Buy Wells Fargo: Jefferies

NEW YORK ( TheStreet) -- Jefferies Analyst Ken Usdin on Monday initiated his firm's coverage of Wells Fargo with a buy rating, saying "the bank's bias is to return capital to shareholders and provide for growth in the near-term."

Wells Fargo's shares closed at $33.05 Friday, trading for just above tangible book value, according to Thomson Reuters Bank Insight, and for nine times the consensus 2013 earnings estimate of $3.66 a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $3.29.

The shares trade significantly higher by both measures than those of the other three members of the "big four" club, reflecting Wells Fargo's stronger and more consistent earnings performance. The company's operating returns on average assets (ROA) have ranged between 1.21% and 1.30% over the past five quarters, according to Thomson Reuters Bank Insight.

Usdin said that "when thought of in relation to the universal banks, Wells has a simpler business model with a smaller balance sheet and potentially stronger growth potential." Here's how the other three "big four" members compare:
  • Shares of JPMorgan Chase (JPM) closed at $33.90, returning 4% year-to-date, following a 20% decline during 2011. The shares trade just below their reported March 31 tangible book value of $34.91, and for six times the consensus 2013 EPS estimate of $5.30. The consensus 2012 EPS estimate is $4.30. The company will kick-off bank earnings season before the market opens on Friday, with analysts polled by Thomson Reuters expecting a 79-cent profit, declining from EPS of $1.31 the previous quarter and $1.27 a year earlier. Investors of course continue to wonder just how much in second quarter trading losses the company will report, after CEO James Dimon disclosed a hedge trading loss by its Chief investment Office (CIO) estimated at "slightly more than $2 billion," on May 10. JPMorgan's operating ROA has ranged between 0.68% and 1.06% over the past five quarters.
  • Shares of Bank of America (BAC) closed at $7.66 Friday, returning 38% year-to-date, after dropping 58% during 2011. The shares trade for 0.6 times their reported March 31 tangible book value of $12.87, and for eight times the consensus 2013 EPS estimate of 97 cents. The consensus 2012 EPS estimate is 56 cents. Bank of America will report its second-quarter results on July 18, with analysts expecting earnings of 15cents a share, compared to a three-cent profit during the first quarter, and a net loss of 90 cents a share in the second quarter of 2011, when the company entered into an $8.5 billion mortgage putback settlement with private investors. Bank of America's operating ROA over the past five quarters has ranged from a negative 1.51% to a positive return of 1.08%.
  • Shares of Citigroup (C) closed at $26.36 Friday, for a flat year-to-date return, following last year's 44% decline. The shares trade for just over half their reported March 31 tangible book value of $50.90, and for less than six times the consensus 2013 earnings estimate of $4.56. The consensus 2012 EPS estimate is $3.95. Citi will report its second-quarter results on July 20, with analysts expecting earnings of 92 cents a share. The consensus EPS estimate for all of 2012 is $4.01. The company's operating ROA has ranged between 0.20% and 0.67% over the past five quarters.

Wells Fargo will report its second-quarter results on July 13, with the consensus estimate being an 81-cent profit, increasing from 75 cents the previous quarter and 70 cents a year earlier. Usdin estimates the company will report second-quarter operating earnings of 81 cents a share, but his EPS estimate of $3.25 for all of 2012 is slightly behind the consensus estimate of $3.29.

Usdin said his $39 price target for Wells Fargo "implies an 11x multiple on our 2013 EPS estimate of $3.55," which is "modestly below the bank's historical forward multiple of 13.8x (from 2001-present)," with the lower multiple accounting "for lower post-cycle growth, lower leverage as a result of Basel III capital rules, and higher-than-historical regulatory risk."

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Jefferies expects Wells Fargo to make "$8.5B of capital distributions in '12 and just under $12B in '13," with the company "targeting 50%-65% of annual earnings" for dividends and share repurchases. Despite the drag on share valuation from the enhanced Basel III capital requirements, Usdin said "the overall glide path to Basel III is manageable, as we believe Wells can generate 5bp-10bp of Tier 1 common capital per quarter even while returning sizable amounts of capital to shareholders."

Like most large U.S. banks, Wells Fargo is facing continued margin pressure, and the strong mortgage volume over the past two quarters will make for some tough comparison when refinancing activity slows.

Wells Fargo reported a 2012 net interest margin -- the difference between a bank's average yield on loans and investments and its average cost for deposits and wholesale borrowings -- of 3.94%. With short-term rates remaining near zero for a prolonged period, banks are approaching the point where they will no longer be able to significantly lower their funding costs as long-term rates continue to decline. Usdin said he expected Wells Fargo's net interest margin to decline to 3.70% in 2013, "with a 3.63% low-point in 4Q13," but also said "we expect Wells to be able to maintain its net interest income trajectory over time through balance sheet expansion (led by deposit growth)."

Wells Fargo's record first-quarter earnings were driven by $129 billion in mortgage originations, increasing from $120 billion in the fourth quarter and $84 billion in the first quarter of 2011.

Looking forward, comparison's with the last two quarters' mortgage volumes -- reflecting the huge demand form President Obama's expansion of the Home Affordable Refinance Program, or HARP, which allows qualified borrows with mortgage loans held by Fannie Mae ( FNMA) or Freddie Mac ( FMCC) to refinance their entire loans balances at the current historically low rates, no matter how much the value of the collateral property has declined -- could "become a headwind in coming years."

"Mortgage banking has been a hugely profitable, but volatile, earnings stream for Wells Fargo, ranging between 8% and 15% of revenue in recent quarters," Usdin said, adding that "we believe volatility will continue, potentially overshadowing core business growth trends and market share gains."

Commenting on the bank's long-term earnings success, Usdin said "the most notable aspect about the Wells Fargo culture is its emphasis on cross-selling and its ensuing success. While the notion of cross-selling has been the holy grail of the banking industry for years, few actually do it well," and Well Fargo has increased "the average number of retail products per customer to 5.98 in 1Q12, compared with 4.35 in 2003." This helped the company grow its revenue at a compounded annual growth rate of 10% from "2000 to 2007 (compared to 6% for the industry)," Usdin said, adding that "while revenue growth has hit a soft patch recently, cross-sell remains important to the bank's overall strategy as the company looks to increase its product penetration to 8.0 per customer over time."

Interested in more on Wells Fargo? See TheStreet Ratings' report card for this stock.


-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.