Image Source: Mike Mozart
By Matthew Warren
On October 15, Wells Fargo (WFC) reported third-quarter results that showed revenue up 0.3% to $22.01 billion, which beat consensus estimates by $690 million. Earnings came up short with non-GAAP EPS of $1.07 missing by $0.11 and GAAP EPS of $0.92 missing by $0.31. The adjusted figure excludes a $1.6 billion (0.35/share) discrete litigation accrual (related to previously disclosed retail sales practices matters) and a $1.1 billion (0.20/share) gain from its previously-announced sale of its Institutional Retirement and Trust Business.
Net interest margin compressed from 2.94% in last year’s quarter to 2.66% in this year’s quarter, due to the lower interest rate environment and assets repricing lower more quickly than deposits. Deposits grew only 2% year over year, much slower than JPMorgan’s (JPM) 5% growth rate.
Regarding credit quality, the charge-off rate held pretty flat just under 30 basis points (0.30%). This reflects the benign credit environment from the elongated upcycle we have enjoyed in the US, now in its 11th year.
Clearly, Wells Fargo’s missteps have meant that the bank hasn’t fully harvested the gains from this up cycle. There was a lot of talk on the earnings call about whether Wells is at the ‘end of the beginning’ or the ‘beginning of the end’ of all the changes and expenses it has been forced to take on board by the Fed to improve its operating and compliance infrastructure.
Wells new CEO Charles Scharf starts next week, and we expect him to take a full inventory of the current situation, and we’d hope he will soon take the opportunity to describe what additional work is required to satisfy regulators. His experience at Visa (V), JPMorgan, and Bank of New York Mellon (BK) will come in handy as he tries to right this ambling ship.
The core franchise at Wells Fargo is still strong, and we think once the regulators are satisfied with operational and oversight improvements, the bank will again be able to operate on the front foot in with respect to digitalization and going after its fair share of the market. Wells’ broad footprint and national scale make it well positioned to fight with the big boys.
Wells Fargo’s lack of a sizable investment bank and trading operations is a bit of a Rorschach Test for analysts and investors. On the one hand, it makes it harder to compete for business from the largest of large corporates, since it is not a full one stop shop. On the other hand, it means higher-quality earnings from bread-and-butter banking and reduced exposure to the wildly cyclical and low return world of investment-banking and trading. Given its impressive dividend yield of 4.1% as of this writing, we think the shares have a floor beneath them, barring any additional scandals coming to light–something we think is unlikely at this stage. Our fair value estimate remains $52 per share.
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Matthew Warren does not own shares in any of the securities mentioned above. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.