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In terms of second-quarter bank earnings, the reality is, investors shouldn't expect much. This is true even for Wells Fargo (WFC 2.28%), which has been the best-performing big bank since the financial crisis.
Net income at the nation's third biggest bank by assets has fallen on a year-over-year basis in four out of the last five quarters. And analysts generally assume the trend will continue in the three months ended June 30. Among 24 analysts tracked by Yahoo! Finance, the consensus estimate calls for earnings per share of $1.01, which is 2% lower than last year -- click here to see how often Wells Fargo beats estimates.
Interest rates are the primary culprit. Wells Fargo relies on net interest income for more than half of its revenue. But lower rates mean the California-based bank doesn't earn as much from its loan and securities portfolios than it would if interest rates rose.
Higher rates seemed like a distinct possibility after the Federal Reserve increased the Federal funds rate by 0.25% in December. However, following a disappointing May jobs report combined with the heightened uncertainty triggered by the Brexit vote in the United Kingdom, the Fed has backed off from any pretensions of raising rates further.
Wells Fargo has worked to offset interest rate headwinds by growing its balance sheet. In the first quarter of the year, its loans increased by 7% compared to the same period in 2015 -- though, a little less than half the increase came from the bank's purchase of $30.8 billion worth of loans and leases from GE Capital.
Higher loan losses are also weighing on Wells Fargo's bottom line. Credit quality is strong throughout the bank industry, but low energy prices are making it difficult for energy companies to service their debts. Banks have thus begun to prepare for higher defaults in their energy portfolios.
This is reflected in Wells Fargo's charge-offs (the money it actually loses from defaults) as well as its loan loss provisions (money set aside each quarter in anticipation of future loan losses). Net charge-offs increased in the first quarter by $178 million, or 25%. Meanwhile, as opposed to releasing loan loss reserves in the first quarter of 2015, Wells Fargo built its reserves in the first quarter of this year, "driven by deterioration in the oil and gas portfolio."
The combination of these factors led Wells Fargo to reduce its profitability guidance earlier this year. At the bank's investor day in May, it lowered its full-year return on assets target to 1.1%-1.4%. This is down from a previous range of 1.3%-1.6%. Wells Fargo did the same with its return on equity guidance, reducing both the top and bottom of its anticipated range by one percentage point.
The consolation for investors is that Wells Fargo's shares yield 3.2% and are trading much closer to their 52-week low than their 52-week high. This suggests the time may be ripe for adding to one's position in the $1.8 trillion bank. It was, after all, at the bottom of a cycle when Warren Buffett bought 10% of Wells Fargo in the early 1990s.
It's also important to keep in mind that all of these headwinds are temporary -- though, of course, this isn't to say they'll abate anytime soon. On top of this, Wells Fargo continues to generate industry-leading profitability and could very well emerge from the current turmoil in a stronger competitive position as its weaker competitors are forced to further retreat and retrench.
In sum, while investors should temper their expectations for Wells Fargo's second-quarter performance (and even more so for the third quarter), the long-term outlook for this bank is rock-solid.
