What To Expect From Wells Fargo’s Q3 Results

by Trefis Team
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Wells Fargo & Co.
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Wells Fargo (NYSE:WFC) is one of four U.S. banking giants scheduled to report results for the third quarter of the year on Friday, October 12, and we expect Q3 2018 to be another forgettable period for the third-largest U.S. bank. We estimate that Wells Fargo will report earnings of $1.15 per share on revenues of just under $21.9 billion for the quarter, based on our detailed interactive model for Wells Fargo’s revenues and expenses for the quarter. Given the consensus estimate of $1.17 for Wells Fargo’s EPS and $21.6 billion for its revenues, this implies an earnings miss for the bank, although revenues should come in ahead of expectations.

The three key trends that contribute to our forecast are: a depressed net interest income figure for the bank despite the improving interest rate environment; continued pressure on its cornerstone mortgage banking unit; and elevated operating expenses from non-recurring costs linked to its legal troubles as well as its ongoing efforts to reduce headcount.

We maintain a $59 price estimate for Wells Fargo’s stock, which is about 10% ahead of the current market price.

Key Expectation #1: Net Interest Income To Remain Under Pressure

In early February, the Federal Reserve passed an enforcement order against Wells Fargo prohibiting the banking giant from growing any larger until it has satisfactorily resolved its internal governance issues. This meant that the bank would have to accommodate growth in core loans and deposits without letting its balance sheet swell in size – something that is estimated to cost the bank between $300-$400 million in profits this year.

Over recent quarters, Wells Fargo has worked its way through its portfolio of non-core loans to maintain its balance sheet, even as it suffers from subpar growth across loan categories in the wake of its account opening scandal. This has resulted in a steady decline in the bank’s interest-earnings assets over recent quarters – in turn negating the impact of the Fed’s rate hike process on its net interest margin figure. We expect the trend to continue in Q3 2018 too, with interest-earning assets sliding marginally even as the NIM figure improves from 2.93% in Q2 to 2.95%. The net impact of this would be a negligible change in Wells Fargo’s net interest income sequentially.

Key Expectation #2: Mortgage Fees To Remain At Recent Lows

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. But the cornerstone business has seen revenues falling to post-recession lows, as a notable reduction in the origination of fresh mortgages coupled with dwindling mortgage refinances has hurt mortgage origination fees. The Mortgage Bankers Association (MBA) estimates that total mortgage origination volumes fell slightly from $447 billion in Q2 2018 to $443 billion in Q3 2018, which will weigh on origination fees for the quarter.

Although increasing mortgage rates have had a positive impact on the value of mortgage servicing rights (MSRs) over recent quarters, this has not helped servicing fees due to the negative impact of stricter regulatory requirements imposed on mortgage servicing activities in the aftermath of the downturn. Taken together with weak origination fees, we expect total mortgage banking fees to remain largely level with the low figure for the previous quarter.

Key Expectation #3: Legal Overhead Costs, Reorganization Efforts To Weight On Profits

Wells Fargo has been under investigation by several federal and state regulators since September 2016, when it was revealed that its employees fraudulently opened millions of accounts. Since then, these agencies have also been investigating other improper practices across its operating units. While Wells Fargo continues to work on fixing internal control policies in a bid to get clear of the Fed’s enforcement order, it has also had to shell out millions of dollars in legal and settlement costs to put these misgiving behind it.

More recently, Wells Fargo announced plans to reduce its employee headcount by 5-10% over the coming years as it automates various operations to improve customer services. While these efforts will drive growth in the long run and will also reduce recurring costs, they are likely to have a negative impact on operating costs over the next few quarters as Wells Fargo incurs one-time charges like severance pays and restructuring costs.

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