2023-11-18 11:40:00 ET
Summary
- Wells Fargo & Company's earnings remain strong, with net interest income increasing by approximately 10% compared to last year.
- The bank only needed about 5.5% of its earnings to cover the preferred dividends.
- The Wells Fargo Series L preferred shares are non-callable and offer a fixed dividend, making them an attractive investment.
Introduction
Wells Fargo & Company ( WFC ) is a well-known name in the U.S. banking landscape where it is considered a top-5 player in the financial services industry. Although the U.S. banking sector has faced some headwinds recently, the sector's financial performance has held up better than I expected, and that includes Wells Fargo. As I discussed a specific issue of the bank’s preferred shares in a previous article , I wanted to keep an eye on the bank’s performance as I initiated a long position after the article was published.
The bank’s earnings remain strong, and I feel comfortable being a preferred shareholder
The net interest income result is one of the most important metrics for a bank, and Wells Fargo is no exception (although the bank obviously also generates a decent revenue from its non-interest activities). During the third quarter, Wells Fargo reported a total interest income of $22.1B , which is in excess of 50% higher than the interest income it generated in the same quarter last year, while the interest expenses increased at a relatively faster pace as the interest expenses almost four-folded.
In absolute numbers, there was an increase of the net interest income by almost 10% to $13.1B. And while that’s a good result compared to the third quarter of last year, it is slightly lower than in the previous few quarters. That’s not unexpected, and it was up to the bank to make sure its net non-interest expenses remained relatively low to ensure another multi-billion dollar bottom line result.
The bank generated about $7.75B in non-interest income and about $13.1B in non-interest expenses , resulting in a net non-interest expense of approximately $5.36B. A good result compared to the $6.8B non-interest expenses in the third quarter of last year when certain operating losses weighed on the bottom line result.
This resulted in a pre-tax and pre loan loss provision income of approximately $7.75B and a net income of $5.74B. That’s the net income on a consolidated basis and as a $31M loss was attributable to non-controlling interests, the net income attributable to Wells Fargo was $5.77B. The total preferred dividends came in at $317M which means the net income attributable to the common shareholders of Wells Fargo was $5.45B, which represents an EPS of $1.49. The EPS in the first nine months of the year was $3.99.
Based on the Q3 results , the bank only needed about 5.5% of its attributable income to cover the preferred stock dividends. So, although the preferred shares are non-cumulative, there is no reason why Wells Fargo would suspend its preferred share dividends. Based on the Q3 and 9M 2023 performance, Wells Fargo could cover an additional $6B per quarter in loan loss provision and it would still be profitable.
My Series L preferred shares won't be called
As I explained in my previous article, the Series L preferred shares are an interesting (non-cumulative) preferred capital security. Wells Fargo has had to deal with this preferred issue after its acquisition of Wachovia during the Global Financial Crisis. This specific preferred share (initially issued by Wachovia) has an issue price of $1,000 per share and is non-callable. This means Wells Fargo cannot call these preferred shares for redemption and will have to continue to make the 7.5% preferred dividends . Those preferred dividends total $75 per share per year, payable in four equal quarterly installments of $18.75 per share.
In the previous article, I also explained that owners of the preferred shares have the right to convert the preferred shares into common shares of Wells Fargo in a ratio of 6.3814 common shares per preferred share . This means the conversion price is $156.7, and with the current share price of the common shares trading at just under $41, it is pretty clear there is absolutely no incentive for the preferred shareholders to convert the Series L into common shares.
The preferred shares are currently trading at just over $1,100 per share, which means the preferred dividend yield is still approximately 6.8%. And while that might be too low for a non-cumulative security for some investors, I am comfortable with the risk.
Investment thesis
As these securities can’t be called, and as the preferred dividend has been fixed for as long as these preferred shares remain outstanding, the preferred share price will be nicely correlated with the market interest rates: if interests start to decrease again, the share price of the preferred shares will go up. If the rates go down and the market thinks a 6% preferred dividend yield is an appropriate return for an investment in a Wells Fargo preferred share, the share price will be $75 / 0.06 = $1250.
I have no position in Wells Fargo’s common shares nor in any of its other preferred shares. I have a long position in the Series L preferred shares predominantly for the preferred dividend, but I also consider it a speculative position to benefit from potential interest rate decreases further down the road.
For further details see:
Wells Fargo: I Started To Buy The 6.8% Yielding Preferred Shares