Please ensure Javascript is enabled for purposes of website accessibility

What Wall Street Didn't Like About Wells Fargo's Earnings

By Jordan Wathen – Updated Apr 18, 2019 at 10:24PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The big story with Wells Fargo remains the same: It's stuck in place.

The market didn't like something in Wells Fargo's (WFC -2.67%) earnings report, as shares fell nearly 3% at their low on Tuesday morning after the bank posted results for the fourth quarter.

Was it loan quality? No, net charge-offs remain low at 0.30% of the loans. Deposit costs? Nope. Even though the Fed increased rates four times in the past year, its average deposit costs increased only 0.27 percentage points over the same period.

Credit quality is fine. Deposit costs, which have been a problem for other banks, are increasing, though not at a rate that should cause any concern.

So, what's wrong with Wells?

The only problem with Wells Fargo -- admittedly, it's a big one -- is that it's still a long way from getting the green light from regulators to grow again. Last year, after headlines told the story of numerous scandals surrounding its sales practices, regulators took the unprecedented step of limiting Wells Fargo to its then-current size of about $2 trillion in assets.

Wells Fargo branch

Image source: Wells Fargo.

That means that Wells Fargo is stuck in place until regulators allow it to grow again. At the margin, the megabank simply has to be more selective about new lending opportunities or new deposit relationships, to hold its balance sheet at a size roughly equal to, or slightly less than, where it stood at the end of 2017.

Banks that can't grow their balance sheets have a hard time growing their earnings. Sure, Wells Fargo could earn more if long-term rates rise, allowing it to make higher-yielding loans. But it lacks the ability to grow in the most obvious way banks grow, by taking in more deposits and making more loans.

Regulatory head fakes

Last summer, many investors, myself included, speculated that Wells Fargo could be close to exiting regulatory purgatory. The stress tests revealed that Wells Fargo was on solid footing, as the Fed raised no objections to its plan to buy back nearly $25 billion in stock.

If the Fed had an issue with Wells Fargo's balance sheet -- if it saw real and serious problems that would affect its loan portfolio -- it had all the cover it needed to tell Wells Fargo "no" to buying back stock. The Fed can deny a bank's capital plans for quantitative or qualitative reasons. If it wanted to fail it for qualitative reasons, it could have, and in light of its scandals, investors probably wouldn't have even questioned it.

Keep in mind that the buyback approval came just weeks after CEO Tim Sloan told investors that the bank was planning to operate under the $2 trillion asset cap "through the first part of 2019." That message, when taken together with the Fed's approval for the largest buyback plan of any big four bank, was taken as a sign that it wouldn't be much longer until Wells Fargo would get regulatory approval to grow again.

Even as recently as last month, the message from Wells Fargo's chief executive was that the bank could be just months from the end of the asset cap restriction.

Yet, here we are

It's now 2019, and Wells Fargo's earnings report today revealed one thing: The timeline for getting out from under the $2 trillion asset cap is clear as mud. On the conference call this morning, Sloan said the bank is now preparing to remain under the growth restriction for the rest of 2019.

That wasn't what Wall Street wanted to hear. Considering the circumstances, Wells Fargo earned a relatively impressive 13.7% return on tangible equity in 2018. If it could retain its earnings to support loan and deposit growth, it could earn returns that would make shareholders wealthier.

For now, Wells Fargo has nothing better to do with its earnings power than send it back out to shareholders in the form of dividends and stock buybacks. In the last two quarters, it has repurchased a ton of stock -- its share count fell by about 6% in the last six months -- but it would much prefer to keep some of its earnings on the balance sheet so that it can take in more deposits, make more loans, and grow the old-fashioned way.

Shares now trade at about 11 times its 2018 earnings, a price that implies Wells Fargo will be a no-growth bank not just for 2019, but perhaps even longer. Patient investors may be rewarded if Wells Fargo can make lemonade of regulatory lemons, buying back billions of dollars of stock at depressed prices. But shareholders will have to be very patient -- by all appearances, the asset cap will stay in place for yet another year, if not longer.

The quick plunge shortly after market open today suggests that, for some shareholders, patience has simply worn off.

Check out the latest Wells Fargo earnings call transcript.

Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Wells Fargo & Company Stock Quote
Wells Fargo & Company
$40.41 (-2.67%) $-1.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/25/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.