Portfolio holding Wells Fargo (WFC) reported much better than feared second-quarter results before the opening bell, and shares soared 7% in Friday’s strong overall market. Total revenue of $17.03 billion, a decrease of 16% year-over-year, missed the FactSet consensus estimate of $17.43 billion. Adjusted earnings-per-share of $0.82, excluding an $0.08 per share impairment, edged estimates of $0.81.

Key company metrics

Before digging into the various operating segments, let’s take a quick look at how some key overall metrics stacked up in the second quarter.

• Net interest income: $10.2 billion, up 16% year-over-year, versus $10.12 billion expected.

• Net interest margin: 2.39% vs. 2.32% expected.

• Non-interest income: $6.83 billion versus $7.4 billion expected.

• Non-interest expense: $12.88 billion, down 3% year-over-year and down 7% over last quarter, versus $12.73 billion.

• Return on average tangible common equity (ROTCE): 8.6% versus 9.2% expected

• Efficiency ratio: 76% versus 72.5% expected.

• Common equity tier 1 (CET1) capital ratio: 10.3%, down from 10.5% last quarter due to strong capital returns and a decline in cumulative other comprehensive income driven by higher interest rates, among other reasons, but well above the regulatory minimum of 9.1%

• Period-end Loans: $943.7 billion, up 11% year-over-year and 4% over last quarter versus $923.65 billion expected. Fourth consecutive quarter of loan growth.

• Average deposits: $1.46 trillion, 1% increase year over year, versus $1.48 trillion expected.

• Tangible book value per share (TBVPS): $34.66 vs. $35.56 expected.

 Financial definitions for bank stocks

• ROTCE is a measure of annualized earnings applicable to Wells Fargo common shareholders as a percentage of average tangible common equity.

• Expense efficiency ratio is a measure of efficiency that is calculated as total non-interest expenses divided by net revenues, lower is better on this front

• CET1 is a measure of bank capital versus risk-weighted assets and a sign of the bank’s ability to endure financial stress

• TBVPS is a measure of intrinsic liquidation value that removes intangibles such as goodwill. Think of goodwill as the value of the Wells Fargo brand. 

Segment results

Consumer Banking and Lending total revenue Q2 was $8.51 billion, down 2% over last year and down 1% over last quarter. Consumer and small business banking (CSBB) revenue increased 17% year-over-year primarily due to higher interest rates and deposit balances. Within consumer lending, home lending was down 53% over last year and down 35% over last quarter on lower originations and gain on sale margins, among other things. Credit card revenue increased 7% over last year on higher loan balances, which speaks to the normalization of consumer balance sheets post-Covid. It also reflects an increase in point of sale volumes. Auto rose 5%, also on higher loan balances, and personal lending was up 7% versus the year ago period. 

Commercial Banking total revenue Q2 was $2.49 billion, up 18% year-over-year and up 7% over last quarter. Middle market banking revenue of $1.46 billion represented an increase of 27% over the same period last year, on the back of higher rates and loan balances. Asset-based lending and leasing revenue of $1.03 billion increased 8% year-over-year, driven by higher loan balances. 

Corporate and Investment Banking total revenue Q2 was $3.57 billion, up 7% year-over-year and up 3% over last quarter. Total banking revenues increased 4% year-over-year but was essentially flat sequentially with the annual advance reflecting higher rates and loan balances that were partially offset by lower investment banking fee revenue resulting from lower market activity. Commercial real estate revenue increased 5% year-over-year, again on higher rates and loan balances that were partially offset by lower capital markets results. Total markets revenue was up 11% annually driven by higher foreign exchange and commodities trading revenue that were compounded by increased equities trading revenue.

Wealth and Investment Banking total revenue Q2 was $3.71 billion, up 5% year-over-year. Net Interest Income increased 50% year-over-year thanks to higher rates. Non-Interest Income, however, fell 5% annually on lower asset-based fees primarily due to a decline in market valuations, and lower transactional activity. 

For the rest of 2022

A couple of reasons why we have remained invested in Wells Fargo despite concerns of an economic recession are because of its interest rate sensitivity and our belief that management can meaningfully reduce expenses. That’s why we were pleased to see management raise its net interest income outlook this year. Management now expects to see this figure increase approximately 20% from 2021 levels. This view is an upgrade from their previous call of about 15% year over-year-growth and much stronger than the 8% increase management expected at the beginning of the year. An aggressive Federal Reserve interest rate hiking cycle will do that.

On the expense front, management reiterated its view that full year 2022 expenses are still expected to be approximately $51.5 billion. We’ll take this as a small win due to ongoing inflationary pressures and higher operating losses. Looking to next year, management set the expectation that it wants to see net expense reduction. This is another positive update.

As expected, there was no formal update around the timing of when the asset cap placed on Wells Fargo will be lifted. Although we cannot predict when this event will occur, we believe management is working hard to fix its problems. Once the cap is lifted, we believe Wells Fargo will be less constrained and will seek more deposit growth, leading to stronger ROTCE performance, and a stock re-rating.

Capital returns

Wells Fargo did not repurchase any shares in the second quarter, consistent with previous commentary, even though this year’s Federal Reserve stress test confirmed the bank has the capacity to return excess capital to shareholders. The bank plans to be prudent and will consider market conditions and the various banking and economic crosswinds before making share repurchase decisions over the coming quarter. On the dividend side, as previously announced, the bank plans to increase its third quarter dividend by 20% to $0.30 per share.

Bottom line 

Not the cleanest of quarters but that’s consistent with the other banks that have reported so far this earnings season. But what is important to know here is that the core parts of the WFC bullish thesis —which is based on expense reduction and the positive impact higher interest rates have on net interest income — remains intact. Loan growth is still healthy, and the bank still has capacity to buy back shares when they believe is appropriate. The key to pay attention to was despite the miss on Q2 results, Wells Fargo along with other banks rallied nicely off the lows. For these reasons, we believe investors are looking past the noise of the quarter.