EUR 850.00 For Business Accounts Only

Morningstar | More Positives, Less Negatives Likely for Wells Fargo in 2019

Wells Fargo is one of our top banking picks entering 2019, as the bank is currently trading at one of the highest risk adjusted discounts to our fair value estimate among the U.S. money center and regional banks. We believe shares are worth $67, which is 13.5 times our 2019 earnings estimate and 2.1 times tangible book value as of September 2018.

Wells recently came to a settlement with the Attorneys General of all 50 states (as well as the District of Columbia) in regards to many of the already disclosed issues the bank is facing. This settlement covered the fake accounts sales practices, the unnecessary auto insurance issues, and the mortgage rate lock issues. The bank agreed to pay a total of $575 million to resolve the civil claims related to these. Wells had already accrued $400 million for these items, meaning an additional $175 million would be needed in its fourth-quarter earnings. We note that Wells had already been fined by regulators for these issues, therefore we would expect much, if not all of the liabilities resulting from these specific items to be closed.

Overall, we believe this is how 2019 will play out for Wells Fargo, as the bank settles outstanding items and puts much of the last three years in the rear view mirror. As the news cycle runs out of new negative items to report, the bank increasingly puts old issues behind it, and more normal levels of profitability return to the bank, we would not be surprised to see sentiment change over time. The next big item we expect an update on would be progress on getting the asset cap lifted.

We have added wide-moat rated Wells Fargo to the Best Ideas list.

Wells has been in a multi-yearlong cultural, reputational, and legal upheaval that has gone on longer than most would have anticipated when the fake accounts scandal began in earnest in 2016. While predicting the exact timing of a reversal in the negative news cycle and sentiment is difficult, we believe we are closer to the end than the beginning. We also believe it is likely that Wells will have its asset cap, imposed by the Federal Reserve in early 2017, lifted sometime during 2019. This should serve as a positive catalyst and remove one of investors’ primary concerns, which is “Why would I invest in a bank that can’t grow?” The bank is currently trading well below its historical tangible book value multiple, has the highest dividend yield among the big four, and we forecast the bank has the most room for operating income growth independent of revenue growth simply due to retreating legal and other accruals. Wells is not a revenue growth story but instead a story of declining expenses and improving sentiment. As highlighted in our piece, “New Regulatory Proposals Will Change Stress Test Landscape,” published on July 8, 2018, Wells may also have some of the most room to return capital to shareholders over the medium term among the big four. This should serve as a further backstop to the share price.

Wells certainly still has issues to resolve, including getting the asset cap lifted, responding to and resolving other consent orders, stemming the loss of financial advisors, and returning to offense among its small business and consumer clients. Because the bank has been on the defensive for so long, we now see Wells lagging behind in certain areas of investment compared with some of its toughest competitors. However, we do not believe the franchise has been fundamentally impaired. We note that the inappropriate sales practices generated essentially no profits for the bank, and a number of the more recently disclosed issues have been self-reported and occurred, in some cases, years ago. Many of the board members and managers present during the scandal have been replaced, and we believe it is only a matter of time before the microscope is removed from Wells and the bank returns to business as usual.

Further, while sentiment is at a low for the banking sector in general, we note that Wells has seen minimal net interest margin expansion compared with peers, has a history of smart credit underwriting, and we were already projecting essentially zero revenue growth net of provisioning through 2021. While the road ahead may get even bumpier for banks in general, Wells' combination of less rate exposure, a history of good underwriting, and the path forward not being dependent on outsized revenue growth all lead us to conclude there is a wider margin of safety in the name than with most peers.