Wells Fargo (WFC 2.73%) reported earnings results for the first quarter of 2022 last week that failed to excite investors, sending the stock price tumbling on the day of the report. Earnings beat analyst estimates but were inflated by a large release of reserve capital previously stored away for loan losses from the pandemic that never materialized. Revenue missed estimates in the quarter. Revenue at the bank dropped off more than expected, and expenses came in high.
But looking ahead to the rest of the year, both revenue and expenses should begin moving in the right direction, resulting in better core earnings results. Here's why.
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Wells Fargo's net interest income hasn't picked up yet
The big headwind on revenue in the quarter came to Wells Fargo's fee income businesses. With mortgage rates shooting up in the quarter, Wells Fargo saw its mortgage banking business take a huge hit, down 33% from the previous quarter and 48% year over year, as higher mortgage rates slowed the refinancing boom seen earlier in the pandemic. Fee income also struggled as higher interest rates sent bond yields surging, which hurt the bank's gains from equity and debt securities. Overall, fee income was down 28% from the prior quarter and 14% year over year, largely due to rising interest rates.
The flip side of rising interest rates, however, is that it's supposed to help Wells Fargo's other main revenue source, net interest income (NII), which is the money banks make on loans, securities, and cash after covering the cost of funding those assets.
Data source: Wells Fargo.
While NII is up nicely year over year, it's basically flat from the previous quarter, despite the big increase in interest rates during the quarter. This should change. With commercial loan growth strengthening and the Federal Reserve expected to raise its benchmark overnight lending rate, the federal funds rate, potentially six more times this year, Wells Fargo CFO Mike Santomassimo said NII in 2022 may grow in the mid-teen percentage range from 2021, which came in at $35.8 billion.
If we call it 15% growth, that's roughly $41.2 billion of NII. Considering the bank just generated $9.2 billion of NII in Q1, that leaves almost $32 billion of NII for the rest of the year, or roughly $10.7 billion more per quarter, significantly higher than NII in Q1.
Lower expenses are in the forecast
The other issue for Wells Fargo in the quarter is that expenses came in at the highest level seen in four quarters, mainly due to the fact that the bank experiences higher expenses in Q1 due to seasonality.
Data source: Wells Fargo.
Santomassimo said Q1 included roughly $600 million of seasonally higher personnel expenses for things like payroll tax, restricted stock expenses, and 401(k) matching contributions. The bank also had $673 million of operating losses baked into expenses, the highest level seen in five quarters, primarily from higher customer remediation expenses, which are tied to past regulatory violations from things like the phony-accounts scandal.
Those will eventually go away, although it's hard to know when. But management is sticking to its $51.5 billion expense target for 2022, which means it has about $37.6 billion of expenses left to incur this year, or roughly $12.5 billion a quarter, which is much lower than the $13.9 billion in Q1.
The rest of the year looks promising
The future is very uncertain right now when factoring in high inflation, lots of upcoming monetary changes, and Russia's invasion of Ukraine. The Fed may not raise rates as much as it is currently projecting, and if a recession hits sooner than expected, loan demand could fall and loan losses may increase, impacting current projections at Wells Fargo. There are also a number of uncertainties in Wells Fargo's business, including how fee income will shape up.
But based on management's estimates, which Wells Fargo has been pretty good at hitting, the bank should see a material uptick in NII and a material decline in expenses going forward this year, which should translate into better core earnings (not including reserve releases or a lack thereof) for the rest of 2022.
