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Wells Fargo (NYSE:WFC) has done alright since my last update on the company, outperforming its large bank brethren by about 600bp since my last update and posting strong core growth in the fourth quarter. Wells Fargo looks well set to provide two of the things the market really wants from banks in 2023 – spread-driven pre-provision earnings growth and sizable returns of capital to shareholders. At the same time, though, the regulatory overhang is not going away and I see more risk of harsher sanctions against the company.
I’m looking for mid-single-digit long-term core earnings growth from 2022’s level, and along with ROTCE-driven P/TBV and P/E methodologies, it supports a mid-$50s fair value. I do use higher near-term discount rates with Wells Fargo due to the regulatory risks, and while I do think above-average growth can continue to drive a healthy valuation, I see better risk-reward trade-offs among smaller regional banks.
Reviewing The Fourth Quarter
As is typical for the largest banks, there were a lot of moving parts and adjustments needed for Wells Fargo’s fourth quarter results. The core results were nevertheless strong, though, as the bank continued to leverage its asset sensitivity and growth initiatives.
Core adjusted revenue rose almost 12% year over year and almost 5% quarter over quarter, beating by about $0.11/share. Net interest income jumped almost 45% yoy and 11% qoq, one of the strongest results in its peer group (and almost $0.10/share better than expected), with strong net interest margin improvement (up 103bp yoy/up 31bp qoq to 3.14%).
Adjusted fee income fell 23% yoy and 6% qoq, but still beat expectations. Service charges declined 9% qoq, card fees declined 2%, and mortgage banking remains quite weak, but trading was strong (fixed income up 18% and equities up 36%), as the bank continues to invest in this area.
Operating expenses were messy, but I pegged core opex down 5% yoy and up about 2% qoq. Comps to sell-side estimates are tougher to make since not all analysts make the same adjustment, but I feel confident in saying that this outcome was still meaningfully better than expected.
Adjusted pre-provision profits rose about 54% yoy and 9% qoq, again a strong result relative to peers, and again better than expected. Provisioning was a little higher than expected, but not meaningfully so (about $0.01/share).
Wells Fargo was somewhat underwhelming on lending, with end-of-period gross loan growth of about 1%, including nearly 2% C&I lending growth, barely any CRE or mortgage lending growth, and about 6% card loan growth, while auto loans declined almost 2%. Yields improved nicely (up 181bp yoy and 85bp qoq to 5.13%), and Wells Fargo’s nearly 52% loan beta is very strong for its peer group.
Funding remains mixed. On one hand, total deposit costs of 0.46% are quite low, as is the 12% cumulative beta, but Wells Fargo also saw elevated attrition in non-interest-bearing deposits (down 7.4%). Given rising deposit costs and less upside on earning asset yield growth, I expect NIM to peak in Q1 or Q2 (probably in the 3.25% range, but 3.3x% wouldn’t shock me).
Capital And Regulatory Issues Are Important Watch–Items
Prior to the fourth quarter, Wells Fargo provided another regulatory update, this time concerning a settlement with the Consumer Financial Protection Bureau (or CFPB) relating to auto lending, customer deposits, and mortgage lending. In addition to another $2B or so in remediation costs, the settlement included a $1.7B fine, as well as a new consent order that will end 180 days after the completion of further remediation work or 3 years (whichever is sooner). As part of this announcement, the CFPB also terminated a consent order tied to student loan servicing.
What concerns me are the comments that CFPB director Chopra made in connection with the enforcement action. Specifically, he mentioned this as an “initial step” to relief and specifically called out Wells Fargo as “one of the most problematic repeat offenders”. Chopra also chastised the bank for the pace of progress in addressing ongoing issues and noted “concern” that the bank’s focus on growth initiatives (including new cards and products like Wells Fargo Premier, not to mention extensive hiring in trading and investment banking) is delaying progress on the reforms.
Toward the end of the prepared remarks, Chopra said that regulators must consider additional limitations on Wells Fargo above and beyond the asset cap. I’m not entirely sure what that might entail, but I can’t see how it won’t be bad for the company’s growth outlook and its ability to return capital. And for whatever it’s worth, I agree with Chopra at least in part – I do think Wells Fargo has dragged its feet on fixing many of these issues and it has at least given the outward appearance that regaining full regulatory compliance is not management’s top priority.
With that, I segue to Wells Fargo’s robust CET1 ratio and the prospects for above-average capital returns in 2023 and beyond. Although the Fed’s stress test this year will be tougher (a more severe downside scenario), it’s not exactly surprising given regulators’ push for higher capital requirements for the large banks. While I do think higher required buffers are a real risk, and it’s possible that the CFPB may push to limit Wells Fargo’s ability to return capital as another punishment, the mid-teens pre-provision growth I expect over the next two years (annualized) on top of an already robust capital base and likely modest credit cycle should pave the way for strong capital returns.
The Outlook
I’ve said elsewhere that I expect the strongest loan growth opportunities in 2023 to be in card and C&I lending, and so far, the data back that up, with cards and C&I both outperforming sluggish year-to-date loan growth numbers. Wells Fargo isn’t as leveraged to cards as Bank of America (BAC), Citigroup (C), JPMorgan (JPM), or U.S. Bancorp (USB), and its C&I exposure is basically average at around 42%. On the other hand, asset sensitivity can still provide a tailwind and since the asset cap limited the bank’s ability to accept surge deposits, they may well have less vulnerability on funding costs.
I do see some elevated credit risk here, as Wells Fargo has more non-prime business in cards and autos, but I don’t think we’re going to see a serious downcycle in credit quality. So, that’s “elevated” in the context of a likely pretty benign overall credit cycle. I’d note that the bank’s commercial credit quality remains excellent and the reserve situation looks fine.
All told, I’m expecting mid-teens pre-provision growth across the next two years, with over 25% growth this year and likely mid-single-digit growth in FY’24. Longer term, I expect core growth around 5% to 6% (or closer to 2% relative to pre-pandemic levels). I do think ongoing regulatory issues are a headwind that needs to be addressed more significantly, and current management has been on the job for three years with a mandate to clean this mess up.
Discounting those core earnings gives me a fair value in the mid-$50s, with ROTCE-driven P/TBV (a 1.55x multiple) and P/E (an 11x multiple) giving me similar results. Relative to my last update, my ’23 EPS estimate is $0.27/share lighter, even though 2022 was a better year than I expected.
The Bottom Line
It’s not hard to model a scenario of even more robust growth that can support a fair value of WFC stock closer to $60 (if not $65), but I do think business is going to slow and management has been actively reducing its exposure to some business lines (like auto lending and CRE). I do like the long-term potential of building up the trading and i-banking operations, but I think Wells Fargo management needs to take heed of the optics and the risk of provoking regulators to implement further sanctions.
At this point, I see valuation with JPMorgan as a toss-up, and I own JPMorgan myself, and I see better risk/reward opportunities with names like Cullen/Frost (CFR), M&T Bank (MTB), Synovus (SNV), and Truist (TFC).
Source: seekingalpha.com
