Wells Fargo Showing Damage from Scandals

Image Source: Mike Mozart

Wells might be leaking core deposits as compared to peers and paying up for interest earning deposits.

By Matthew Warren

Wells Fargo (WFC) reported second-quarter 2019 earnings July 16, with revenue flat at $21.6 billion and diluted EPS of $1.30 as compared to $1.16 Wall Street consensus and $0.98 earned in the same period last year. Cost control improved marginally with noninterest expense down $533 million to $13.4B in the quarter, but at an improved 62.3% (versus 64.9% last year) the bank’s efficiency ratio is still meaningfully worse than peers. Since the beginning of 2018, Wells has reduced 18,000 full time employees via cost cutting efforts, but then had to add back the same amount in risk, compliance, and audit, meaning the savings were lost to keep the bank out of trouble with regulators and to keep up on the technology front.

Credit quality remains benign as it has at the other banks which have reported, with a strong consumer given the low unemployment rate and some degree of real wage inflation. The bank’s return on average common equity rose to 15.78% from 12.62% last year. Wells returned $6.1 billion to shareholders in the quarter via dividends and share buybacks. The bank plans to raise its quarterly dividend to $0.51 per share, which would mean a 4.5% dividend yield. The bank is well capitalized with a common equity Tier 1 ratio of 12.0%. Management indicates they plan to move towards a target of 10.25%-10.5% over the next two years, which would mean increased leverage and higher returns on capital if they are able to follow through.

Aside from bloated expenses (management is no longer sure they will be able to cut expenses in 2020), the other cloud on the horizon was that the bank’s net interest margin fell to 2.82% from 2.91% last quarter and 2.93% in the same quarter last year. This will only get worse with outside pressure from expected Federal Reserve rate cuts. In fact, management indicated if the current rate environment persists and we get one to two rate cuts, they expect to come in at the low end of last quarter’s guidance for net interest income shrinking 2-5% for the year.

Internally, average deposits were down $2.4 billion from last year to $1.27 trillion despite the bank paying more for deposits sequentially. “The average deposit cost for the second quarter 2019 was 70 basis points, up 5 basis points from the prior quarter and 30 basis points from a year ago quarter.” The bank also cited its “increased promotional activity” as it relates to deposit costs. It seems like Wells might be leaking core deposits as compared to peers and paying up for interest earning deposits. In my view, this reflects an ongoing branch closure program as well as the ongoing damage the franchise has incurred as a result of recent scandals. Wells’ board is still searching for a permanent CEO. Our fair value estimate is unchanged.

Related: XLF, BRK.A, BRK.B

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