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Wells Fargo: Fed Lawsuit Loser

Stocks in this article: WFC STI JNJ GS XLF I:BKX

Wells Fargo's shares trade at much higher to book value than the other three members of the "big four" U.S. banking club, reflecting the firm's stronger and more consistent earnings. According to Thomson Reuters Banking Insight, the company's return on average assets for the 12-month period ended June 30 was 1.30%, while its return on average tangible common equity was 15.86%.

The company will report its third-quarter results on Friday, with a consensus EPS estimate of 87 cents a share, increasing from 82 cents in the second quarter, and 72 cents during the third quarter of 2011.

With the mortgage refinancing wave continuing, analysts expect another solid quarter for Wells Fargo's mortgage production and gains on sale of new loans, but the company has already signaled that it will report a major narrowing of its net interest margin, which is the spread between a bank's average yield from loans and investments and its average cost for deposits and borrowings.

At a conference on Sept. 11, Wells Fargo Wells Fargo CFO Tim Sloan said that although the company achieved a "stable" net interest margin during the second quarter, in part because of "a 7 basis point linked quarter benefit from higher variable items," the margin for the third quarter "could be similar to what we experienced in the third quarter of last year when our net interest margin was down 17 basis points."

According to Guggenheim Securities analyst Marty Mosby, among the largest U.S. bank holding companies, "Wells Fargo has the most margin compression today expected over the next year," as the company has a large percentage of assets with original maturities of greater than three years, that are "repricing down now, lower than they were three years ago."

Oppenheimer analyst Chris Kotowski rates Wells Fargo "Outperform" with a 12-18 month price target of $40, saying on Sept. 25 that "we think deposit growth will help offset some of the margin contraction and mortgage banking revenue has been very strong and is likely to continue to be so for the back half of the year."

"With WFC, the risk to the downside is always on the expense side, and the company has had to pull back on some of the earlier promises made to get its quarterly expenses in the $11B range," Kotowski said, adding that "while we are modeling $11.8B in expenses for this quarter and $11.5B for next, we realize that is nudging up against the guidance and that if Wells misses, it is the likeliest to be there."

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