As per Wells Fargo & Co. (NYSE: WFC), we expect Mr. Scharf to primarily focus on regulatory issues that have hindered growth, particularly a consent order with the Federal Reserve that has capped assets at the end of the 2017 financial year at $2 trillion. The consent order required that several changes (some of which have already been implemented) be made to board governance, including separating, amending, and enhancing the company’s board in such areas as risk management and cybersecurity, reviewing and appointing new chairs of the risk governance, and nominating committees. In addition, we expect a focus on strengthening the sales culture in the wake of the 2016 sales practice scandal.
Still, we acknowledge that earnings improvement will be hampered by a currently less favorable interest rate environment. In the fourth quarter, revenues were challenged by a flat core fee-based income. We expect the impact of reduced interest rates to result in lower interest income in 2020. But we now look for revenue growth to improve in the second half of 2020 as regulatory burdens lessen, benefits accrue from a new sales culture, and the Fed’s limited rate hike campaign is mostly lapped. While the company has embarked on an aggressive expense containment plan, we expect that the new CEO will have a bit of runway for expense initiatives early in his tenure, enabling growth investments that have stalled amid the lack of permanent leadership.
The company has also sold its Institutional Retirement & Trust Business to Principal Financial Group.
Capital return measures are also improving, as the Fed allowed WFC to raise its dividend by 13% in 3Q19. In addition, the company continues to reference improving customer loyalty scores at its branches, a positive sign as WFC works to restore customer trust following the sales scandal.
On January 14, WFC reported adjusted 4Q19 earnings of $0.93 .21 $1.12 consensus forecast. .33 per share of litigation accruals. Revenue declined 5% to $19.9 billion.
Average earning assets rose 2.8%, but with the net interest margin narrowing to 2.53% from 2.94% a year earlier, net interest income fell 11%. Credit quality improved, with net charge-offs of 0.32% of average loans, up from 0.27% in 3Q and 0.30% a year earlier. The loan loss provision rose from $644-$769 million.
Non-interest income rose 4%, mostly reflecting sharply higher gains on equity securities.
For all of 2019, revenues were down 2%, to $85.1 billion, while EPS rose to $4.50 from $4.39.
EARNINGS & GROWTH ANALYSIS
Average loans have been flat-lining around the $950 billion level, with growth in commercial loans offset by modestly declining consumer loans, although the year-over-year rise in first mortgages in 4Q19 was encouraging. The company’s lending business continues to face challenges from the Federal Reserve consent order capping asset growth. Meanwhile, we expect the Fed’s recent rate cut campaign to result in further net interest margin contraction, keeping pressure on net interest income.
Non-interest income benefited in 4Q from sharply higher equity securities gains, but many core income categories (service charges, brokerage advisory and card fees) were relatively flat. Overall, we look for 2020 revenue to be down 8% from 2019.
Wells is attempting to establish better control on expenses, and has noted that its efficiency ratio (non-interest expense divided by revenue) is too high. The company met its efficiency initiatives in 2018 by lowering expenses by $2.4 billion, to $56.1 billion. The 2019 expense target of $52.0-$53.0 billion was slightly missed as adjusted expenses amounted to $53.7 billion. The company has projected a further decline in expenses to $50-$51 billion in 2020.
We are also lowering .39 from $4.66 mostly on further net interest margin contraction. We are initiating a 2021 forecast of $4.84.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on Wells Fargo is High.
As at December 31, 2019, Wells Fargo estimated was 11.1% under Basel III (advanced approach, fully phased-in).
In 4Q19, the company repurchased 141.1 million shares of common stock. We look forward to a 6% decline in the average share count in 2020, among the larger decreases among the major banks we cover.
MANAGEMENT & RISKS
Charles W. Scharf was named the company’s new president and CEO in October 2019, taking over from Allen Parker, who had held the positions on an interim basis following the resignation of Tim Sloan in March 2019.
Wells Fargo views the mortgage as the gateway to a broader consumer relationship, and its earnings growth strategy has always been focused on revenue growth, driven in part by cross-selling, or selling multiple products to each customer. However, these sales practices were sharply curtailed in the wake of the 2016 sales scandal. There is also the risk that demand for WFC products may slow down—at least on the consumer side. In addition, Wells Fargo focuses exclusively on the U.S.—a mature and intensely competitive market.
Wells Fargo is primarily a retail, commercial banking and consumer finance firm. While the company has added to its trust and investment management business in recent years via internal growth and acquisitions, market-sensitive revenues have remained a relatively small part of the company’s mix.
Wells Fargo is among the largest mortgage originators and servicers in the United States. It has direct exposure to about $322 billion of consumer mortgage loans, of which about $30 billion are second liens.
Wells Fargo provides a full range of consumer banking, commercial banking, and investment banking services. The company nearly doubled its assets with the acquisition of the former Wachovia. Wells Fargo accounts for roughly one of every four residential mortgages in the United States.