Wells Fargo: A Year of Struggles in 2017

Founded in 1852, Wells Fargo (WFC ) is one of the nation’s oldest banks and now stands as the third-largest bank in the U.S. with roughly $2 trillion in total assets.

The bank operates in three primary lines of business. Its community banking division includes consumer and small business checking and savings, credit cards, mortgages, student loans and small business lending. The wholesale banking segment covers business banking, commercial real estate, corporate lending and treasury management. The wealth and investment management group includes wealth and retirement planning, trust services, private banking, brokerage and mutual funds.

The stock pays a dividend yield of roughly 2.4% and has seen its quarterly dividend raised consistently since 2012.

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According to 2017 Q4 results, Wells Fargo generated $22.18 billion of net income in 2017, an improvement of just around 1% over the year prior. The community banking division accounted for 54% of that number, with wholesale banking responsible for 39%.

While Wells Fargo is still considered one of the “big four” banks along with JPMorgan Chase (JPM ), Citigroup (C ) and Bank of America (BAC ), but it’s been struggling over the past 12 months compared to its peers. JPM and BAC both posted annual revenue gains of more than 4%, compared to Wells Fargo’s improvement of less than 1%. Efficiency ratios of WFC such as return on equity and return on assets dipped strongly in the third quarter before rebounding in Q4. Part of the decline may be due to one-time legal charges related to the account opening scandal, but it’s worth noting that total loan balances, one of the big money makers for the bank, has been steadily declining.

Wells Fargo’s stock price is up 8% thus far in 2018 and currently sits at all-time high levels. The stock trades at 14 times 2018 earnings estimates, much lower than the 19 multiple of the broader S&P 500. That P/E ratio is comparable to those of its big bank peers.

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Wells Fargo pays an annualized dividend of $1.56 per share. Like many financial companies during the financial crisis, the company slashed its dividend in 2009, cutting it by 85%. Since 2011, Wells has recommitted to its dividend by raising it from $0.05 quarterly up to its current level of $0.39. Despite the rapid growth, the stock’s payout ratio remains well below 40%, a very sustainable level for a cash cow, such as WFC.

In 2017, Wells Fargo returned $14.5 billion to shareholders through a combination of common stock dividends and net share repurchases, up 16% from 2016.

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Despite current competitive pressures, Wells Fargo remains a leader in the financial services sector and, as such, enjoys several advantages in the industry.

• Clean loan book – Following the financial crisis, Wells spent years working non-performing loans off of its books in order to clean up the balance sheet. Now the bank has one of the more impeccable balance sheets in the industry. In 2017, Wells worked its net charge-off rate – the percentage of all loan balances that it believes it won’t be able to collect – down to 0.31 percent of average loans and its provision for non-performing assets to under $10 billion.

• Strong capital position – The bank reported a common equity tier 1 capital ratio of 11.9% in 2017, up from 10.8% in 2016. A well-capitalized position gives Wells the flexibility to increase dividends and share buybacks in the future.

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With weaker-than-average loan and revenue growth recently, Wells Fargo is focused on a few areas to help drive future growth.

• Benefits from tax reform – Banks are traditionally one of the most highly taxed entities. With the recently passed corporate tax reform package, Wells stands to save a lot of cash in 2018. The company reported a $3.35 billion net income benefit, or $0.67 per share, in Q4, and forecasted that its effective tax rate, which has stood at around 30% over the past several years, will be just 19% in 2018.

• Beneficiary of rising interest rates – Higher rates are a positive for banks, because it means they can charge more loans. The Fed raised the target Fed Funds rate three times in 2017 and is expected to raise rates as many as three more times in 2018.

• Potential for stock buybacks – The company’s strong capital adequacy position could mean it’s poised to return additional capital to shareholders in the coming quarters. In January, Wells management announced that it had authorized the repurchase of up to 350 million shares.

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Wells Fargo had a challenging year in 2017, and needs to manage a number of headwinds going forward.

• Reputational damage – The bank’s fake account opening scandal, which resulted in $185 million in fines and multiple management changes, has caused it severe reputational damage in an industry that often relies on customer trust. The financial implications of the scandal are largely in the past, but the company’s struggles with revenue and loan growth could be more long-lasting.

• Shrinking operating margins – As recently as 2016, Wells Fargo had the strongest operating margins among the big four banks. At the end of 2017, Wells’ margins had dropped to last place and by a large margin. It reported an operating margin of 21% in the fourth quarter, well behind the roughly 30% figure of its peers.

• Negative loan growth – Loan balances have been on the decline for several quarters in a row. Wells reported average loan balances of $964 billion in Q4 2016. In the fourth quarter of 2017, it was down to $951 billion. That figure dropped in every quarter in 2017.

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Wells Fargo remains in a strong financial position overall, but it’s had its share of struggles lately. It’s tough to say how much the fake account scandal has impacted its financials, but the bank has definitely been underperforming its peers. The dividend yield appears to be in good shape, but keep an eye on loan growth and margins to indicate whether Wells is turning things around.

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