Wells Fargo: 1Q21 Update

by The Compound Investor

Banking giant Wells Fargo (WFC) last appeared on the site back in the summer. At the time, San Francisco-based Wells was setting aside billions of dollars for potential bad debt due to the COVID downturn. That, in turn, was putting obvious downward pressure on net income. No surprises there; the biggest economic hit in generations was never going to be good for bank stocks.

That said, results for the full year were not as bad as many would have expected in the early days of the pandemic. Indeed, 4Q20 financial results released earlier this month revealed a circa $2.6b quarterly net profit. Net interest income (“NII”) clocked in at $9.3b in the quarter, down from $11.2b in 4Q19 on the back of lower interest rates. That contributed to total revenue of $17.9b, some 9.7% lower than in 4Q19. Revenue for FY20 as a whole came in at $72.3b, down from $85.1b in FY19.

Not much to cheer about on the face of it, but COVID losses have not materialized to the extent that many predicted. I mean, the bank holds circa $900b in loans all together. Just over 2% of that figure is currently set aside for bad debt. Actual net charge-offs, however, only clocked in at around $3.4b last year. Granted, that was up from $2.8b in FY19, but not by a crazy amount. Net charge-offs in Q4 came in at $584m, lower than the $731m booked in Q3. The bank also managed to release circa $765m in loan loss reserves, resulting in a $180m gain in loan loss provisions last quarter.

Headwinds

Most folks know that Wells is battling some serious headwinds right now. For one, it faces the same low-interest rate environment as its peers. NII fell over 15% last year as interest rates cratered due to COVID. That, in turn, caused its net interest margin to drop to 2.23%, some 46 basis points lower than FY19. This remains a near-term headwind, with the bank expecting NII to decline by up to 4% next year.

(Source: Wells Fargo 4Q20 Results Presentation)

More specifically to Wells, it is still living with the asset-cap imposed by the Fed. Past transgressions means that it is stuck at just under the $1.95t mark, limiting the bank’s ability to grow. Finally, the pandemic has hindered the necessary cost cutting program here. Wells originally targeted around $10b in cuts to its annual expense bill, a figure it saw as bringing it into line with peers. That has since been lowered to $8b, and will take up to four years to pull off.

(Source: Wells Fargo 4Q20 Results Presentation)

All said and done, non-interest expenses clocked in at $57.6b in FY20. That was barely unchanged on the $58.1b recorded the year before. Lower revenue, plus an extra $12b set aside for bad debt due to COVID, helps explain the profit wipeout. Net income applicable to the common stock came in at $1.7b for the year, or 41¢ per share. That was down from $17.9b, or $4.05 per share, in FY19.

On the plus side, the bank looks well capitalized. Its CET1 ratio clocked in at 11.6%, up from 11% in Q2 as capital returns to shareholders essentially ceased. That means Wells now holds around $30b in capital over the regulatory minimum, with increased shareholder returns hopefully on the cards soon.

Valuation

When Wells Fargo last featured on the site back in July, analysts had FY21 profit coming in at circa $2.15 per share. That figure has since been bumped up to the $2.30 per share mark. The stock currently trades for circa $30, with quick math putting it around 13x estimated earnings per share (“EPS”). Estimated FY22 EPS of $3.30 lowers the forward price-earnings ratio (“PE”) to just 9.5.

(Source: Wells Fargo 4Q20 Results Presentation)

I maintain the view that the bank is very cheap. Almost everything that could go wrong here has gone wrong. As a result, the stock remains around 35% lower than pre-COVID levels. Looking slightly further ahead, Wells thinks it can eventually hit a 15% return on tangible equity. That currently stands at circa $33 per share, so a 15% return implies EPS in the $5 region. If successful, I would expect a share price closer to $75 than $30. The numbers continue to imply double-digit annual returns for prospective investors, with some margin of safety in there too.

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