Wells Fargo & Co (WFC), And One Type Of Play In This Space

With the sluggish U.S economic recovery, major banks in the country are finding it difficult to report impressive growth figures. Adding to the miseries, the pending Dodd-Frank reform and Basel III norms will further crunch the banks financially and maybe even slowdown their growth. In such a scenario, aggressive banks often increase their leverage to boost their gains, but Wells Fargo & Co (NYSE:WFC) has discovered a new growth avenue for itself.

A new growth avenue

Wells Fargo & Co (NYSE:WFC) has teamed up with Dublin-based Avolon Capital Partners to enter the aircraft leasing business. Usually commercial banks either lend money or own an interest in aircraft companies, but Wells Fargo begins with a $500 million portfolio and 10 jets, which it will own and which will be available for leasing.

As of now, Wells Fargo & Co (NYSE:WFC) has ordered the latest The Boeing Company (NYSE:BA) 737 Max and Airbus A320neo, which consume 12% to 16% less fuel as compared to the typical A320. Airline travel is already peaking and companies are reporting record load factors, due to which the demand for aircraft leasing is expected to increase.

Meanwhile, it is the fuel-efficient aircraft which will benefit over the long run. With the rising environmental concerns and high oil prices, airlines have begun shifting to fuel-efficient aircraft, and Wells Fargo & Co (NYSE:WFC)’s fleet could comfortably replace the less-efficient aircraft. Since aircraft-leasing is a $110 billion industry, it is highly probable that Wells Fargo increases its leasing portfolio with time.

Lower refinancing?

Thanks to the recovering investors’ confidence and rising disposable income in a low-interest-rate environment, Wells Fargo & Co (NYSE:WFC) funded around 25% of total U.S mortgages in 2012. For the first quarter, its loan origination business stood at $109 billion, while mortgage banking accounted for 13% of its overall revenue and 23% of its fee income.

Its wholesale-banking segment reported record quarterly net income of $2 billion (rising 9% year-over-year), which accounted for 38.9% of its net income. Its net income stood at approximately $5.2 billion, which rose by 22% compared to last year’s quarter.

But results received mixed response because its mortgage originations were $14 billion lower on a sequential basis. Its management acknowledged the slowdown, and stated that mortgage income and revenue could slip further. Furthermore, its net interest margins shrank by 8 bps, which added to the disappointment. But I’m still bullish on Wells Fargo

Peer talk

This is because JPMorgan Chase & Co. (NYSE:JPM) recorded loan originations of $52.7 billion, which rose by 37% compared to last year’s quarter. Although interest margins were under pressure, its massive loan originations revived hope for Wells Fargo & Co (NYSE:WFC), indicating that growth prospects in mortgage banking are still there.

For the recent quarter, JPMorgan Chase & Co. (NYSE:JPM) posted a 33% surge in its net income and posted a record quarter, yet the Street wasn’t delighted with these results. This was because the bank’s revenue slipped by 3%, while its net interest income fell by 6%. Furthermore, the bank released $1.2 billion in loan-loss reserves to bolster its earnings, but it effectively lowered JPMorgan Chase & Co. (NYSE:JPM)’s risk-taking capacity.

Goldman Sachs Group, Inc. (NYSE:GS) also posted mixed results. Its quarterly revenue from investment banking rose by 36% y-o-y, while its quarterly net income rose by 5%. This was bolstered by its lending and investing businesses, which raised $2 billion in capital and saved some grace.

However, its operational expenses rose by 36%, which, coupled with a 7% decline in bond-trading revenue, has raised some eyebrows. Analysts believe the upbeat results were a “one-time” thing, thanks to a pickup in bond underwriting, which was primarily driven by low interest rates and $85 billion worth of liquidity injections.

A short conclusion

At the current prices, shares of Wells Fargo & Co (NYSE:WFC), JPMorgan and Goldman Sachs Group, Inc. (NYSE:GS) trade at forward earnings multiples of 9x, 8x and 9x, respectively, indicating that these banks are undervalued.

Although analysts expect their annual EPS to grow around 7% each for the next five years, I believe that Wells Fargo would make a better pick due to the housing recovery and its aircraft-leasing business.

The article A Value Play in Banking originally appeared on Fool.com and is written by Piyush Arora.

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