Wells Fargo: Why Investors Shouldn’t Worry About NIM Compression

Wells Fargo: Why Investors Shouldn’t Worry About NIM Compression
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Shares in Wells Fargo & Company (NYSE:WFC) began to fall this morning, after the company announced earnings which trumped analyst estimates. The major worry related to the company’s report appears to be centered around the continued drop in the firm’s Net Interest Margin.

Wells Fargo: Why Investors Shouldn't Worry About NIM Compression

Wells Fargo & Company (NYSE:WFC) announced earnings of $0.91 cents per share for the fourth quarter of 2012 before the market opened this morning. Analysts had expected the firm to announce profits of just $0.89 per share. Those numbers mark an increase of 24% over the same quarter in 2011.

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The firm’s stock price fell by more than 1.5% in morning trading, despite results that trumped expectations. The major problem appears to be the bank’s Net Interest Margin, or NIM, which was compressed by 10 basis points during the quarter. The narrowing of the firm’s NIM is a trend that has been evident for a while, and is not one analysts expect to discontinue.

NIM is the per asset difference between interest earnings and expenditures. A reduced NIM means that, per asset dollar, Wells Fargo company (NYSE:WFC) made less money on its investments than it did in the previous quarter.

A Buckingham Research note released this morning in response to the earnings report said the 10 bps drop in NIM trumped their expectations. The firm had predicted that NIM would be compressed by 6 bps. Wells Fargo Company (NYSE:WFC) reported that the metric had fallen from 3.66% to 3.56%.

Today’s drop can, according to the Buckingham report, be explained by a faster than expected growth in deposits at Wells Fargo & Company (NYSE:WFC). A large sum of the extra money was placed in short term investments, at a lower interest rate. This leaves the company paying out the same amount of interest, but bringing in less, per asset dollar. The company’s deposits were 7% higher than the same quarter last year, and 3.1% higher than the third quarter.

The Buckingham report concludes that the rate of NIM compression is not as dangerous as it may seem, but the research firm expects the trend to continue. The report highlights the better than expected decline in expenses, and the firm’s earnings growth as positives. The analysts sets a price target of $38 on the company.

A Bank of America Corp (NYSE:BAC) report reaches similar conclusions about Wells Fargo’s Net Interest Margin. The company estimated that the NIM would be reported at 3.62%, missing the mark by seven basis points. The firm highlights the increase in deposits. Cash on hand, which increased by $117 billion in the quarter, was responsible for 8 bps of the 10 bps margin compression.

The bottom line is that NIM is going to be low in the current low interest rate environment. More worryingly is that, according to a Barclays report on this morning’s earnings, the NIM would have been compressed by 3 further points if it had not had a boost from variable income from various sources. The Barclays PLC (NYSE:BCS) (LON:BARC) report also suggests that the current low interest rates resulted in 5 bps of the NIM compression.

Wells Fargo performed well in the fourth quarter of 2012, but the market is still worried about the future of the bank.  Today’s earnings bode well for the other big financials, most of which are reporting next week. The NIM compression is not apocalyptic. If the economy continues to improve, deposits are likely to increase faster than the firm increases its exposure to risk, and higher interest assets. Repricing of current balance sheet items will also continue.

Wells Fargo & Company (NYSE:WFC) shares fell by 1.75% as of this writing. The firm, which has had its share price rise by about 2% so far this year, is growing faster than expected. Investors are still not convinced that the US economy can handle a bank in recovery, perhaps the financials reporting next week will sway their opinion.

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