Wells has been forced to do a lot of hiring related to remediating its problems with regulators, but the problem is simply larger than that. This is an inefficient bank, which is very odd considering the massive scale that it benefits from.
By Matthew Warren
Well Fargo (WFC) reported terrible fourth-quarter results January 14. The company earned 60 cents per share, down from $1.21 in the same quarter last year, missing analyst consensus estimates for both the top and bottom line. While it is a messy quarter with a large litigation write down related to previous scandals and other “one time” items, the main theme is that expenses are simply too high and going in the wrong direction at Wells Fargo. As you can see below, the bank is worst-in-class amongst its money center peers regarding its efficiency ratio, which was an enormous 78.6% in the quarter. This is more than 20 percentage points worse than JPMorgan (JPM).
Image Source: Wells Fargo Earnings Supplement
Wells has been forced to do a lot of hiring related to remediating its problems with regulators, but the problem is simply larger than that. This is an inefficient bank, which is very odd considering the massive scale that it benefits from. Speaking of regulatory issues, this is what new CEO Charlie Scharf had to say regarding regulatory problems on the earnings call: “I will say this several times, but you should know there’s still much work to do. Many have focused on the Fed consent order but remember we have 12 public enforcement actions that require significant resource commitment. While I certainly wish more of this work was behind us, what’s required of us is clear and we will get it done. It’s work that other banks have done already, so there’s a clear roadmap for what we need to achieve.” The new CEO was asked several times on the call to put some kind of timeline on resolving the regulatory issues, but he flat-out refused. He wouldn’t even bite when asked whether it was a year or two or three to five years out.
In our mind, there are two ways to think about Wells Fargo. One is that it is inefficient, and management is on their back foot and simply missing out on capitalizing on the 11th year of this economic recovery. The bank is losing market share to money center peers and the end is not currently in sight.
The other way to look at the situation is that you get paid roughly a 4% dividend yield (assuming it doesn’t get cut, which appears a good assumption at this juncture) plus share buybacks to wait for new CEO Charlie Scharf to right this ship. If he executes to plan, the regulatory issues will eventually be put in the rear-view mirror, and the company will have a chance to go on a massive efficiency drive that could be a multi-year or even decade-long improving-returns story.
While this is a very messy story and involves no small amount of risk, we are inclined to believe the latter description of an (eventual) improving returns story. The core franchise has been damaged but not destroyed. Once the regulatory problems clear, watch for Wells Fargo to focus on retaining and re-growing market share while improving its fundamentals. For the risk averse, watch for many bumps on the road from here to there. We are maintaining our $52 fair value estimate.
Related: XLF, VFH, XFO
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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.