Wells has a solid franchise, which we expect to bounce back once these troubles are squarely in the rear-view mirror, but the timing and magnitude of decline and then ultimate improvement are anyone’s guess at this tender stage of regulatory reproach and perspective client disillusionment. Our fair value estimate remains $52 per share.

By Matthew Warren

Wells Fargo (WFC) reported first-quarter 2019 results that showed revenue falling $300 million from last year’s first quarter, to $21.6 billion this year. Net income was $5.9 billion or $1.20 per share, up from $5.1 billion and $0.96 per share last year, respectively. Wells posted a 12.7% return on equity and 15.2% return on tangible common equity in the quarter, better than the cost of capital. This reflects the firm’s competitive advantages as one of the largest scale consumer banks in the country--a business where scale matters, especially against the backdrop of digitalization of both front-end consumer engagement with websites and mobile apps, but also the digitalization of backroom processes which support the business.

The bank is well-capitalized with a common equity tier 1 ratio of 11.9%, above the regulatory minimum of 9% and current internal target of 10%. This is after returning $6.0 billion to shareholder in the first quarter of 2019, just a touch more than the firm earned in the quarter. This reflects Wells’ lack of reinvestment needs required to produce the current earnings stream. In fact, Wells’ share count is down 7% from last year due to ongoing share repurchases over and above the money returned to shareholders via dividends. Given the company’s well-capitalized position, we’re not too concerned with the bank’s buyback program.

During its earnings call April 12, Wells Fargo’s CFO lowered its net interest income guidance for the year from the range of -2%-2% to the range of -2%-5%, which had the shares reversing and trading lower immediately upon this revelation. The bank’s own actions caused its reputation to be dragged through the mud the past three years. Internal incentives to drive “cross-selling” ended up instead driving misbehavior with bank employees opening customer accounts without their permission. This major scandal combined with some additional SNAFUs that have come to light since have really dinged the bank’s reputation. Banking is built on trust and therefore reputation.

The regulators have gotten involved, forcing changes at the bank including an asset cap of $1.93 trillion in place since February 2, 2018 which limits growth, especially compared to peers, contributing to market share losses - above and beyond the difficulty of attracting new customers given the reputational problems. The bank has also beefed up its compliance and operational staff, brought in outside hires and now is looking to replace the recently-departed CEO, the second departure since the scandal broke. It is unclear how long-lasting this damage will be, but you can clearly see the pressure in the current results with revenue down while more successful peers are growing nicely.

Wells also has lower return on capital metrics than the likes of J.P. Morgan (JPM), despite (very slightly) lower Tier 1 common equity capital levels. Wells has a solid franchise, which I expect to bounce back once these troubles are squarely in the rear-view mirror, but the timing and magnitude of decline and then ultimate improvement are anyone’s guess at this tender stage of regulatory reproach and perspective client disillusionment. 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 companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.