Company Overview: Wells Fargo & Company (NYSE: WFC) is a bank holding company and a diversified financial services company that offers services under three key categories namely personal, small business and commercial. The company is engaged in providing retail, commercial and corporate banking services via banking locations and offices, the internet and other various distribution channels to businesses, individuals and institutions.

WFC Details

Higher Restructuring Activities & Cost Control Measures Aid WFC: Wells Fargo & Company (NYSE: WFC) is considered to be one of the largest financial services companies in the U.S. with $1.92 trillion in assets and ~$1.4 trillion in deposits as at 30 September 2020. The company is engaged in offering banking, insurance, trust and investments, mortgage banking, retail banking, brokerage services and consumer and other commercial services via its stores, ATMs, the internet and other distribution channels all over the world. The company has three key reportable segments namely Community Banking, Wholesale Banking and Wealth and Investment Management unit.

The company is undergoing restructuring changes, due to mounting pressure of cost control. In doing so, the company plans to carry out cost control measures through consolidating processes, outsourcing of certain operations, and branch shutting down implementations.  In October 2019, Wells Fargo divested its commercial real estate brokerage business, Eastdil Secured and noted a pre-tax gain of about $362 million, which was reflected in 4QFY19 net income. In July last year, Wells Fargo sold its Institutional Retirement & Trust business to Principal Financial Group for a sale consideration of $1.2 billion. In February 2018 and 2017, it completed the sale of its Shareowner Services business to U.K.-based Equiniti Group plc, and Wells Fargo Insurance Services USA, Inc to USI Insurance Services, respectively. In 2016, Wells Fargo also divested its fund administration business, Wells Fargo Global Fund Services.

The bank’s mortgage activity remains strong, backed by high refinance activity and healthy purchase activity. The bank remains on track to gain from high origination volumes and an increase in sale margins. These factors are anticipated to support Wells Fargo’s mortgage banking fees, going forward. Further, non-interest revenues continue to reveal strength in equity markets, enhancing market-driven revenues. Diversity and inclusion are also an integral part of the banks’ business. Coming to past performance, FY19 saw a net income of $19.5 billion. Diluted earnings per share for the period stood at $4.05 per share, which increased from $3.99 per share in 2016. During FY19, average loan and average deposit stood at $950.9 billion and $1.3 trillion, respectively. Average deposits were up $10.4 billion from 2018, mirroring higher other time deposits, mortgage escrow deposits and commercial deposits. ROA (Return on Assets) and ROE (Return on Equity) came in at 1.02% and 10.23%, respectively. The period was marked by a capital return of $30.2 billion to its shareholders via dividend and share repurchases, up 17% from $25.8 billion in FY18.

Past Performance (Source: Company Reports)

3QFY20 Key Highlights: During the quarter, the company reported diluted earnings of 42 cents per share, aided by robust mortgage banking revenues. However, the company reported diluted EPS of 92 cents in the year-ago period. Net income, including certain adjustments, during the quarter, stood at $2.04 billion. The quarter was marked with cautious expense management implementation. Further, high loans and deposits balance displayed a strong capital position. During the quarter, total revenues came in at $18.9 billion as compared to $22 billion reported in the year-ago quarter, owing to lower sales from business segments. Further, reduced net interest income on lower rates were key headwinds in 3QFY20. Segment revenues from the Community Banking decreased 4.5% year over year, while Wholesale Banking revenues declined 18.8%. Further, revenues in the Wealth and Investment Management were also down 25.5%.

3QFY20 Key Highlights (Source: Company Reports)

Key Highlights of Net Interest Income and Fee Income: During the quarter, the bank’s net interest income stood at $9.4 billion, a decline of 19% on a year over year basis, owing to lower interest income. However, decreased interest expenses were key positives during the quarter. Notably, net interest margin stood at 2.13%, down 53 basis points (bps) on a year over year basis. Non-interest income decreased by 9% on pcp and stood at $9.5 billion, owing to a fall in card fees, lending-associated fees, deposit-correlated fees, trust and investment fees, net gains on debt and equity securities as well as other income. Nonetheless, higher revenues from net gains from trading activities and mortgage banking partially offset these declines. Total loans as on 30 September 2020 came in at $920.1 billion, down 2% on a quarter over quarter basis. Total deposits at the end of the quarter came in at $1.38 trillion. Coming to the bank’s non-interest expense, the company recorded $15.2 billion during the July-September quarter, which was almost flat on pcp. The company’s efficiency ratio came in at 80.7%, up from 69.1% recorded in 3QFY19.

Interest & Loans Highlights (Source: Company Reports)

Credit Quality Sneak Peek: The bank’s credit quality was a jumbled bag in 3QFY20 end. As at 30 September 2020, allowance for credit losses (which included an allowance for unfunded commitments) came in at $20.5 billion, up a whopping 93.4% from the prior corresponding period. Net charge-offs during the quarter stood at $683 million or 0.29% of average loans, as compared to $645 million reported in the year-ago period. During the quarter, non-performing assets stood at $8.2 billion, up 36.7% on a year over year basis. It is worth mentioning that provision for credit losses stood at $751 million, up from $695 million reported in 3QFY19.

Non-Performing & Provision Expenses Highlights (Source: Company Reports)

Balance Sheet & Liquidity Position:  The bank has retained a robust capital position. The bank’s Common Equity Tier 1 under Basel III decreased from $144.7 billion reported in 3QFY19 to $134.9 billion in 3QFY20. The Common Equity Tier 1 (CET1) ratio to total risk-weighted assets ratio was estimated at 11.4% at the end of the quarter, as compared to 11.6% reported in the year-ago quarter. Book value per share in 3QFY20 came in at $38.99 as compared to $40.48 reported in the year-ago quarter.  ROA and ROE for the period stood at 0.42% and 4.22%, respectively, as compared to 0.95% and 9%, respectively, reported in 3QFY19. As on 30 September 2020, the bank’s eligible external total loss-absorbing capacity (TLAC) as a percentage of total risk-weighted assets came in at 25.8%, as compared to the least requisite of 22.0%. During the quarter, the company announced a quarterly dividend of 10 cents per share.

CET1 Highlights (Source: Company Reports)

Key Metrics: Net interest Margin for 3QFY20 stood at 2.13%, slightly lower than the previous corresponding period figure of 2.66%. Efficiency ratio stood at 80.7% in 3QFY20, up from the industry median of 64.1%.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Key Updates: Recently, the company unveiled the WellsOne Virtual Card Payments service, a new virtual payment system to safeguard effortless transactions for its corporate customers, as the demand for online payment modes has surged tremendously led by COVID-19 pandemic.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 30.89% of the total shareholding. The Vanguard Group, Inc. and BlackRock Institutional Trust Company, N.A. holds the maximum interests in the company at 7.73% and 4.43%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Risks: Reduced net interest income on lower rates, global economic slowdown led by coronavirus pandemic, reduced business activities, softness in overall growth in loans were key headwinds faced by WFC. Warren Buffett recently reduced its position by 26% in Wells Fargo & Co. amid the COVID-19 crisis. This is expected to hurt WFC’S net interest margin and income. Additionally, the bank’s costs are likely to flare up given the franchise investments in areas, including mobile-banking technology, digital lending, and brokerage subscriptions. Additionally, ongoing litigation hassles also add to higher expenditure.

Outlook: Despite the legal hustles, the bank remains well focused on preserving its financial position and is working on its strategic priorities, which is likely to aid the company to reclaim the confidence of its clients and shareholders. Further, as the economy recovers, demand for loan should increase, which, in turn, will aid banks’ net interest income and net interest margin.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: P/BV Multiple Based Relative Valuation (Illustrative)

P/BV Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of WFC closed at $28.59 with a market capitalization of ~$118.2 billion. The stock is currently trading towards the lower band of its 52-week’s trading range. The stock went up ~25.9% in the last one-month period. Despite numerous tensions, the bank remains focused on sustaining its financial position. On a technical analysis front, the stock has a support level of ~$23.4 and a resistance level of ~$34. Considering the above factors, we have valued the stock using a P/BV multiple based illustrative relative valuation method and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like - Bank of America Corp (NYSE: BAC), Citigroup Inc (NYSE: C), and Goldman Sachs Group Inc (NYSE: GS), to name a few. Hence, we recommend a “Buy” rating on the stock at the closing price of $28.59, down by 0.07% on 25 November 2020.

WFC Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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