Event: WFC reports its fiscal Q3 earnings on Friday, Oct. 11th before the open. The options market is implying about a 2.75% one day move, which is above both the 4 qtr avg of about 1.75% and in line with the 8 qtr avg of about 2.75%.
Sentiment: Wall Street analysts are mixed on the stock, with 19 Buys, 22 Holds and 2 Sells, with an average 12 month price target of around $46. Despite the stock’s recent weakness, it is still up around 18% in 2013.
Options Open Interest: Open interest actually has substantially more puts than calls outstanding (685k vs. 512k). That’s a reflection of the significant put open interest in Jan14, concentrated in the 25 to 40 strikes. The Jan14 40 strike calls also have a lot of open interest, almost 50k.
Price Action / Technicals: WFC had a very important long-term breakout in May of this year, rising to new all-time highs after years of resistance in the 38 area:[caption id="attachment_31092" align="alignnone" width="595"] WFC Monthly Chart, Courtesy of Bloomberg[/caption]
The $38 level now becomes crucial support going forward. In the short-term, the chart shows a stock sandwiched between its rising 200 day moving average (now around $39) and its falling 50 day moving average (now around $42.50):[caption id="attachment_31094" align="alignnone" width="600"] WFC daily, 50 day ma in pink, 200 day ma in black, Courtesy of Bloomberg[/caption]
Those are really the short-term term support and resistance levels to watch following earnings. A short vol trade targeting that range might make sense too, especially since some of the expected bad news on the mortgage front is likely priced in already.
Fundamentals: While many commercial banks have indicated the potential benefit to the bottom line for a rise in interest rates (as their net interest margin increases, since deposit rates are stickier), WFC is one of the few who is unlikely to see much of a benefit from higher rates since its mortgage banking business sees a major decline when mortgage rates go higher, thus offsetting the benefit of the higher NIM.
WFC is diversified enough that the decline in the mortgage arm could be offset by improvements elsewhere. However, it’s worth remembering that we are now already 4 years into this cyclical recovery, which means that commercial banks like WFC have already released the bulk of their loan loss reserves. That’s one fewer lever to pull for upside to earnings, on top of the weakness in mortgages.
Add it all up, and the potential for significant earnings growth for WFC over the next year is unlikely. WFC management is likely to acknowledge as much. The real question that analysts will be asking on the earnings call will the extent of the impact of higher rates on residential real estate.
Regardless, this is relatively stable company with a fair valuation on no major wild cards. For now, we don’t expect major fireworks from earnings.
Volatility: Implied vol has ramped into the event, matcing highs its seen for earnings the past year. Historically, it’s not off the charts though it’s much higher than realized vol.
Vol in Nov is about 23, and will probably see the mid teens after the event.
Trades: We’ll post any trade we decide to do on WFC tomorrow, before earnings on Friday morning.