Wells Fargo: Quality, Income, Growth

07/16/2015 7:00 am EST

Focus: STOCKS

Genia Turanova

Editor, Leeb Income Performance

Expectations for rising interest rates might actually create a much better business environment for the banks in the US, asserts Genia Turanova, editor of Leeb Income Performance.

Higher interest rates on the short side of the spectrum are a significant positive for them.

Moreover, if short rates move higher at a faster rate than the long ones, that will further benefit banks’ future earnings due to stronger potential for margin expansion.

Wells Fargo (WFC) is a good example. Its net interest margin (which is interest earned on earning assets minus interest paid on funding sources as a percentage of interest earning assets) is about 4.5% and is higher than the average for the peers.

Wells Fargo does not need long introductions. It is the fourth largest bank in the US by assets and the largest bank by market capitalization.

The bank is also a good play on housing as it originates and services the largest number of mortgages in the country, being the country’s largest mortgage originator.

The economic recovery has been slowly, but surely transferring into the housing area; Wells Fargo should be a good stock to play the continuation of the trend.

Higher demand for home mortgages will directly benefit Wells Fargo’s top and bottom line, while higher average home prices will positively influence the absolute amount of mortgage loan values, another potential positive.

Wells Fargo is a quality bank, which we feel will be safe to hold even if the recovery falters.

Its high net interest margin (largely attributed to its large average core deposits) is another positive.

Wells has also seen strong core deposit growth and has been very proficient at cross-selling, providing the basis for future loan growth and, by extension, future profits. Analysts expect low double digits EPS growth for the next few years.

In short, Wells Fargo seems a strong choice for this environment. It operates a profitable business leveraged to a recovery in both the housing and lending markets while also providing dividend income to investors.

Wells Fargo’s potential leverage to higher interest rates and widening spread makes this recommendation even timelier. Yielding 2.7%, Wells Fargo joins our model portfolio.

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