Wells Fargo, a stock we own in the portfolio, reported third-quarter 2021 earnings before the opening bell today. 

Total revenue of $18.834 billion (-2% YoY) exceeded street expectations of $18.35 billion, while adjusted earnings per share of $1.22 topped estimates of $0.99. 

It is a big earnings beat on paper, however, the $1.22 figure excludes a $250 million pre-tax ($0.05 per share) negative impact associated with the September 2021 Office of the Comptroller of the Currency enforcement action and includes a $0.30 per share positive impact from the change in the allowance for credit losses (we wrote about the fine here). 

Digging into the results:

Net Interest Income of $8.909 billion (+1% QoQ, -5% YoY) came in shy of the $8.976 billion estimate. Although NII was lower on a year over year perspective, we were pleased to see the sequential growth because NII had been on the decline for many quarters in a row. 

Meanwhile, Non-interest income (i.e., fee-based revenues) was $9.925 billion (-13% QoQ, flat YoY), topping estimates of $9.469 billion as increases in investment advisory and other asset-based fees, as well as higher card, deposit-related and investment banking fees were more than offset by lower mortgage banking revenue and lower markets revenue in Corporate and Investment Banking. 

As for some other items of note, average loans of $854.0 billion were roughly flat from the second quarter, while average deposits increased to $1.450.9 trillion from $1.435 trillion. The big thing to know here is that Wells Fargo grew both period-end loans and deposits for the first time since the first quarter of 2020. 

Looking to several bank-wide metrics, the bank's net interest margin or "NIM" was reported at 2.03%, which was up 0.01 percentage point from the second quarter and in-line with estimates. NIM is essentially the spread between what banks pay on deposits and what they earn on loans.

Wells Fargo is one of the most interest rate sensitive names we own, meaning a steeper yield curve and higher rates will lead to stronger levels of profitability in the future. 

On the expense front, Non-interest expense of $13.303 billion was slightly higher than the $13.179 billion estimates, but this was simply a result of the stronger fee-based revenues. More importantly, expenses were lower compared to the second quarter and the third quarter of 2020, pointing to signs of progress towards management’s goal of restructuring/rationalizing the business. Headcount was also lower by 2% from the second quarter. 

Wells Fargo's closely watched "efficiency" ratio, which is a measure of operating expenses as a percentage of revenues, was 70.6% in the third quarter compared to estimates of 72.3%. Lower is better here, so we are happy with the result. 

The return on tangible common equity (ROTCE) came in at 13.2%, a big improvement from 8.7% one year ago, and the bank's tangible book value per share (TBVPS) increased to $35.95 from $34.95 in the second quarter and exceeded estimates of $35.56. 

On the capital return front, a positive surprise in the quarter was that the company repurchased 114.2 million shares, or $5.3 billion, of stock in the quarter. We thought the buyback would be closer to $4.5 billion based on the $18 billion program that was announced after this year’s CCAR, but Wells has plenty of flexibility to increase its capital distributions. 

By division, Consumer Banking and Lending total revenue were $8.804 billion, representing an increase of 1% QoQ but a decline of 4% YoY. Consumer and Small Business Banking (CSBB) revenue was $4.822 billion, up 2% QoQ and 2% YoY thanks to an increase in consumer activity and lower fee waivers provided in response to the pandemic.

Within Consumer Lending, Home Lending was lower by 20% YoY to $2.012 billion due to lower mortgage banking income and lower net interest income. In Credit Card, revenue increased 4% YoY to $1.399 billion on higher point-of-sale volume, lower customer accommodations, and fee waivers provided in response to the pandemic. Rounding things out, Auto revenue was $445 million, up 10% YoY on higher loan balances, while Personal Lending revenue fell 15% YoY to $126 million due to lower loan balances.

Commercial Banking total revenue was $2.076 billion, representing a decline of 2% QoQ and 7% YoY. Middle Market Banking revenue fell 3% primarily due to lower loan balances on reduced client demand and line utilization. Lower interest rates were a headwind too but were partially offset by higher deposit balances and deposit-related fees. Asset-Based Lending and Leasing revenue declined 12% due to lower loan balances and lower lease income, partially offset by improved loan spreads. 

In Corporate and Investment Banking, total revenue was $3.385 billion, up 1% QoQ and 2% YoY. Breaking this figure down further, total banking revenue increased 12% YoY to $1.241 billion thanks to higher advisory and equity original fees and higher loan balances. Lower deposit balances (due to actions related to the asset cap) were a headwind. Commercial Real Estate revenue increased 10% YoY to $942 million, a result of higher commercial servicing income, loan balances, and capital markets results. Down in the quarter was Total Markets revenue, which fell 15% YoY to $1.176 billion due to lower trading activity across most asset classes.

Lastly, Wealth and Investment Management total revenue was $3.618 billion, representing an increase of 2% QoQ and 10% YoY. On a year over year basis, an 11% decline in net interest income (lower rates, partially offset by higher loan and deposit balances) was more than offset by the 16% increase in non-interest income, which is tied to asset-based fees on higher market valuations. Total client assets fell 2% QoQ to $2.091 trillion. 

The outlook:

Taking a look at management’s 2021 outlook, management continues to expect net interest income to be near the bottom of their initial guidance range of flat to down 4% from the annualized fourth-quarter level of $36.8 billion. Wells Fargo would need to see higher interest rates and faster loan growth for a positive change to its outlook.  

On expenses, management reiterated its target of $53.5 billion in 2021. The current consensus estimate reflects this target so no surprise here. Longer term, management continues to target year after year net reductions to the overall expense base. In time, the removal of these excess expenses should unlock plenty of efficiencies.  

On the asset cap and outstanding consent orders, management once again expressed confidence in their belief that progress has been made and the company is moving forward towards a resolution. However, they also reiterated their view that “speed bumps” will happen from time to time. Setbacks are to be expected. We view the asset cap being lifted as a major catalyst event for Wells Fargo, though the timeline of when this event will occur remains a heavily debated topic. 

Overall, a solid quarter for Wells Fargo, with more progress made on its restructuring efforts.

Our view:

It’s disappointing to see WFC trade lower on a day when Bank of America and Morgan Stanley (a portfolio name) are both up in response to their quarterly reports. Perhaps some investors wish to see Wells Fargo management move faster with their expense reduction program and consent order remediation, explaining the profit-taking action today. However, we are sticking with this one and are willing to be patient here and watch management buy back stock hand over first, quarter after quarter. Not only is Wells Fargo one of the biggest beneficiaries of higher rates, but there is also a self-help turnaround story here that includes cost reductions with an operations improvement catalyst.