Wells Fargo & Co. (WFC) reported fourth-quarter and fiscal 2018 results on Tuesday morning.
The company ended the year with $745 billion in average consumer and small banking deposits (down 1%), with the slight year-over-year decline driven by customers moving cash to higher rate alternatives. Primary consumer checking accounts increased approximately 2% to 24 million, with digital customers and digital secure sessions +4% and +20%, respectively, reflecting continued customer migration to digital channels (as noted at JPMorgan’s (JPM, Financial) 2018 Investor Day, digitally engaged clients have a roughly 10% higher retention than non-digital clients).
Outstanding loans at quarter-end were $953 billion, down slightly from the year-ago period and up 1% sequentially - the first period of sequential loan growth since Q4 2016. Loan growth came from commercial and industrial, as well as from auto, small business, home equity and student lending.
Net interest margin (NIM) in 2018 was 2.91%, an improvement of four basis points. This reflects a significant increase in the yield on earning assets (up 36 basis points to 3.76%, despite some headwinds from mix shift), offset by the rising cost of funding sources (up 32 basis points to 0.85%). Net interest income was $50 billion, up slightly from 2017.
Net loan charge-offs were $2.7 billion in 2018, or around 0.3% of average total loans (that level has been fairly consistent as of late). By comparison, the allowance for credit losses at year-end was $10.7 billion, enough to cover 3.7 times annualized net charge-offs in the fourth quarter.
Noninterest income of $36.6 billion was down 6% in 2018, but this was offset by a 4% decline in noninterest expense to $56.1 billion. It’s worth noting this includes $1.1 billion in “Core deposit and other intangibles expense,” which is purely an accounting charge as opposed to a “real” expense. In addition, it’s my understanding that about half of the “FDIC & other deposit assessments” expense will roll off in the coming year (another $500 million or so).
For 2018, Wells Fargo reported $22.4 billion in net income, an increase of 1%. The share count declined 4%, resulting in mid-single-digit EPS growth to $4.3 per share. It’s worth noting the repurchase spend ramped significantly in the back half of 2018 to ~$15 billion; at the pace exhibited in Q3 and Q4, the share count would decline by ~11% per year (as management noted on the call, we’ll see a slowdown in the first half of 2019 to ~$10 billion because the company has to stay within the constraints of the 2018 CCAR capital plan approved by the Fed). As Wells Fargo works toward its target CET1 ratio (which will free up an additional $20 billion of capital from current levels), it has significant capital at its disposal to repurchase shares. We will find out in June how aggressively management pushes with the 2019 capital plan (and whether they can get approval for incremental repurchases from the Fed). My hope is the stock languishes so that the impact of these future share repurchases will be as meaningful as possible.
Mr. Market may be willing to oblige, particularly after news that Wells expects to operate under the asset cap imposed by the Fed throughout 2019, as opposed to only in the first half of the year (remember this target was already extended from an earlier prediction that the cap would be lifted by year-end 2018). As CFO John Shrewsberry noted Tuesday, this is a first of its kind of exercise for both parties. Here’s how CEO Tim Sloan put it: “From my perspective, we’re making good progress. It’s just taking a little bit longer than what we had originally anticipated.”
While staying in the penalty box another six months is a negative, I ultimately think the impact on intrinsic value is immaterial (not being on the same page as the Fed is a different concern).
Conclusion
Wells Fargo has set explicit targets on expense controls and capital returns through 2020. By my math, even assuming modest growth in the core business, that will be enough to increase diluted earnings to well over $5 per share. At a recent $47 per share, I think the stock trades at a high single-digit multiple on 2020 earnings. Personally, I don’t think that valuation makes a lot of sense. That’s not to say I expect it to change – and as a long-term investor, it will likely be to my benefit if that persists. If the valuation holds near current levels, I hope Wells Fargo repurchases a large number of shares every year for a long, long time.
I’ll close with something Sloan said on the call about the broader U.S. banking system: “I think the entire regulatory environment post the Great Recession has fundamentally changed the quality of assets on the balance sheets of the entire industry. I think the balance sheets of the banks today are stronger than they’ve ever been - not just as it relates to credit, but also as it relates to liquidity.”
Disclosure: Long WFC.
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