Wells Fargo (WFC) stock had a great year in 2021, climbing nearly 59%, which not only outperformed the market but also the broader banking sector. The stock had been quite beaten down in 2020, so a rebound looked like all but a certainty.
Wells Fargo has gotten off to a nice start in 2022, and now the next potential catalyst could be earnings results for the fourth quarter of 2021 as well as full-year results, which are set to be released on Jan. 14. Analysts on average expect the bank to generate $1.09 in earnings per share (EPS) on total revenue of about $18.7 billion. For the full year, analysts on average expect $4.67 EPS on total revenue of $76.2 billion.
Net interest income
Wells Fargo, one of the largest commercial lenders in the country, has been ravaged for nearly two years by low interest rates and weak loan demand. The bank does not have the same kind of investment banking and capital market operations as JPMorgan Chase, Citigroup, and Bank of America, so it has felt the sting more than its competitors.
In 2018, net interest income (NII), the profit the bank makes on loans and securities after covering the cost of funding those assets, nearly touched $50 billion. In 2020, it was under $40 billion, and in 2021 it is on pace to do about $35.4 billion. Part of the reason for this has to do with the fact that the bank has sold some divisions and simplified, but rates have also played a role in addition to the asset cap the bank is under, which essentially prevents it from growing the balance sheet.
But it appears that loan growth may have bottomed and now is set to rise even if at a modest pace. At a recent conference, CEO Charlie Scharf said loan demand is picking up and the bank is seeing a continuation of the modest growth they saw in Q3. In particular, Scharf said the bank is seeing growth in certain residential mortgage portfolios as well as a continuation of auto loan growth. Scharf also said the bank is seeing a pick up of loan demand in the middle market space as well.
I will be very interested to see how loan balances trend in Wells Fargo's credit card book in Q4. The bank has rolled out new and enhanced card products over the past year, and credit card applications hit a pandemic high toward the end of 2021. The Fed just released new data that shows revolving debt, which is mostly credit card debt, bounced more than 23% in November on a seasonally adjusted annual rate. With longer-term interest rates higher in Q4 than in Q3 and increased loan demand, I am hopeful for a decent improvement in net interest income.
Investors and analysts will be closely watching expenses at Wells Fargo because one of the bank's big initiatives right now is trimming expenses and reducing its efficiency ratio, which measures expenses expressed as a percentage of total revenue, so lower is better. The bank recently set a goal of cutting $8 billion in gross expenses over the next three or four years. For 2021, the bank expects to see $3.7 billion of those cost savings achieved and overall see annual expenses come in around $53.5 billion.
For the bank to hit its goal, Q4 expenses would have to come in at around $12.9 billion, which would be a pandemic low for the bank. However, CFO Mike Santomassimo said on the bank's Q3 earnings call that the $53.5 billion number would exclude expenses for restructuring and business exits. He added the bank had $193 million of these costs through the first three quarters of the year.
Santomassimo also noted that the bank's outlook includes the fact that operating losses are expected to come in $250 million higher than projections made earlier in the year. It also includes extra expenses related to the sales of the bank's asset management and corporate trust services divisions, which are expected to close in Q4. So there could be some one-time expenses baked into Q4, but hitting the $53.5 billion number, or being close on a core basis, will be important because lowering expenses and getting the efficiency ratio down is a big part of the investment thesis for Wells Fargo.
My big question is how big of a reserve capital release there will be from Wells Fargo in the quarter. Banks spent much of 2020 building huge stores of reserve capital to prepare for potential loan losses as a result of the pandemic. When those losses didn't materialize, most banks spent much of 2021 releasing reserves back into earnings. While Wells Fargo has released reserves, it has done so at a much slower pace than its big-bank peers despite having the best credit profile among them.
At the end of Q3, net charge-offs, which are debts unlikely to be collected and a good indicator of actual loan losses, as a percentage of total loans, came in at just 0.12%, the lowest charge-off rate seen in decades. Yet Wells Fargo's total allowance for loan losses after Q3 remained fairly elevated at 1.57%.
The bank has been more cautious about releasing reserves, but I still think the allowance is too high right now. Scharf noted that he thinks "the bottom has been reached" in terms of delinquency levels and charge-offs, and expects things to begin to normalize this year. I'm still confident there will be some kind of a reserve release, but given that there could be some loan growth, and that delinquencies and charge-offs are expected to creep up, I'm very curious as to what the release will look like.
Will Wells Fargo beat?
Since the fourth quarter of 2016, Wells Fargo has missed on EPS six times and on revenue 11 times, so this money-center bank is not as much of a guarantee to beat as some of the other big banks. But overall, with loan growth continuing to tick up, and given that I am expecting some kind of reserve release, I am optimistic the bank will beat expectations.