Wells Fargo (WFC 0.23%) paused share repurchases in the second quarter of the year after buying back $18 billion of stock in the preceding three quarters. However, the decision caught some by surprise, considering that Wells Fargo has a lot of excess capital and the credit quality at the bank is still quite healthy.
Now the question is, will the hiatus last a long time, or could the bank resume share repurchases later this year? Let's take a look.
Plenty of capital
If you want to evaluate where a bank stands in its ability to return capital to shareholders through repurchases or dividends, one important ratio to look at is the common equity tier 1 (CET1) capital ratio, which measures a bank's core capital as a percentage of its risk-weighted assets such as loans. CET1 capital is replenished each quarter by retained earnings. It also gets depleted through distributions such as dividends and repurchases, as well as loan growth because banks must set aside capital to reserve for loan losses.
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At the end of the second quarter of this year, Wells Fargo's CET1 ratio stood at 10.3%. Its current regulatory requirement is 9.1%. If you hold the risk-weighted assets steady at the end of Q2, Wells Fargo has about $15 billion of excess capital. Considering the bank has been making between $3 billion and $6.5 billion per quarter over the last four quarters, it's going to have plenty of capital to cover its growing dividend and conduct share repurchases if it wants to.
Previously, management had seemed concerned about higher regulatory capital requirements next year, which a lot of banks are facing. However, following the Federal Reserve's annual stress testing, it became clear that the bank's new CET1 requirement is only expected to rise to 9.2%.
Management continues to stay conservative
Markets are volatile, and there are a lot of puts and takes right now. While earnings have dropped off from last year, largely because banks are no longer releasing reserve capital and fee businesses are taking a hit, Wells Fargo's business looks strong.
Credit costs are near historic lows, and higher interest rates are benefiting the bank's net interest income (NII), which is the profit banks make on loans, securities, and cash after covering the cost to fund those assets. Management recently boosted its NII guidance, and now expects the bank to generate close to $43 billion of net interest income this year, up roughly $7 billion from 2021. Based on these estimates, Wells Fargo should earn roughly another $23.6 billion of NII in the back half of the year.
But the new management team, led by CEO Charlie Scharf and CFO Mike Santomassimo, has been more conservative than peers this year, notably releasing reserve capital built up during the pandemic much more slowly than other large U.S. banks. This could simply be because of all of Wells Fargo's recent regulatory troubles over the years, including the phony-accounts scandal, which has marred the bank in controversy.
This may have made the newer management team more cautious about overpromising, which probably is the smart play, anyway. It seems like Scharf is still waiting for more clarity about where the economy might be headed over the next six to 12 months. As Scharf said on the bank's recent earnings call:
As we sit here today and we look at what's happening in spreads and what's happening with the 10-year that was at 2.92% right now... we do want to be just a little bit conservative in terms of how we think about managing the capital base. We're very happy with the amount of capital that we have... . We certainly have [the] capacity to buy shares back at this point. And as I think Mike alluded to, we just probably want to wait a little bit just to see what happens in terms of the volatility in spreads and rates before we start to do that.
Don't rule them out
Management has been conservative, given the bank's past scandals and the tepid relationship Wells Fargo may still have with regulators. But it's sitting in a terrific capital position with earnings looking solid for the rest of this year. If Wells Fargo can get some line of sight into the trajectory of inflation and the economy, just to make sure credit costs don't suddenly jump, I wouldn't rule out the bank restarting share repurchases later this year.
