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Morningstar | Small Additional Legal Accrual for Wells, but Expenses Remain on Target for Longer-Term Decrease

Wide-moat Wells Fargo continues to wade through its legal issues, recording another $241 million in remediation accruals. However, operating losses were at $605 million, down from $619 million last quarter, and far lower than the over $1 billion in losses per quarter for multiple quarters preceding this. This is at least in the right direction, and the bank announced no new legal issues, as the charges were related to already announced items. The return on average tangible common equity improved to 14.3%, and diluted EPS was up over 30% year over year. If Wells can begin to get past its legal and operating woes, maintain expense discipline, and return to anywhere close to its former profitability, the bank is arguably undervalued at today’s prices. We are maintaining our fair value estimate of $67 per share.

Primary consumer checking customers were up 1.7% year over year, retention rates for these customers reached a five year high, and debit and credit card purchase volumes were also both up year over year. We view these as positive signs that Wells’ underlying consumer business has not been permanently weakened or impaired. Average loan balances were down, which was largely expected, and this was across a broad number of different loan portfolios. However, average credit card balances still managed to grow quarter over quarter for the bank. Credit quality remained pristine, as the net charge-off ratio remained range-bound and provisions picked up only slightly. Management reiterated their expense guidance, and we see the bank being able to consistently decrease the expense base through 2020. This is partially helped by the assumption that legal accruals will not be as sizable and will eventually go away, but it is also based on taking real costs out of the business as well.

Given how Wells is repositioning its balance sheet, it hasn't seen as much of an increase in net interest margins as some peers. However, the bank’s deposit betas remain low, and we still project some expansion in net interest margins helping offset the shrinking balance sheet. Fee income was roughly flat year over year. The bank’s trust and investment fees continued their slow downward trend, but Wells surprisingly saw an uptick in mortgage related fees, despite current headwinds. Expenses remain well in line with our own projections, and we largely view Wells as an expense story over the next several years. Even with little to no revenue growth, if the bank can control expenses and eliminate legal charges, Wells should be well on its way to regaining its past profitability.