Wells Fargo (WFC) reported core Q2 EPS of $1.11 versus street expectations of $1.12. Results were a bit messy and included several one-timers. Wells continues to make progress on improving relations with employees and customers as they look to put the various scandals behind them. Wells is becoming a return of capital story with over $25b in excess capital. Wells plans to increase dividends and double their already sizable share repurchase program – increasing shareholder yield to over 11%.
Current Price: $56.7 Price Target: $60 (increased from $56 15x 2018 earnings)
Position Size: 3.6% Trailing 12-month: 6.1%
Highlights:
- Update on settlements, lawsuits and balance sheet restrictions
- Expects the Federal Reserve to lift balance sheet restriction during first half of 2019
- Accrued charges in Q2 2018 to refund customers for pricing of foreign exchange transactions and fee calculations for wealth management area
- On 4/20/18 Wells reported a $1b settlement with OCC and CFPD relating to forced car insurance and mortgage fees.
- Wells still needs to settle with DOJ over residential mortgage policies dating back to the financial crises. Estimates place the settlement at $2b, but Wells has already set aside reserves of $3.2b
- Additional lawsuits exist for overdraft fees, foreign exchange, mortgage fees, improper account closing and other smaller suits. Wells is not out of the woods, yet.
- Replaced former Chairman, John Stumpf with CEO, Tim Sloan, and CFO Elizabeth Duke, a former Fed member, as independent chairman.
- Named 6 new independent directors
- Plans to spend 2% of earning to philanthropy (up from 1.3%)
- Recent moves to improve standing of employees
- Increased base minimum hourly wage to $15.00 an increase of 11%
- Increased 401k and profit sharing programs
- Increased stock incentive compensation
- Recent improvements to help customers
- Overdraft rewind, zero-balance alerts, debit card on/off capability, and P2P payments
- Wells is a return of capital story
- Common Equity Tier 1 Ratio of 12.0% with a target of 10% – $25b in excess capital
- ROE 10.6% (Return on tangible equity 12.6%)
- Returned $4.0b to shareholders through dividends and share repurchases.
- Increased dividend 10% from $.39 to $.43.
- Increased share repurchases from $4b to over $8b which is shareholder yield of over 11%.
- Excellent banking business
- Strong balance sheet – Net charge offs and Nonperforming loans near historic lows.
- Balance sheet restrictions has allowed trimming of lower quality loans – autos loans and pick-a-pay mortgage loans
- Return on tangible equity 12.6%
- Generates $5b per quarter in earnings
- $1.27 trillion deposits with average cost of 40 bps
- Noninterest revenue down -8% yoy – area affected most by changes to companies practices
- Weak Mortgage banking with drop in margins for origination
- Consumer fees (deposit service, card fees and other) were down in effort to please customers
- Noninterest expenses were up 3% YoY mainly on higher salaries and benefits
- Efficiency ratio improved to 64.9
- Net interest income improved 1% yoy
- Average total loans down 1% yoy
- Consumer loans down $6.6b with largest reduction in auto loans
- Rate paid on deposits has risen from 0.17% 1Q17 to .40% 2Q18
- Valuation is fair on depressed earnings WFC now trades at 14.5x P/E. WFC is targeting $4.0b in cost savings over the next two years – an aggressive target.
WFC Thesis:
- Best franchise in banking due to disciplined loan writing and quality mortgage underwriting
- Large deposit base that provides low cost funding
- Strong capital ratios put WFC in a good position to be opportunistic, invest for the long-term and return capital to shareholders
- Fair valuation and potential for earnings rebound in 2018
($WFC.US)
John R. Ingram CFA
Managing Director
Asset Allocation and Research
Direct: 617.226.0021
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square
Suite 500
Boston, MA 02109