2024-01-03 09:15:46 ET
Summary
- Wells Fargo enters 2024 with stock near $50, despite fears of unrealized losses and a U.S. recession that did not materialize.
- The bank has a strong capital ratio of 11.0% and excess capital above the regulatory minimum even with the upcoming Basel III requirements.
- The stock trades at just 10x EPS targets, though Wells Fargo has the potential for solid EPS growth in the years ahead, especially with the asset cap removal.
After a wild 2023 for banks, Wells Fargo (WFC) actually enters 2024 with the stock back at the highs close to $50. The large bank hasn't seen the earnings stream diminish during this period, yet investors panicked over fears of unrealized losses and a U.S. recession, neither that actually materialized. My investment thesis remains ultra Bullish as the stock enters 2024 with more stability in the business and especially with interest rates normalized at higher levels.
Source: Finviz
Capital Bubbling Over
Wells Fargo ended Q3'23 with a very strong capital ratio. The large bank boosted the CET1 ratio to 11.0%, up 70 basis points from the prior year period despite lowering the share count by 157.5 million shares in the year.
Wells Fargo has capital far in excess of the current requirement for only an 8.9% regulatory minimum. The problem facing all of the large banks is the Basel III Endgame rules set to dramatically increase capital ratios over a phase-in period.
On the Q3'23 earnings call , CEO Charlie Scharff made the following statement on the expected hike to capital ratios:
Our strong capital levels position us well for the anticipated increases related to the Basel III Endgame proposal released in the third quarter. Based on where we ended the quarter, we estimate that our CET1 ratio would be 50 basis points above the fully phased-in required minimum if the proposed rules were implemented as written after factoring the growth in RWAs and the resulting decline in our stress capital buffer as well as the impact of the new G-SIB buffer calculation changes.
If understood correctly, Wells Fargo would see the CET1 capital ratio requirement surge to 10.5%, which amounts to an ~260 basis points boost in capital requirements. The regulatory body is currently in ongoing discussions with the large banks with a heavy push back on the hefty required capital ratio boost.
In the last year, Wells Fargo cut the period-end common shares outstanding down 157.5 million, or 4% from Q3'22. The large bank repurchased 33.8 million shares alone in Q3, or $1.5 billion worth of common stock.
Wells Fargo was able to boost the capital ratios while repurchasing these large amounts of shares. The bank additionally offers a nearly 3% dividend yield for shareholders.
Otherwise, under the worst-case scenario of a massive hike to required capital ratios due to the Basel III implementation, Wells Fargo will continue reducing shares counts while boosting capital. The bonus could be a reduction in Basel III requirements, providing the large banks an immediate level of excess capital leading to more share buybacks.
Profit Picture
Wells Fargo has gotten to this point of a $5 EPS, but the market generally views the large bank of hitting a profit wall. The market wasn't really expecting the bank to return to these profit levels, yet the market appears wildly off target suggesting numbers won't improve despite ongoing expectations for EPS boosts from share reductions.
The company has long had the potential for a $6 to $8 EPS stream based on efficiency improvements. Wells Fargo had a goal for cutting costs by up to $10 billion before the large interest rate hikes boosted NII and inflation made reducing costs dramatically nearly impossible.
NII has held around $13 billion per quarter lately. A big problem facing Wells Fargo is the asset cap still being in place after all of these years.
The Fed set the asset cap at $1.95 billion over 5 years ago and management has apparently suggested a realistic target for removal is 2025 . During this period, Wells Fargo has seen quarterly revenues maintain around the $20 billion range while industry leader JPMorgan Chase (JPM) has grown revenues to nearly $40 billion, nearly double Wells Fargo.
Clearly, the biggest issue is that Wells Fargo has been unable to boost revenue while operating expenses are more under control. The company has a target for 2023 expenses in the $51.5 billion range, but revenues are now only running at the $80+ billion range.
Even with slightly higher credit costs at $5.5 billion annually, Wells Fargo has an easy path to a $6 to $7 EPS just on slightly higher revenue and lower share counts. The projection isn't that the large bank cuts operating expenses anymore due to inflation and such, but the company keeps costs flat while revenues rise to generate solid leverage.
The big question remains when the asset cap is finally lifted, allowing Wells Fargo to finally grow the business again. The large bank will have solid growth potential as the cap is lifted.
Takeaway
The key investor takeaway is that Wells Fargo trades at only ~10x normalized EPS targets while the company has easy EPS growth from limited revenue growth and solid share buybacks. Even with the new Basel III regulations, the large bank should have the capital for share buybacks and ultimately Wells Fargo will get the asset cap lifted allowing for the business to finally grow again.
For further details see:
Wells Fargo: Setting Up For A Solid 2024