Wells Fargo’s Results Will Continue To Be Impacted By Fed’s Enforcement Order
The second quarter of the year was an overall disappointing period for Wells Fargo (NYSE:WFC), with the U.S. banking giant falling short of investor expectations when it reported results late last week. Investors had already set the bar fairly low for Wells Fargo, given that the bank is primarily focused on working its way through the Federal Reserve’s enforcement order prohibiting it from growing any larger until it fixes its internal governance issues. However, continued weakness in the bank’s core mortgage business – coupled with a notable decline in fortunes for its wealth and investment management business – made things worse than expected.
We have summarized Wells Fargo’s Q2 2018 earnings and also detailed the major takeaways from the announcement in our interactive dashboard, the key parts of which are captured in the charts below. With the Fed’s enforcement order likely to stay in place for the rest of the year, the bank’s consumer and wholesale banking activities are expected to remain under pressure for the rest of the year. While the bank is losing ground in the U.S. retail and commercial banking space, the fortunes of its wealth management division have also been dwindling over recent quarters. Taking all this into account, we have reduced our price estimate for Wells Fargo’s stock from $65 to $60. The new price estimate is slightly ahead of its current market price.
See our full analysis of Wells Fargo
Net Interest Margin Finally Nudged Higher, Boosting Top Line
The biggest impact of the Fed’s enforcement order on Wells Fargo’s operations over recent quarters has been the decline in its interest-earning assets – especially its loan portfolio. The bank’s interest-earning asset base has steadily shrunk from a peak of nearly $1.8 trillion in Q3 2017 to $1.73 trillion in Q2 2018 – primarily because it has had to work its way through low-yielding loans in its portfolio to make room for potential growth over coming months in its core focus areas.
Fortunately, the bank witnessed an uptick in its net interest margin (NIM) figure for Q2 2018 after reporting a decline in the key metric for three consecutive quarters. It should be noted that the Fed’s ongoing rate hike process has improved the NIM figure across the U.S. banking industry for several quarters now. With the NIM figure increasing to 2.93% from 2.84% in the previous quarter, Wells Fargo’s net interest income figure crossed the $12.5 billion mark for the first time in its history
Mortgage Banking Revenues Continue Downward Trajectory
Wells Fargo’s business model focuses considerably on the mortgage industry, with the bank making a sizable chunk of its net interest revenues from residential mortgages in addition to generating fees from originating and servicing mortgages. However, the weak level of activity in the U.S. mortgage industry over the last few quarters has weighed on its top line. Although there was a slight uptick in mortgage origination activity for Q2 over the seasonally slow Q1 ($50 billion in mortgage originations in Q2 vs. $43 billion in Q1), the associated fees fell to the lowest level since Wells Fargo’s acquisition of Wachovia at the peak of the recession. Notably, this resulted in total mortgage banking fees falling to just $770 million – or 8.5% of the total non-interest revenues of $9 billion for the quarter – the lowest proportion in at least 15 years.
Worst Appears To Be Over In Terms Of Legal, Settlement Costs
Over recent quarters, Wells Fargo has had to set aside billions of dollars in cash to cover legal costs from its ongoing investigations. This is clear from the fact that Wells Fargo’s “Other Expenses” jumped to over $6.5 billion in Q4 2017 from an average figure of $3.2 billion over the ten-quarter period before its account opening scandal came to light. While these expenses remained elevated at around $3.7 billion in Q1 as well as Q2, the bank has reached an agreement in most lawsuits against it, and these expenses should fall to around $3.3-$3.4 billion over subsequent quarters.
We expect Wells Fargo to report EPS of $4.44 for full-year 2018. Taken together with a P/E ratio of 13.5, this works out to a price estimate of $60 for Wells Fargo’s shares, which is slightly ahead of the current market price.
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