It has been about a month since the last earnings report for Wells Fargo (WFC). Shares have added about 7.5% in that time frame, outperforming the S&P 500.
Will the recent positive trend continue leading up to its next earnings release, or is Wells Fargo due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.
Wells Fargo's Q3 Earnings Disappoint, NII Down
Wells Fargo’s third-quarter 2019 earnings of 92 cents per share lagged the Zacks Consensus Estimate of $1.15 on lower net interest income. The figure also comes in lower than the prior-year quarter earnings of $1.13 per share.
Results include discrete litigation accrual (not tax-deductible) worth 35 cents per share, and gain from the sale of Institutional Retirement and Trust (IRT) business worth 20 cents. Also, the partial redemption of Series K Preferred Stock decreased earnings by 5 cents.
Higher fee income driven by improved trading activities, partly offset by lower mortgage banking revenues, aided the company’s performance. Further, escalation in loans and deposits acted as tailwinds. However, reduced net interest income and rise in expenses were undermining factors. Moreover, provisions soared.
Net income came in at $4.6 billion compared with the $6 billion recorded in the prior-year quarter.
The quarter’s total revenues came in at $22 billion, outpacing the Zacks Consensus Estimate of $21.1 billion. The reported figure also comes in higher than the prior-year quarter’s tally of $21.9 billion.
Furthermore, on a year-over-year basis, quarterly revenue generation at the business segments was mixed. The Community Banking segment’s total quarterly revenues slipped 5.1% and Wholesale Banking revenues were down around 5.5%. Yet, revenues in the Wealth and Investment Management unit were up 21.4%.
Net Interest Income Falls, Costs Up, Fee Income Improves
Wells Fargo’s net interest income in the quarter came in at $11.6 billion, down 8% year over year. Higher interest expense and lower interest income from loans held for sale, equity securities and loans led to this downside, partly offset by increased interest income from debt securities, mortgage loans held for sale along with higher other interest income. Furthermore, net interest margin shrunk 28 basis points (bps) year over year to 2.66%.
Non-interest income at Wells Fargo came in at around $10.4 billion, up 11% year over year, primarily owing to rise in service charges on deposit accounts, card fees, net gains from trading activities and equity securities along with elevated other income. These increases were mainly muted by lower mortgage banking revenues and reduced net gains on debt securities.
As of Sep 30, 2019, total loans were $954.9 billion, slightly up sequentially. Higher consumer as well as commercial loan portfolio was recorded. Total deposits came in at $1.31 trillion, up 2% from the prior quarter.
Non-interest expense at Wells Fargo was around $15.2 billion, up 10% from the year-earlier quarter. This rise in expenses primarily resulted from elevated salaries and commission and incentive compensation, equipment costs and other expenses. These were partly offset by lower employee benefits, core deposit and other intangibles, along with FDIC and other deposit assessments.
The company’s efficiency ratio of 69.1% came in above the 62% recorded in the year-ago quarter. A rise in efficiency ratio indicates a fall in profitability.
Credit Quality: A Mixed Bag
Wells Fargo’s credit quality metrics was a mixed bag in the September-end quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $10.6 billion as of Sep 30, 2019, down 3.6% year over year.
Net charge-offs were $645 million or 0.27% of average loans in the reported quarter, down 5.1% from the year-ago quarter’s net charge-offs of $680 million (0.29%). Non-performing assets slipped 16.7% to $6 billion, in the third quarter, from $7.2 billion reported in the prior-year quarter. Notably, provision for credit losses was $695 million, 20% higher.
Strong Capital Position
Wells Fargo has maintained a sturdy capital position. During the July-September quarter, the company returned $9 billion to shareholders through common stock dividends and net share repurchases.
Wells Fargo’s Tier 1 common equity under Basel III (fully phased-in) decreased to $144.7 billion from $148.9 billion recorded in the prior-year quarter. The Tier 1 common equity to total risk-weighted assets ratio was estimated at 11.6% under Basel III (fully phased-in) as of Sep 30, 2019, down from 11.9% in the year-earlier quarter.
Book value per share advanced to $40.48 from $37.55 recorded in the comparable period last year.
Return on assets was 0.95%, down from 1.27% in the prior-year quarter. Return on equity was 9%, down from 12.04% in the comparable prior-year quarter.
Wells Fargo partially redeemed Series K Preferred Stock, which reduced earnings by 5 cents per share due to the elimination of purchase-accounting discount recorded on these shares during the Wachovia acquisition. This partial redemption will reduce the amount of the company’s quarterly preferred stock dividends by about $23 million, starting in the fourth quarter.
Management currently expects MBS premium amortization to continue to increase in the fourth quarter but at a slower pace.
Mortgage originations for the quarter are expected to remain at a level similar to third quarter. Notably, originations increased sequentially due to higher refinance volumes from lower interest rates with refinancing increasing to 40% of originations in the third quarter.
The company expects effective income tax rate to be about 17.5%, excluding the impact of any unanticipated discrete items.
Management expects NII to be down 6% compared with 2018 influenced by a number of factors including loan growth, pricing spreads, the level of rates and the slope of the yield curve.
The company expects 2019 expenses to be around $53 billion, which is at the top end of $52 to $53 billion target range. This excludes annual operating losses in excess of $600 million and also excludes deferred compensation expense. For 2020, expenses are expected in $50-$51 billion range.
Per management, the bank’s strategic and financial targets beyond 2019 will be established once a permanent CEO comes in place. Therefore, currently, the bank focuses on cost-saving initiatives.
Moreover, ROE is anticipated to be 12-15% over the next two years (ended 2020), while ROTCE is expected to be 14-17%.
How Have Estimates Been Moving Since Then?
It turns out, estimates revision have trended upward during the past month.
At this time, Wells Fargo has a poor Growth Score of F, however its Momentum Score is doing a bit better with a D. However, the stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.
Overall, the stock has an aggregate VGM Score of D. If you aren't focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Wells Fargo has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
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