On Jan. 11 Wells Fargo & Company (NYSE:WFC) reported stronger than expected performance for the fourth quarter of the previous year. The earnings of $0.91 per share beat estimates by $0.02, while the top line of $21.9 billion surpassed expectations by $600 million.

Compared to the fourth quarter of 2011, EPS surged 25%, while revenues edged up 7% year over year. Average total deposits and loans surged $72 billion and $29.9 billion, respectively, over the same time period, while core loans portfolio was up $47.7 billion from the fourth quarter of 2011.

The rest of this investment analysis aims to look at the drivers of growth for the fourth quarter earnings of Wells Fargo & Company (NYSE:WFC).

Revenues

The graph above shows the contributions of net interest income and non-interest income to the total fourth quarter revenues. It is evident from the graph that the Bank of America Corp (NYSE:BAC) has a diversified business model, which is why net interest income and non-interest income have 52% and 48% contributions, respectively. Fourth quarter revenues surged 7% sequentially on growth in non-interest income, while interest income remained relatively flat compared to the same quarter last year.

A closer look into the non-interest income for the fourth quarter reveals a 28% sequential growth in service charges, trust and investment fees, and mortgage banking. Almost a third of the revenues from non-interest income were associated with mortgage banking income. Income from mortgage banking fees was $3.1 billion, up 261 million from the same quarter a year ago. The bank had $125 billion in originations, compared with $139 billion originations in the previous quarter. Originations were slow, largely due to seasonal factors.

Net interest margin decreased 10 basis points compared with the same quarter last year. This led to a slight decline in the net interest income of $10.6 billion during the fourth quarter. Much of the decline (approximately 8 basis points) was associated with a strong growth in deposits.

Expense

The bank’s non-interest expense edged up to $12.9 billion, up 3% quarter over quarter, largely on commission and incentive compensations. Commission and incentive compensations surged 5% to $2.37 billion compared to the third quarter of 2012. The efficiency ratio deteriorated from 57.1% to 58.8% over the same time period. I believe the bank needs to show some progress on the expense levels.

While most US banks have initiated cost cutting programs, WFC has not shown improvement in expense management during the fourth quarter. Bank of America Corp (NYSE:BAC) initiated a project named “New BAC” aimed at curtailing cost, partially by shedding around 30,000 consumer banking workers. Under the program, another 400 workers from the bank’s investment banking, corporate banking, and sales and trading units are expected to loose their jobs. In another example, expense control management was one of the main drivers of improvement in third quarter results for Citigroup Inc. (NYSE:C). Through this cost-cutting program, Citigroup aims to self-fund new investments. The program aims to reduce costs up to $3 billion of costs in year 2012. During the year 2013, the bank expects to eliminate 11,000 positions, which will save the bank $900 million during the year.

Business Segment Performance

Each of the business segments of WFC performed better during the fourth quarter compared to the previous quarter. Revenues from Community Banking surged 4.7%, while revenues from Wholesale Banking and Wealth, Brokerage and Retirement increased 2% and 4%, respectively.

Community banking revenues increased higher mortgage banking revenues and above-average quarterly equity gains. Revenues from Wholesale banking improved largely on broad business growth, including acquisition and solid loan and deposit growth. Higher brokerage transactions revenues and asset-based fees increased revenues from Wealth, Brokerage, and Retirement revenues.

Credit Quality

The bank demonstrated solid improvement in credit quality when it reported fourth quarter results. Net charge-offs as a percentage of average total loans fell from 1.21% at the end of the same quarter last year to 1.05% at the end of the most recent quarter, while allowance as a percentage of total loans declined from 2.27% to 2.19% over the same time period. In addition, non-performing assets declined by $1.5 billion during the fourth quarter.

Capital Position

At the end of the fourth quarter, the bank maintained a Basel I tier 1 capital ratio of 10.15%, while the Basel III tier 1 capital ratio estimate was at 8.18%. This is an improvement from 8.0% Basel II tier 1 capital ratio at the end of the third quarter of 2012. The Basel I tier 1 capital improved from 9.92% at the end of the linked quarter.

Conclusion

While Wells Fargo has continued to show growth in the top line, near-term headwinds will cause some revenue pressures. The net interest margin has continued to decline under the prevailing challenging situation, but the bank’s diversified business model is the key to growth. I believe expenses are elevated and need to go lower given the low interest rate environment. In the longer-term, WFC presents an excellent opportunity due to its potential merger with Wachovia. Credit Suisse has a price target of $38 on the bank, with the consensus price target at $38.92 for shares of WFC that are currently selling at $35.10. Therefore, I believe WFC presents an excellent opportunity for investors, and I recommend that they buy the stock.

The article Wells Fargo Reports Solid 4Q Earnings On Higher Mortgage Banking originally appeared on Fool.com.

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