2024-01-12 17:53:59 ET
Summary
- Wells Fargo's Q4 GAAP earnings fell short of expectations due to an expense related to an FDIC special assessment.
- The bank's core underlying performance remains strong, and its non-GAAP earnings exceeded analyst consensus.
- I expect Wells Fargo to earn higher profit margins going forward.
- The share buyback is set to get even larger in 2024 and generate significant EPS growth.
Wells Fargo & Company ( WFC ) has been a long-running turnaround story. Since running into trouble thanks to its fake accounts scandals in the late 2010s, the bank has underperformed most of its large rivals. It has dealt with high legal and compliance costs, regulatory limits to growth, and a tarnished reputation with consumers.
My view, however, is that Wells Fargo can be fixed and that CEO Charlie Scharf is the right person to do it. While WFC stock has had an uneven run in recent years, shares ended in 2023 on a high note, with the stock at 52-week-highs. That said, the stock has slipped a bit following the firm's Q4 earnings report:
Has something gone wrong with the turnaround story, or is this simply a blip within the broader recovery? My view leans toward the latter. Here's why Wells Fargo's Q4 earnings report was fine and confirms that the longer-term turnaround story is playing out as expected.
Q4 Earnings: What You Need To Know
On Friday, Wells Fargo reported Q4 GAAP earnings of 86 cents per share, which was up from 75 cents in the prior year's Q4, but fell short of expectations. It also was down sharply on a sequential basis from Q3 of 2023.
I've seen commentary on social media suggesting that Wells Fargo's quarter was a big letdown. Indeed, operating income fell nearly 40% on a sequential basis. That headline could certainly sound scary in isolation. When provided the proper context, however, the situation is just fine.
That's because the company had an extraordinary expense due to an FDIC special assessment charged to member banks in relation to the costs of taking over Silicon Valley Bank and Signature Bank, both of which failed earlier in 2023. The FDIC is deposit insurance, after all, and banks sometimes have to pay additional premiums when the fund takes a big charge.
The company's chart of non-interest expenses shows the FDIC charge clearly:
Wells Fargo non-interest expenses (Earnings release)
Back out that expense (shown in purple for 4Q23) and operating costs were roughly flat. As revenues were up slightly, this would have been a fine quarter aside from that item.
And indeed, Wells Fargo's non-GAAP Q4 earnings were $1.29 per share, which far exceeded the analyst consensus of $1.09.
Given that interest rates have started to decline and banks no longer appear to be at risk of failure due to sharply rising rates anymore, there shouldn't be much systemic risk to the banking system which would cause additional problems at the FDIC. Meanwhile, Wells Fargo's core underlying bank had a strong Q4, especially compared to its peers, and there's no particular reason why the bank's stock should be down on these results.
Impact Of Change In Interest Rate Direction
Historically, investors have assumed that rising interest rates were good for banks since they can lead to higher net interest margins. As we saw in 2023, however, higher interest rates can suddenly become a major problem if they rise too quickly and create a significant duration mismatch on the balance sheet. In addition, some banks seemingly assumed that near-zero interest rates would go on indefinitely and reached for way too much yield and duration back in 2020 and 2021.
Wells Fargo, by contrast, stuck with a traditional bank balance sheet that did in fact respond to rising interest rates. Wells Fargo's net interest margin ((NIM)) rose from 2.1% in 2021 to as high as 3.2% early in 2023. However, the NIM has clearly peaked both as interest rates stopped rising and also the cost of deposits has gone up with some savers demanding higher rates on their funds. This has led to a meaningful fade in the bank's NIM in recent quarters:
Wells Fargo net interest margin (Earnings release)
While 11 basis points sequentially of decline this quarter isn't a huge deal, there's a clear downtrend here now, and that's likely to continue given the macroeconomic environment. Fortunately for Wells Fargo, it can make up for this through its continued cost-cutting efforts.
Meanwhile, the firm's gigantic share buyback program should keep EPS rising overall even with the fade in the NIM. In fact, perhaps the most important bullish point for WFC stock is the firm's buyback. From the company's earnings release, Wells Fargo states that:
During the fourth quarter, we repurchased $2.4 billion in common stock. We repurchased a total of $12 billion in common stock in 2023, and we currently expect to be able to repurchase more than this amount in 2024.
Wells Fargo has a market cap of around $175 billion. The company took out 1.4% of the share count last quarter alone and nearly 7% of the company in 2023. And Wells Fargo just said that it will buy up even more of the firm's outstanding shares in 2024 than the already generous amount it picked up last year. To support this idea, Wells Fargo noted that its CET1 capital ratio rose this quarter to 11.4% which is well ahead of the regulatory requirement. Even with the bank's huge buyback and sizable dividend, it is accumulating more capital that it could return to shareholders.
Investors may complain that WFC stock is still well below the company's seeming fair value. But this could be a blessing in disguise. With Wells Fargo set to buyback at least $12 billion of stock this year if not more, the cheaper share price allows it to get a lot more bang for the buck on these buys.
Buying back stock at such a rapid rate will naturally increase earnings per share by decreasing the denominator of that calculation. However, things get really interesting for WFC stock when considering that it is also set to increase net income quite considerably in the coming years thanks to rising profit margins.
Longer-Term Margin Targets
In its earnings presentation, Wells Fargo notes that the return on equity was 7.6% this quarter, which is up from 6.6% for the same quarter of 2020. Similarly, return on average tangible common equity (ROTCE) grew from 8.0% in Q4 2020 to 9.0% this past quarter. This is an improvement, to be sure, but it's not nearly as much as a successful turnaround should lead to.
Again, though, context is needed. Wells Fargo's metrics were deflated this quarter primarily due to the above-discussed FDIC assessment. For full-year 2023, on the other hand, Wells Fargo generated an 11.0% ROE and 13.1% ROTCE, which are far above the levels of the past few years. Full-year 2022, by contrast, had an ROE of 7.8% and ROTCE of 9.3%. While Q4 of 2023 was a step backwards, the overall trajectory remains decidedly positive.
From Wells Fargo's earnings release, the company discusses its margin evolution over the past few years. While seemingly acknowledging that margin growth leaves room for improvement, the company states that it sees the following avenues for increasing margins going forward:
- Returning excess capital.
- Repositioning the home lending business.
- Improving profitability in our consumer credit card business, as near-term results are impacted by acquisition costs and allowance builds.
- Realizing returns on growth-related investments in fee businesses such as Corporate and Investment Banking and Wealth and Investment Management should help fund additional investments.
In its earnings release, Wells Fargo states that it believes a 15.0% ROTCE is achievable over the intermediate term. While there's some variation depending on how it gets to this result (for example, how many shares are repurchased along the way), this suggests something in the neighborhood of $6/share in annualized earnings per share. This would be a fairly significant increase from the $4.83 of EPS that Wells Fargo just delivered for the full-year 2023.
I see a 10-12x P/E ratio as being reasonable for Wells Fargo in a neutral operating environment, which would point to a share price in the $60-$72 range versus today's $47 level.
WFC Stock Bottom Line
Wells Fargo finds itself in an interesting position heading into 2024. On the one hand, its balance sheet was well positioned for rising interest rates, and if the Fed actually follows through on current projections and goes on a major rate-cutting campaign this year, that would limit Wells Fargo's upside as far as profitability metrics go. The firm's revenues in other categories such as investment banking have also fallen a bit short of what bulls were probably hoping for in recent quarters.
The flip side of that coin, however, is that Wells Fargo is running its turnaround plan effectively. The company is cleaning up its outstanding regulatory issues, reducing headcount, and positioning the bank for a fresh wave of growth once regulatory conditions permit. And Wells Fargo is performing well at an operational level. The company's Q4 earnings release was much better than several others of the too-big-to-fail banks.
I have a fairly downbeat view of the economy heading into 2024. Wells Fargo and the other big banks showed some warning signs as far as consumer credit quality goes in their Q4 earnings releases. I wouldn't be surprised if banks as an industry start off 2024 on a soft footing given the macroeconomic landscape. That said, I'm bullish on Wells Fargo compared to the rest of its category thanks to its successful turnaround plan, rising profitability, and massive share repurchase program.
For further details see:
Wells Fargo Q4 Earnings Reinforce The Bullish Outlook