the pre-announcement made by the bank on April 9, 2009.

The company reported that the Wachovia merger is on track, and it expects to realize $5 billion of annual merger-related savings, which will begin emerging in 2Q09. During the current quarter, 41% of combined revenue came from Wachovia.

The bank’s net interest margin improved to 4.16%, and is now highest among large bank peers. Obviously, the banks are benefiting from near-zero funding rates. Total core deposits of $756.2 billion at March 31, 2009, were up 6% from $745.4 billion at December 31, 2008.

WFC reported $101 billion in mortgage originations during the quarter, providing loans to more than 450,000 people — mostly for refinancing. With mortgage rates at record lows, there is a rush to refinance existing mortgages. Mortgage-related revenues are rising at banks like BB&T (BBT), JP Morgan Chase (JPM), Citigroup (C) and Bank of America (BAC).

It appears that WFC also benefited from a larger share in the mortgage markets after acquiring Wachovia, and also from the demise of some smaller players.

Tangible Capital Equity ratio (TCE) improved to 3.28% from 2.86% at December 31, 2008. However, we think this TCE ratio is still low.

Credit quality deteriorated sharply with net charge-offs, rising to $3.26 billion, or 1.54% of average loans. Nonperforming assets, increased to $12.61 billion, or 1.5% of total loans. Allowance for credit losses was $22.8 billion at March 31, 2009.

The bank also benefited from the revised rules on mark-to-market accounting (FSP FAS 157-4) as its net unrealized loss on securities (AFS) declined to $4.7 billion at March 31, 2009, from $9.9 billion at December 31, 2008 — of which $850 million was due to declining interest rates and narrower credit spreads, and the remainder was due to the early adoption of the revised rule.

We are maintaining Hold recommendation on the shares.

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