Wells Fargo's Rising Expenses Take a Bite Out of Its Outlook

Wells Fargo
Wells Fargo

Wells Fargo's

(WFC) stock dropped by about 5% after it announced its earnings last month, due to lower than expected home mortgage originations in the first quarter compared to the previous quarter. While rising interest rates could be one factor at play in the mortgage business, the company's non-interest expenses ballooned to $12.7 billion in first quarter 2011, up by $616 million from a year ago. This includes items like salaries, incentives, benefits, insurance, advertising and promotion and outside professional services. Wells Fargo competes with other financial titans such as Bank of America (BAC), Goldman Sachs (GS), JPMorgan Chase (JPM), Citigroup (C) and UBS (UBS).

Non-Interest Expenses on the Rise

Wells Fargo's annual non-interest expenses have risen historically from $19 billion in 2005 to over $50 billion in 2010, and more than doubled in 2009 due to its acquisition of Wachovia.

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As a percentage of revenues, they have have increased from a low of 53.7% in 2008 to around of 59% in 2010. The increase has been driven primarily by high merger integration costs ($1.9 billion in 2010 and $1.1 billion in 2009) leading to increases in outside professional and contract services in 2009-10.

While we currently forecast Wells Fargo's non-interest expenses as a percentage of revenues to remain constant at 2010 levels in the future, the firm reported a rise in its non-interest expenses for Q1 which stands at almost 63% of the reported revenues. The increase is driven primarily by higher commissions and incentive compensation as compared to previous years. We currently estimate the rise in commissions and incentive compensation to be neutralized by fewer merger integration costs going forward.

However, if the non-interest expenses remain at last quarter's levels going forward, there could be a downside of as much as 10% to our $32.18 Trefis price estimate for Wells Fargo's stock. The mortgage business makes up nearly 30% and you can drag the chart above to see the sensitivity of this driver independently.

See our full analysis for Wells Fargo.

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