/Wells Fargo: Stock Remains Disconnected – Seeking Alpha

Wells Fargo: Stock Remains Disconnected – Seeking Alpha


While Wells Fargo (WFC) may have not have reported a great quarter in relation to previous years, the Q3 results were still far better than the market feared with the stock down 50% for the year at $24. The large bank even saw capital ratios rise during the quarter. My investment thesis remains very bullish on the bank at these levels with a large level of confidence that the new management team improves financials going forward.

Image Source: Wells Fargo website

Quarterly Disconnect

For Q3, Wells Fargo reported revenues dipped 14.3% from last year to only $18.9 billion. At the same time, the bank stock is down an incredible 50% as the market feared far more dire outcomes for the sector.

Instead, the large bank generated a listed net profit of $2.0 billion in what was expected to be a horrible quarter that the Fed forced Wells Fargo to cut their dividend. Once one adjusts pre-tax results to exclude the roughly $1.5 billion in net charges for restructuring and customer remediation accruals in the quarter, the bank actually had a pre-tax profit of $4.1 billion. The company had adjusted EPS of $0.75 on $3.1 billion in adjusted net income.

Source: Wells Fargo Q3’20 supplement

Whether one looks at GAAP or non-GAAP numbers, Wells Fargo still has noninterest expenses at $15.2 billion or over 80% of revenues. The efficiency ratio is by far the largest in a banking sector where the strong banks have ratios in the mid-50s.

The bank has recently promoted a goal of reducing annual operating expenses by $10 billion or the equivalent of $2.5 billion per quarter. As one can see, just a $2.5 billion reduction in the above expenses would only cut the efficiency ratio to 67%.

Once removing $1.5 billion in charges and $2.5 billion in expenses, the efficiency ratio would dip below 60%. In essence, the bank needs to increase income while also reducing operating expenses closer to $10 billion to $11 billion per quarter. At the same time, net interest income will rebound above $11 billion per quarter when interest rates normalize back similar to the Q1 levels where LIBOR rates were still a very low 1.5%.

Source: Wells Fargo Q3’20 supplement

Capital Ratios Remain Strong

The amazing part is that the stock is down ~4% in early trading despite the capital ratios rising. Wells Fargo now has the Common Equity Tier 1 ratio or CET1 up to 11.4%. The ratio is up from only 11.0% in the prior quarter and 10.7% back in Q1.

Source: Wells Fargo Q3’20 supplement

The ratios are higher due in part to cutting the dividend by 80% to only $0.10 per quarter. With 4.1 billion shares outstanding, Wells Fargo is only spending $410 million per quarter on dividends versus the prior dividend payments of $2.1 billion per quarter.

Technically, the bank had GAAP profits to cover the previous dividends and definitely the non-GAAP numbers to support the old dividends. All while the bank will have plenty of tailwinds going forward with higher interest rates eventually pushing up net interest income while the bank slowly cuts employee expenses.

The market is clearly missing that Wells Fargo is highly profitable despite a tough economic environment and lower interest rates while having almost no operating efficiency. The only real risk is higher provision expenses.

The bank only had provision expenses of $769 million in the quarter, but Wells Fargo still has $20.5 billion in allowances for credit losses on loans. As mentioned by the bank, customer forbearance and payment deferral activities due to COVID-19 are delaying recognition of net charge-offs and non accrual status for a large amount of loans. Wells Fargo only has $8.2 billion of nonperforming assets, but the bank has $23.5 billion in just consumer loans under deferrals, but the amount is already down from $37.2 billion in the June quarter.

The bank will surely have higher net charge-offs in future quarters, but Wells Fargo is unlikely to need materially higher loan provisions in the future quarters. While these numbers aren’t ideal, the numbers are far better than the dire stock valuation with Wells Fargo trading far below tangible book value here. In the past, the stock regularly traded at double the price to TBV which easily gets Wells Fargo right back to $50.

ChartData by YCharts

Takeaway

The key investor takeaway is that Wells Fargo had a bad quarter on all accounts, but the stock price reflects far worse outcomes. Investors sold off the bank stocks due to worries of a repeat of the financial crisis, yet the large bank is already back to generating substantial non-GAAP profits.

With the restructuring process full steam ahead now, investors can easily Buy the dip in the stock. Before long, Wells Fargo will be back on pace to top 2019 earnings of $4.05 per share due to normalized rates and far lower noninterest expenses. The large bank stock is an easy Buy at $24.

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Disclosure: I am/we are long WFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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