Wells Fargo: Powell Could Get His Soft Landing (NYSE:WFC)

Wells Fargo (NYSE:WFC) recently reported earnings and held a conference call. I’m going over the earnings calls of all the major U.S. banks to see if anything stands out from a company perspective but especially to watch for clues on how the economy is doing and how banks are doing. The major banks report relatively early in the earnings season. I currently don’t have a position in any major bank but do hold a fair number of small community banks that are in some ways more vulnerable than the majors to the same drivers. I plan to publish a public series on the major banks. The Wells Fargo call had a lot of helpful color.

Here are some of the pieces of information, from the recent earnings call, that stood out to me (emphasis by me):

The Federal Reserve has made clear that reducing inflation is its priority, and it will continue to take actions necessary to achieve its goal. We are starting to see the impact on consumer spend, credit, housing, and demands for goods and services. At this point, the impact to consumers and businesses has been manageable. And though there will certainly be some industries and segments of consumers that are more impacted than others, the rate impact we see in our customer base is not materially — I’m sorry, the rate of impact we see in our customer base is not materially accelerating.

According to Wells Fargo, customers have been impacted by the rate hikes but the rate of impact is not accelerating. This also seems to be reflected in markets that indicate the economy is holding up reasonably well, and it’s likely also a function of the labor market holding up so far. Wells also sees its customers are resilient in terms of deposit balances, credit quality, and spending, still stronger than pre-pandemic levels.

Somewhat surprising to me is that credit performance is still strong. Charge-offs in the credit card portfolio are still below charge-offs in Q4 2019. Nonperforming assets only increased 1% from Q3 2022. The bank did up its allowance for credit losses anticipating more challenging conditions. They’re also anticipating some trouble on the auto front and seem to be pulling back a little bit from that market:

We are closely monitoring our portfolio for potential risk and are continuing to take some targeted actions to further tighten underwriting standards. Let me highlight trends in two of our portfolios. The size of our Auto portfolios declined for three consecutive quarters, and balances were down 5% at the end of 2022 compared to year-end 2021. Meanwhile, originations were down 47% in the fourth quarter compared to a year ago which reflected credit tightening actions and continued price competition due to rising interest rates.

Of note, our new vehicle originations surpassed used vehicles in the fourth quarter, reflecting a combination of credit tightening actions that we’ve implemented and the industry dynamic of higher new vehicle sales growth.

The area of the economy where the bank seemed most pessimistic is the commercial real estate portfolio:

Turning to the commercial real estate office portfolio. The office market is showing signs of weakness due to weak demand, driving higher vacancy rates and deteriorating operating performance, as well as challenging economic and capital market conditions. While we haven’t seen this translate to significant loss content yet, we do expect to see stress over time and are proactively working with borrowers to manage our exposure and being disciplined in our underwriting standards with both, outstanding balances and credits down compared to a year ago.

Maybe this is somewhat of an unusually bad time for commercial real estate, with rates skyrocketing while “work-from-home” may not be a trend here forever. Still, it didn’t immediately die out with the pandemic restrictions either.

The final indicator from the call I want to highlight is credit card spending:

Credit Card spending increased 17% from a year ago, and while the year-over-year growth rate slowed from the third quarter. Almost all categories continue to have double-digit growth. Average balances were up 22% from a year ago. Payment rates have started to moderate, but we’re still well above pre-pandemic levels.

Credit card balances are ticking up as deposits are drawing down. Customers seem to continue spending, but they’re utilizing more credit. If customers continue spending, it is much harder for a recession to be imminent.

Banks usually don’t do great during recessions but the impression from this call is that Powell may actually still be on track for a soft landing which is deemed impossible by many commentators (it also seems unlikely to me but here we admittedly have a positive indicator).

I’m mainly invested in small community banks but I pulled up Seeking Alpha’s valuation numbers of the major U.S. banks to see how they trade relative to each other:

	WFC	BAC	JPM	C	MS
P/E Non-GAAP (FY1)	8.94	9.80	11.26	8.17	14.24
P/E Non-GAAP (FY2)	8.12	9.27	10.62	7.01	12.54
P/E Non-GAAP (FY3)	11.43	8.77	11.15	7.54	11.01
P/E Non-GAAP (TTM)	9.93	11.04	11.84	7.02	12.73
P/E GAAP (FWD)	8.97	9.84	11.20	8.38	14.65
P/E GAAP (TTM)	14.08	11.04	11.83	7.10	13.28
PEG Non-GAAP (FWD)	1.05	1.92	NM	NM	3.86
PEG GAAP (TTM)	NM	NM	NM	NM	NM
Price/Sales (TTM)	2.33	3.09	3.64	1.38	2.85
EV/Sales (FWD)	–	–	–	–	–
EV/Sales (TTM)	–	–	–	–	–
EV/EBITDA (FWD)	–	–	–	–	–
EV/EBITDA (TTM)	–	–	–	–	–
Price to Book (TTM)	1.05	1.15	1.66	0.53	1.68
Price/Cash Flow (TTM)	6.89	38.46	4.61	NM	19.49

Click to enlarge

The key ratio to me is price-to-book value and Wells Fargo is trading at the lower end of the range. Citigroup (C) is trading even cheaper but that has been the case forever. For what it’s worth, it generally trades at the cheaper end of the range for other multiples as well.

In part, the discount to other banks is well deserved. Wells Fargo is currently under capital constraints and can’t expand assets, but in the past, it has traded at the top end of the range. It remains a major U.S. bank and years of good practices and avoiding further scandals should give it a shot to trade at a multiple that’s a bit higher.

Something I thought was very attractive is that the bank will start with buybacks again. I haven’t seen a formal announcement, including a size, but it seems like a matter of time:

Charles Scharf

Well, so just — it sounds like you’re drawing conclusions to the pace at which we said we’re going to buy stock back, which I don’t think we have actually said. What we’ve said is that we haven’t been buying stock back. We’re absolutely — we anticipate we’re going to begin buying it back. As we think about how much we have available in that capacity, what Mike said was our CET1 went up to 10.6%.

Our required minimum buffers are at 9.2%. And we — it said that we’ll manage 100 basis points above the 9.2% plus or minus. So, we do have substantial capacity but the ongoing earnings capacity of the company. And so, that is — that’s — our framework is to target a reasonable CET1 ratio.

If in the future to raise the levels of capital because of Basel III in-game or whatnot, we’ve got earnings capacity to be able to do that. But we do have the flexibility. And now that we’ve got resolution with CFPB and things like that, to be able to go buy stock back. And we’ll be making that decision based upon our views on the value of the stock and liquidity in the market and things like that.

The bank is currently highly profitable, it can’t expand assets (I like companies that can’t expand assets), the dividend is modest and well covered, and the economic outlook is reasonably cautious (instead of dour). This should give them plenty of room for buybacks. A plan to buy back between $8 and $16 billion worth of stock doesn’t seem out of the question to me. They would likely execute it over 1 or 2 years and up the buying as the stock moved below its 200-day. I wouldn’t expect management to really step on the buyback as the stock is surging. I like my smaller banks better, but if I held this, I’d stick with it as the 2.71% dividend is nice and the capital returns are just getting upped. There are companies out there with more upside, but this seems a reasonable place to harvest some equity risk premia.