While Wells Fargo (WFC 0.33%) saw its stock decline pretty significantly during the banking crisis in March and also in May, the bank has seen shares rebound nicely as of late and is now actually in the green for the year.
In general, the megabanks have been better positioned through the turmoil. They have very diverse deposit bases and have been viewed as a flight to safety because they are considered "too big to fail." Although the banking industry continues to face near-term challenges, I still view Wells Fargo as having a healthy outlook this year considering everything that has happened and when you compare it to the broader industry. Let's take a look.
Net interest income is still in good shape
A major source of revenue for nearly all banks is net interest income (NII), which is the money banks make on loans and securities after funding those assets with liabilities such as deposits.
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NII is expected to continue to come under pressure in the second quarter and likely for the bulk of this year due to the high interest rate environment, which has led customers to seek yield in U.S. Treasury bills or certificates of deposits, which are yielding over 5% in many instances. Additionally, the Federal Reserve continues to shrink its balance sheet through quantitative tightening, which is effectively draining deposits out of the banking system and intensifying competition.
At a recent industry conference, Wells Fargo CFO Mike Santomassimo reiterated the bank's guidance from April that NII would grow 10% in 2023 year over year. Furthermore, Santomassimo said that "as more time goes by, we're more and more confident there'll be some upside to that."
Santomassimo said deposits at the bank have largely been trending in line with industrywide data, which has shown some stabilization in recent weeks. He added that management overall feels good about the bank's ability to compete and win for operating deposits, which are those that use the bank for more than just storing deposits. According to Santomassimo, deposits are most competitive on pricing right now in Wells Fargo's corporate and investment bank. Wealth deposits are also still experiencing a shift into higher-yielding products, although that's starting to slow.
Credit and capital
Aside from NII and deposit trends, investors are paying close attention to credit quality, which is expected to normalize after a very benign couple of years. In the first quarter, Wells Fargo built its reserves for potential loan losses by about $643 million.
In the second quarter, Santomassimo said the reserve build could be closer to $1 billion. The reason for the increased build is that credit card loans are up in the quarter, so the bank will naturally have to reserve to account for loan growth. Another consideration is commercial real estate (CRE), which everyone has been concerned about, especially when you think about pockets like office space that have been disrupted by the big shift to remote work. Santomassimo said some of the reserve build for CRE could help the bank start to get ahead of some losses that are expected to eventually materialize in its office portfolio.
Santomassimo also touched on the bank's capital position, which I noted in April is in a very strong spot. Wells Fargo has plenty of excess capital over its regulatory requirement and is in the best capital position of any megabank. Santomassimo said Wells Fargo has been in the market in the second quarter repurchasing shares. But he also said that the decision on repurchases for the rest of the year would be made on a quarter-by-quarter basis. That's because lots of regulatory capital changes could be coming soon as well as the results from the Federal Reserve's annual stress testing exercise, all of which could impact Wells Fargo's regulatory capital requirements.
Well positioned
Despite the challenging environment, I continue to believe Wells Fargo is well positioned, given its outlook for NII, its ability to manage credit, and its capital position. Additionally, Wells Fargo has been operating under an asset cap since 2018 as punishment for its phony accounts scandal. At some point this will get removed, allowing the bank to once again grow the balance sheet and really go on offense. Trading at 126% to its tangible book value or net worth, I think Wells Fargo has good long-term upside ahead.
