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3 Reasons Wells Fargo Is a Buy After Earnings

By Bram Berkowitz – Oct 19, 2021 at 8:45AM

Key Points

  • Wells Fargo cut costs and said it expects full-year expenses to be in line with earlier projections of $53.5 billion.
  • The bank repurchased $5.3 billion of stock in the quarter and plans to buy back at least $13 billion in the next three quarters.
  • Excellent credit quality should give it room to release billions of dollars of reserves back into earnings.

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The stock has seen volatility in recent months, but Q3 earnings continue to show that the bank is on the right path.

Like most banks that have released third-quarter results, Wells Fargo (WFC -0.14%) last week reported earnings per share and revenue that beat estimates from analysts. But the stock has been volatile in recent months as investors and analysts try and make sense of recent developments related to regulatory issues that have now dogged the bank for five years. Although questions linger about when regulators will lift an asset cap and remove consent orders, I saw a lot of good signs in the bank's latest earnings report. Here are three reasons I think Wells Fargo still is a buy.

1. Efficiency initiatives are progressing nicely

Earlier this year, Chief Executive Officer Charles Scharf announced a slate of initiatives to cut expenses at the bank and reduce its efficiency ratio, or expenses expressed as a percentage of total revenue (lower is better). The plan is to realize $8 billion of gross cost savings during the next three to four years by doing things like reducing headcount, using tech to streamline operations, closing redundant branches, and cutting spending on things like consultants. After nine months with that plan in place, investors have to feel pleased. Expenses have gone from nearly $14 billion in the first quarter to roughly $13.3 billion in the most recent quarter. That number would have been even closer to $13 billion had it not been for a $250 million fine Wells Fargo paid to the U.S. Office of the Comptroller of the Currency during the quarter to settle a dispute involving its mortgage-lending program.

Building with Wells Fargo logo on outside.

Image source: Wells Fargo.

Wells Fargo Chief Financial Officer Mike Santomassimo said on the company's earnings call last week that he expects full-year expenses to come in at $53.5 billion, not including any restructuring charges or costs associated with exiting some lines of business. That's roughly in line with management forecasts earlier this year and should give investors confidence in Wells Fargo's ability to meet that goal. The bank expects to achieve about $3.7 billion in gross cost saving this year. There is still another $4.3 billion of cost reductions to come in future years. If and when Wells Fargo resolves remaining regulatory issues, the bank should be able to lower expenses even more, considering the amount it is spending on the regulatory work.

Lower revenue also limited Wells Fargo's ability to pare its efficiency ratio, as mentioned above. Revenue of $18.8 billion in the quarter was down from the prior quarter and from a year earlier. But management does see signs of some loan growth, and the bank is well positioned to benefit from any rise in interest rates.

2. Buying back a healthy dose of shares

The bank repurchased a healthy $5.3 billion of shares during the quarter, which is equivalent to 2.7% of its total market cap. The bank's board has authorized the repurchase of another $13 billion of shares during the next three quarters, and Santomassimo said the bank may be able to repurchase more than the $18 billion initially authorized, depending on how things play out. When this plan is complete, the bank will have bought back shares equal to almost 9% of its market cap, which will provide a good boost to earnings per share.

3. Lots of reserves left to release

Wells Fargo's credit quality is excellent, and net charge-offs (debt unlikely to be collected and a good indicator of actual losses) to total loans in the quarter were a mere 0.12%.Just for comparison, Bank of America's net charge-off ratio declined to 0.20%, a level that the bank's management said was the lowest in 50 years. As a result, Wells Fargo released $1.7 billion previously set aside for loan losses back into earnings, boosting profits. The bank still has $14.7 billion in reserve capital, which is enough to cover losses on 1.7% of the bank's total loan portfolio. At the current net charge-off rate of 0.12%, that seems excessive, but the bank has been slower to release reserves than its peers.

Before the pandemic, the bank's total reserve capital was $9.3 billion, so there could be as much as $5 billion left to shift back into earnings. Santomassimo said on the earnings call that the bank may not return to running with reserve capital that low, but I would still expect billions of dollars to be released back into earnings at some point.

Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has the following options: long June 2022 $55 calls on Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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