Wells Fargo Doth Protest Too Much

Source: The Motley Fool

Statements by corporate executives -- even the absolute best in their respective fields -- should be taken with a grain of salt. At the very least, you should trust but verify.

I was reminded of this when reading through the material that Wells Fargo distributed for its third-quarter earnings release.

To be clear, the California-based bank is one of the best in the business. And it's led by some of the most talented men and women in the financial world.

But that doesn't mean they aren't capable of a little smoke and mirrors -- albeit of the most innocent variety compared to many of their contemporaries at other banks.

What I'm referring to is its executives' repeated references to the bank's diversified business model -- as I've discussed before, this is something that's very much in vogue right now among bankers.

"Our diversified business model and strong risk discipline contributed to record earnings per share along with continued strength in return on assets, return on equity and capital," CEO John Stumpf said in the bank's earnings release.

On the conference call, CEO Timothy Sloan referred to the bank's underlying diversification of revenue streams no less than three times in the first four paragraphs of his prepared remarks.

And in response to an analyst's question about the difficult interest rate environment, Stumpf brought the issue back to, yes, diversification, analogizing Wells Fargo to a stagecoach being pulled by "85 to 90 horses."

After the third or fourth time I heard this point, I couldn't help but think of the famous line from Hamlet: "The lady doth protest too much, methinks."

The point Wells Fargo's executives are trying to make is that even though it's the largest mortgage originator in the country (click here for a chart of the top five), it isn't solely reliant on the mortgage industry for growth and profitability.

As Stumpf alluded to, Wells Fargo has dozens of business lines that generate revenue -- from credit cards, to trust and investment divisions, and everything in between.

But while this is true, and despite Stumpf and Sloan's best efforts to divert our attention, the reality is that last quarter showed perhaps more than any other just how reliant Wells Fargo is on mortgages for growth.

If you exclude the precipitous decline in Wells Fargo's loan loss provisions, its pre-tax, pre-provision profit would have fallen by 8.2% on a year-over-year basis. This is a far cry from the 1% increase in net income it actually recorded.

And what was behind the drop?

The primary, if not exclusive, culprit was a fall in mortgage-banking income. Compared to the same quarter last year, the bank earned $1.2 billion less from the activity. And despite the fact that all other sources of noninterest income grew by 5% over the same time period, total noninterest income fell by nearly $1 billion, or 8%, relative to the third quarter of 2012.

To state the obvious, it isn't a coincidence that noninterest income and pre-tax, pre-provision profit both fell by 8%.

My point here isn't to call Wells Fargo's executives liars, as their pride about diversification doesn't even remotely amount to that. It's also not to dissuade investors from owning shares of Wells Fargo, as it will likely remain at the top of its class for years, if not decades, to come.

My point is rather to underline the important lesson that you should never completely accept what corporate executives say at face value. That applies to Wells Fargo. But more importantly, it applies to all of those companies that have far fewer scruples than this otherwise stellar bank.

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The article Wells Fargo Doth Protest Too Much originally appeared on Fool.com.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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