Through the financial crisis that is now referred to as the Great Recession, there were two banks that seemed to come out ahead. Wells Fargo & Company (NYSE:WFC) and JPMorgan Chase & Co. (NYSE:JPM) have been singled out as examples of how to manage through a crisis. Each company has returned to their old dividend raising ways, and some would suggest that they are the measuring stick by which other banks should be measured. That being said, Wells Fargo’s recent earnings report shows that there could be some cracks in the foundation of this theory.
Quality Means Everything
If there is anything investors have learned over the last few years, it’s to watch the credit quality at financial institutions. When a bank’s credit quality breaks down, it causes management to pull in the reins on loan growth. Lower credit quality also leads to many extra expenses to manage these problem loans. Since Wells Fargo has gotten a lot of attention for the amount of mortgage loans the company is originating, it makes sense to watch their mortgage credit quality carefully.
Banks report credit quality in terms of non-performing loans to total loans. The higher the percentage of non-performers, the bigger challenges the bank will face. Having worked in banking for 10 years, I’ll tell you from personal experience, once a loan gets to 60+ days past due there is a high likelihood of it defaulting.
In the current quarter, one of the banks with the best credit quality was BB&T Corporation (NYSE:BBT) at just 1.2% of non-performers. By comparison, even Bank of America Corp (NYSE:BAC) showed non-performers at 2.62%. However, Bank of America’s percentage includes other real estate owned, which means properties that have already been foreclosed on. This means without other real estate owned, Bank of America’s ratio would have been lower. On the surface, J.P. Morgan’s non-performing percentage of 3.12% looks worse than Wells Fargo at 2.56%. However, beyond the headline number, there is a big issue at Wells.
Wells Fargo’s largest percentage of non-performers is from 1-4 family real estate mortgage loans. Since 55.92% of non-performers for the company come from these loans, investors should be concerned. Wells Fargo has garnered headlines for their huge increase in first mortgage production. The bad news is, their non-performing percentage in this category is 4.58%. If this high percentage continues, Wells Fargo’s non-performing assets percentage will only get worse.
Organic Growth Is What Really Matters
If Wells Fargo isn’t doing quite as well as J.P. Morgan or BB&T, there seems to be a pretty clear connection between organic growth and bottom line results. In traditional banking there are two numbers that define the success or failure of a bank. Great banks are able to grow loans and deposits, lesser banks are not able to do so.