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Morningstar | Wells Fargo Lowers Net Interest Income Guidance; Outlook Turns More Negative. See Updated Analyst Note from 12 Apr 2019

Wide-moat Wells Fargo reported OK first-quarter results, but it cut full-year guidance, and several other negatives brought up during the call weighed on results. The bank’s return on tangible equity was 15.2% compared with 12.6% in the first quarter of 2018. This was largely helped by operating losses improving by over $1 billion. Operating losses were $238 billion for the quarter, the best result in over a year. However, management reduced net interest income guidance for the year, and while it is sticking to the original 2019 expense guidance, management did admit that it needs to outperform on the original cost-saving expectations to make up for more than $1 billion in extra regulatory expenses. It also said that with the leadership transition underway, 2020 expense guidance is no longer official. On the basis of the changing guidance and a re-evaluation of our revenue growth and expense assumptions, we are lowering our fair value estimate to $60 per share from $65.

Wells admits that it is in the early stages of finding its next CEO. While current management reiterates that it has the full backing of the board and has been instructed to proceed as it would have otherwise, the fact remains that the bank has no official long-term leader and management in general remains in the midst of significant changes. This, combined with the asset cap staying on until 2020 at a minimum, the additional public comments from regulators, and the extra $1.4 billion in regulatory and compliance spending, contributes to our increasing conviction that the issues at Wells Fargo run deep and the bank still has a lot of work to do, with potentially years of additional work still outstanding. In the meantime, the bank’s main competitors are reaching newfound levels of operational strength and profitability, putting them decidedly on offense while Wells remains on defense.

Deposit balances continue to shrink for Wells even as they grow for peers. Management said it is instituting certain deposit promotions, and this is contributing to rising deposit costs for the bank even as rate hikes have potentially ceased. Average loans outstanding were down slightly year over year, as commercial and industrial loans and credit card balances have seen some growth, while most other categories have been either flat or down. Fee income was also fairly lackluster, down 4%, although management did highlight that there were some one-time factors that probably suppressed first-quarter results, so we would not be surprised to see the run rate pick up from here. Credit costs also picked up a bit, but most credit metrics are still within a fairly stable range.

More specific business metrics that worry us include some of the community bank metrics, the lack of deposit growth, and continuing growth struggles for the wealth segment. Credit card purchase volume was up 5%, roughly half the growth rate we saw for JPMorgan this quarter. Wells also continues to see advisor counts go down, as well as client assets and assets under management. Some mortgage metrics did improve, such as production margins and the size of the application pipeline, and we agree that with lower long-term rates we could see some boost in activity. However, we don’t see this being a consistent and material earnings driver over the medium term.