2023-10-11 17:07:08 ET
Summary
- Earnings season for banks begins with Wells Fargo, JPMorgan Chase, and Citigroup on deck for Friday.
- Investors are concerned about the banking sector due to factors such as rising interest rates and the potential for mounting losses in commercial real estate.
- I believe Wells Fargo is well positioned for current market conditions and that management is doing a good job turning the bank around from its prior scandals.
Earnings season kicks into high gear on Friday with a number of large banks including Wells Fargo ( WFC ), JPMorgan Chase ( JPM ) and Citigroup ( C ) expected to announce their earnings that day.
It will be a revealing quarter for bank earnings. There are a great deal of cross-currents in the banking sector right now. Among them, the historic surge in interest rates, the plunge in activity in the mortgage market, rapid movements of deposits between various banks, and the mounting issues in the commercial real estate market.
All this has investors casting a wary eye toward the sector heading into this quarter's results. Stock prices reflect that, with the nation's largest banks largely trading at or near their recent lows and flat to down over the past year:
The one notable exception is JPMorgan Chase, which has seen its shares advance 37% even as the rest of the sector has struggled. Now the question is whether other banks, such as Wells Fargo, can capture some of the same positive momentum that has powered JPMorgan higher over the past year.
Creating Underlying Shareholder Value
It's easy to look at the combination of Wells Fargo's flat stock price and ongoing regulatory headaches and assume that Wells Fargo has seen its business stagnate in recent years.
However, despite the abundance of negative stories about the bank, it has continued growing a key fundamental metric - tangible book value per share - at a favorable rate.
That marks a 70% increase over the past decade. And Wells Fargo has continued to increase its tangible book value at a healthy clip even after all the regulatory matters and business model changes that occurred since the latter part of the 2010s.
The underlying growth of the business has not, however, been reflected whatsoever over the past decade. Shares traded around $40/share in 2013, and once again trade at that price today. As a result, Wells Fargo's price-to-tangible book value ratio has fallen sharply over the years:
While Wells Fargo isn't back to the COVID-19 lows, it's at its otherwise lowest valuation ratio in recent memory.
I would argue that this is not justified given the bank's improving fundamentals and earnings outlook.
Wells Fargo Isn't At The Center Of The Current Industry Storm
The banking industry has had a rough 2023. That's in large part due to the heightened volatility in interest rates. Banks that made untimely bets on long-term bonds at relatively high prices, such as SVB and First Republic, saw their balance sheets crumble in the wake of soaring interest rates.
There was the second piece of that, which was that clients pulled money - particularly unsecured deposits - out of firms that were seen as having especially vulnerable balance sheets.
Wells Fargo is far from the epicenter of that storm, however. Wells Fargo was not aggressively gathering deposits in recent years. In fact, due to the asset cap, Wells Fargo was not incentivized to attract vulnerable deposits or invest in low-yielding long-duration securities much at all. While Wells Fargo's scandals hurt the business in a wide variety of ways, the silver lining may be that the bank was protected from levering up in 2021 at a time when other banks made inopportune bets.
As the interest rate and deposit flight narrative has started to recede a bit, investors have turned to a different concern, risk in commercial real estate. Given the trend toward remote work, office loans in particular face great stress. And there are pockets of weakness in other parts of CRE such as malls, shopping centers, and healthcare real estate as well.
A recent Bloomberg story highlighted that analysts are expecting a sharp jump in bank loan write-offs this quarter due to rising levels of impairment in the commercial real estate sector. If analyst projections are on target, write-offs will come in around twice as high as they were for the same period of 2022.
This will be a key metric to watch for all the large banks reporting earnings over the next week. Again, however, I don't believe this is a problem where Wells Fargo is one of the more vulnerable banks. Wells Fargo has a decent reputation in the lending side of its business. Don't forget that Wells Fargo was one of the best-positioned during the 2008 Financial Crisis and was long a favorite of Warren Buffett due to its ability to navigate through prior crises. Furthermore, the asset cap likely constrained Wells Fargo's lending in recent years keeping it out of some dodgier parts of commercial real estate that are now showing cracks.
The Path Toward Multiple Expansion
Though it's understandable why Wells Fargo shares haven't kept up with JPMorgan Chase this year, Wells' results have been favorable up to this point, and it makes little sense that shares are trading near 52-week lows.
The sentiment around Wells Fargo seems to be that it's a wait-and-see stock rather than a near-term opportunity. CFRA's analyst Kenneth Leon encapsulated the present situation well. Leon said that Wells Fargo is on "the right path with improved execution" and further added that: "We do see momentum in the transformation, new card offering, and cost controls."
Despite those positives, Leon downgraded the stock from buy to hold given ongoing uncertainty around when the Federal Reserve will lift Wells Fargo's asset cap and allow it to resume normal growth. With the lack of visibility and insufficient near-term catalysts, WFC stock may be set to trade sideways well into 2024 given those uncertainties.
A lot of people simply aren't going to be interested in Wells Fargo until the asset cap is lifted, and the bank can fully return to growth. That's an understandable impulse.
However, I'd point out that Wells Fargo already appears to be moving to a growth posture. Recently, the bank has been much more aggressive in launching new card products. It's growing the number of wealth advisors it employs again after years of decline there. And Wells Fargo is increasing internal investments as it begins to transition from spending heavily on legal and remediation costs toward more normal operations.
To me, this indicates that Wells Fargo has passed through the worst of the storm as it relates to the fake accounts scandal and related reputational and regulatory consequences from that. Wells Fargo is once again acting like a bank that can seize opportunities when they present themselves. When the Fed eventually lifts the asset cap, be that a few quarters from now or farther into the future, that will give the bank the green light to go full-speed ahead. At that point, I expect a lot of investors to take a fresh look and see just how well the underlying business has performed and how much value management has created in the interim.
That is to say, once the cap is lifted, I expect shares to re-rate sharply higher. With that being the case, the question comes down to timing. Is it better to buy Wells Fargo shares now and be positioned for the eventual expanding multiple, or is it better to wait for the asset cap to be lifted and buy as soon as the good news arrives? I believe Wells Fargo's shares are cheap enough here that it is worth holding them even if the Fed doesn't move quickly in removing the asset cap.
Analysts are projecting that Wells Fargo will earn $4.86 per share this year, which would be its highest figure to date. That figure is expected to top $5 per share over the next two years. Despite the lingering issues the bank is facing, the core metrics are pointing upward. And using a not too aggressive 12x P/E multiple on said earnings gets us a stock price of around $60. I believe that's a sufficient margin of safety to support a bullish view.
Wells Fargo Stock Bottom Line
There are a few things to be watching for in Wells Fargo's upcoming earnings release. Any updates on the regulatory front would be most welcomed, as I believe this is now the key overhang on WFC stock specifically.
More broadly, the bears will be looking at metrics in commercial real estate closely. I expect Wells Fargo to fare better than many of its peers on asset quality; that will be something to watch for. Additionally, I will be looking at whether Wells Fargo can continue to grow its net interest margin "NIM" as it has been doing in recent quarters. Wells Fargo's balance sheet has been positioned nicely for the current interest rate environment, and further NIM improvements would be beneficial.
I'm not expecting a big pop in earnings unless there are positive developments with regulators. That said, Wells Fargo's core operations are running well, and the bank is generating significant shareholder value despite the poor performance in the share price. As long as Q3 continues to reflect further progress in that direction, I will have a positive outlook for WFC stock heading into 2024.
For further details see:
Bullish On Wells Fargo Stock Ahead Of Q3 Earnings