Wells Fargo Shows Upside, Downside of Improving U.S. Economy

Wells Fargo Chief Executive Officer John Stumpf is a longtime bull about the fitful U.S. economic recovery, which his bank has ridden to record profits.

So when Wells reported fourth-quarter net income of $5.7 billion on Wednesday, it was no surprise that Stumpf used a conference call with analysts to point out that 2014 featured the nation's strongest job growth in 15 years.

At the same time, Stumpf and Chief Financial Officer John Shrewsberry acknowledged a downside of the improved economic outlook, which is that loan growth will likely lead to rising credit losses. They also indicated that other forces outside of Wells Fargo's control — specifically, low oil prices and the cost of complying with regulations — could put a crimp in the San Francisco bank's earnings in 2015.

Over the last few years, Wells' earnings have benefited substantially from reserve releases, which are often a byproduct of low loss rates on loans. But as loans grow, so usually do losses.

In the fourth quarter, Wells released $250 million in loss reserves, which was down from a $600 million release a year earlier. And with Wells Fargo's period-end loans rising by 5%, compared to a year earlier, Shrewsberry acknowledged that the company may soon need to start adding reserves, rather than releasing them.

"If we have robust loan growth going forward, all things being equal," he said, "that would contribute to the need for some amount of incremental provisioning."

Cheap energy was on the mind of several analysts, who quizzed Stumpf and Shrewsberry about the likely impact of crude oil prices on Wells Fargo's fortunes.  Roughly 2% of the bank's loans are in the oil and gas business, and about 15% of its investment banking fee revenue comes from the sector. But like other banks, Wells stands to benefit from consumers and businesses spending less to fill the gas tank.

Shrewsberry acknowledged that the price decline's impact is starting to be felt by some of Wells Fargo's commercial customers.

"This drop in crude is very recent, and the companies are taking the appropriate evasive actions to preserve cash, to de-lever, to reduce their expense base," he said. "But it hasn't worked its way into loan quality."

Meanwhile, Stumpf said that price fluctuations are normal in the energy business.

"If you go back just six years, we've had $30 a barrel oil, and we've had $140 a barrel oil," he said. "And that's just part of that business."

Wells Fargo's noninterest expenses rose to $12.6 billion in the fourth quarter, up about 5% from the same period a year earlier. That increase put Wells at the top end of its targeted range for expenses as a share of revenue, prompting questions from CLSA analyst Mike Mayo about what the company can do to reduce its expenses.

Shrewsberry made no promises in that regard, noting that Wells has been spending money on risk management and compliance activities. "And some of that is semi-permanent," he said.

Despite a few negative marks, Wells Fargo's fourth-quarter results were largely in line with analysts' expectations.

Revenue rose by 4% compared with a year earlier. One key measure of profitability, net interest margin, fell 23 basis points to 3.04% as the company's stockpile of cash and short-term investments grew.

More than any other megabank, Wells Fargo's earnings power is tied to the American economy. Ninety-seven percent of the firm's revenue comes from the U.S., Stumpf said Wednesday, before adding optimistically: "Consumer confidence is at its highest level since the peak of the last economic expansion."

But major stock indexes had fallen nearly 1% in late trading on Wednesday, and shares in Wells Fargo dropped by a similar percentage, after the release of disappointing retail sales data for December. During Wednesday's conference call, Stumpf was pushed by Nancy Bush, an analyst at NAB Research, to provide more support for his upbeat views on the economy.

Bush noted that Stumpf's predecessor, former Wells Fargo CEO Richard Kovacevich, is less optimistic, and asked what is behind the two men's differing views.

"What was his name again?" Stumpf joked, before restating his  case for bullishness.

"I don't think this is a breakout, but I think we're on the front foot," he said. "So the way I read the tea leaves, I'm optimistic."