Potential upside & downside to trefis price
Wells Fargo & Co. Company
- Wholesale Banking (Commercial Lending, Trading & Investment Banking, Insurance & Other) constitutes 59% of the Trefis price estimate for Wells Fargo & Co.'s stock.
- Community Banking constitutes 25% of the Trefis price estimate for Wells Fargo & Co.'s stock.
- Wealth & Investment Mgmt constitutes 15% of the Trefis price estimate for Wells Fargo & Co.'s stock.
WHAT HAS CHANGED?
Latest EarningIn Q3 2020, Wells Fargo posted revenues of $18.86 billion, which was 14% lower than the year-ago period. This could be attributed to a 5% y-o-y drop-in community banking followed by around 19% decline in the wholesale banking segment.
Impact of coronavirus outbreak Wells Fargo is the biggest mortgage banker in the United States, with a sizable loan portfolio of around $399 billion in community loans and $456 billion in commercial loans (as per 2019 data). But businesses are staring at potential losses due to the combined effect of lower consumer demand, supply chain disruption, and global economic slowdown – exposing the bank to the possibility of sizable loan defaults. Additionally, it could increase the cost of funds for the bank, negatively impacting all its operations. While the company’s results for the first three quarters were on the similar lines, we believe Wells Fargo’s Q4 results will confirm this reality with a reduction in both community and commercial banking revenues.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICEBelow are key drivers of Wells Fargo's value that present opportunities for upside or downside to the current Trefis price estimate for Wells Fargo:
For additional details, select a driver above or select a division from the interactive Trefis split for Wells Fargo at the top of the page.
- Net Interest Income as % of Total Loans: We currently estimate that the net interest yield on Wells Fargo's community banking loans will slightly decrease going forward from 6.37% in 2019 to around 6.2% by the end of the Trefis forecast period. However, there could be a 3% upside to the Trefis price estimate if the yield figure reaches the 7%-level seen over 2005-2007.
- Provisions as % of Mortgage Loans: We currently forecast that the credit losses on Wells Fargo's outstanding home mortgage loans as a percentage of the total loans will normalize around 0.05%. However, if the credit losses as a percentage of loans settle around 0.25%, there could be a potential downside of 2% to the Trefis price estimate.
BUSINESS SUMMARYWells Fargo & Co. is a diversified financial services company headquartered in San Francisco, U.S. It is the third largest bank in the U.S. by assets and the largest bank by market capitalization. Wells Fargo originates and services the largest number of mortgages in the country. It is also the second largest bank in terms of deposits and debit cards in circulation.The bank offers financial products and services for corporates, government, financial institutions, private and business clients throughout the world. Services offered include banking, insurance, investments, mortgage and consumer finance.
SOURCES OF VALUE
Mortgage OperationsWells Fargo's mortgage division, consisting of home mortgage loans (does not include commercial real estate mortgage loans), mortgage servicing business and mortgages held for sale, is the cornerstone of Well Fargo's business model.Wells Fargo is the nation's largest mortgage originator. The bank originated a record $524 billion in mortgages in 2012 - a figure that fell to $175 billion by 2014 due to weak industry conditions before recovering to $249 billion by 2016. The figure again dropped to $177 billion in 2018 due to difficult market conditions, before increasing to $204 billion in the subsequent year. Also, at the end of 2019 Wells Fargo serviced (processed monthly payments of home loans) $1.63 trillion in third-party mortgages (besides the mortgages it originated and retained) - making it the largest servicer of mortgages in the U.S.
Asset Management & Brokerage, Deposits and Insurance & OtherNon-interest income generating divisions like Asset Management & Brokerage, Deposits and Insurance & Other are some big sources of value for Wells Fargo. The income from these divisions includes maintenance fee on deposit accounts & Individual Retirement Accounts (IRA), brokerage on trading, insurance fee, trust and investment management fee.With more than 20 million retail bank households and over 2.5 million small business and business banking households, Well Fargo had around $1.3 trillion in deposits at the end of 2018. Wells Fargo is also one of the country's largest IRA providers. The segment has great potential as currently only about six of every 100 Wells Fargo customers have an IRA account with the bank.
Wells Fargo's reputation has taken a hit from a series of mis-selling scandals:Wells Fargo revealed in September 2016 that its employees fraudulently opened millions of accounts. Since then, internal investigations by the bank have unearthed other improper practices by some employees including making unsuitable mortgage modifications, selling unwanted auto insurance, improperly charging fees for locking-in mortgage rates, and adding chargeable add-ons to accounts without the customers' permission.The series of mis-selling practices targeting retail customers has had a notable negative impact on Wells Fargo's reputation, besides already costing the bank millions in settlement and remediation fees.With plans to increase retail cross-sell to around 8 products per relationship from the current levels of just above 6, Wells Fargo will observe increasing revenues in the future.
Recent decrease in prime loan interest rates can hurt Wells FargoAs a result of the economic downturn, the U.S. government decreased the prime loan interest rate (the interest rate that commercial banks charge their most credit-worthy customers) from levels of around 8.25% in late 2007 to 3.25% in 2008. The prime rate remained at this level for more than 7 years, before being hiked on four separate occasions - in December 2015, December 2016, March 2017 and June 2017 - by 25 basis points (0.25%) each to bring it to 4.25%. It gradually increased to 5.50% in Dec 2018 after a series of hikes, before reducing to 5% in 2019 after two consecutive cuts. As economic conditions improve, interest rates will eventually return to historical levels, at which point Wells Fargo's revenues will be positively impacted.
High core deposits and low cost of funding:Wells Fargo has a net interest margin (interest earned on earning assets minus interest paid on funding sources as a percentage of interest earning assets) of 3.8% (10-year average over 2007-2016) which is significantly higher than that for its peers Citigroup, JPMorgan Chase and Bank of America. High net interest margins at Wells Fargo are largely attributed to its large average core deposits (which include non-interest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits). Nearly two-thirds of Wells Fargo's funding comes from deposits, much higher than the peer average of under 50%.
Consolidation expected to continueAs a result of the financial crisis, the banking industry saw a period of mergers and consolidation. The financial crisis has seen nearly 15-20% of market share change hands. The banking industry continues to see consolidation in almost every aspect of the business as players try and globalize and seek scale. Customers are also increasingly becoming more risk averse and turning to larger players with stronger deposit bases due to uncertainty. The number of operating commercial banks declined from 7,630 in 2004 to less than 5,000 in 2017.