WFC Wells Fargo and Company

By Aaron Back 

The outlook for the top U.S. banks is brightening, but Wells Fargo is being left behind.

That showed clearly when the three major banks reported earnings Friday. Fourth-quarter net profit rose by 24% from a year earlier at J.P. Morgan Chase, and by 43% at Bank of America , both beating already high expectations.

Wells Fargo, on the other hand, saw net profits decline by 5.4% from a year earlier, coming in below analyst expectations. Most significantly, Wells Fargo is on the cusp of losing its title as the highest returning big bank to J.P. Morgan, making its valuation look increasingly unrealistic.

The fallout from the bank's account-sales fiasco continues to hurt, mainly through elevated costs. There was also a big, $592 million loss associated with interest-rate hedges, which essentially offset hedging gains earlier in 2016.

The bigger picture is that Wells Fargo isn't set up to benefit as much from the current environment. Its balance sheet is deliberately geared toward a low interest rate environment by holding more long-dated assets. As recently as May the bank said it continues to plan for a lower-for-longer rates environment.

Wells Fargo's guidance on how it will be affected by rates is also less detailed than peers. On a conference call with analysts, Chief Financial Officer John Shrewsberry suggested the Federal Reserve's December interest-rate increase, along with recent market moves in long-term rates, would contribute extra interest income somewhere north of $150 million a quarter. That would be an incremental gain of about 1.2% from the level of net interest income in the fourth quarter of 2016.

Bank of America, by contrast, was clearer and more optimistic, saying it expects an extra $600 million in the first quarter, or an incremental gain of 5.8%.

Wells Fargo, a more retail-oriented bank than its peers, is also suffering from its relatively small trading operation. This wasn't an issue during the years that bond and currency trading activity was weak. But volumes suddenly rebounded in the second half of last year, handing a big windfall to banks like J.P. Morgan.

The clearest indication that Wells Fargo's edge is slipping is its return on equity, the ultimate gauge of value creation for shareholders. This fell to 10.9% in the fourth quarter, from 11.9% a year earlier. That compares with 11% for J.P. Morgan in the fourth quarter, the first time in years that Wells Fargo wasn't the top returning big bank.

Despite that, Wells Fargo shares are trading at 1.57 times book value, compared with 1.36 for J.P. Morgan and 0.96 for Bank of America. This premium looks less justified with every passing quarter.

Write to Aaron Back at aaron.back@wsj.com

(END) Dow Jones Newswires

January 13, 2017 14:08 ET (19:08 GMT)

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