Wells Fargo (WFC) Q2 Earnings Beat Estimates, NII Disappoints

Driven by prudent expense management, Wells Fargo (NYSE:WFC) recorded a positive earnings surprise of 12.1% in second-quarter 2019. Earnings of $1.30 per share surpassed the Zacks Consensus Estimate of $1.16. Results also came in higher than the prior-year quarter adjusted earnings of $1.08 per share.

Higher fee income and fall in expenses aided the company’s performance. Further, escalation in loans and deposits acted as tailwinds. However, reduced net interest income was an undermining factor. Moreover, provisions soared.

Net income came in at $6.2 billion compared with $5.2 billion recorded in the prior-year quarter.

The quarter’s total revenues came in at $21.6 billion, outpacing the Zacks Consensus Estimate of $20.8 billion. The reported figure, however, came in line with the prior-year quarter’s tally.

Furthermore, on a year-over-year basis, quarterly revenue generation at the business segments was mixed. The Community Banking segment’s total quarterly revenues edged down and Wholesale Banking revenues were down around 1.8%. Yet, revenues in the Wealth and Investment Management unit were up 2.5%.

Net Interest Income Falls, Costs Down, Fee Income Improves

Wells Fargo’s net interest income in the quarter came in at $12.1 billion, down 4% year over year. Higher interest expense and lower interest income from loans held for sale led to this downside, partly offset by increased interest income from debt and equity securities, loans along with higher other interest income. Furthermore, net interest margin shrunk 11 basis points (bps) year over year to 2.82%.

Non-interest income at Wells Fargo came in at around $9.5 billion, up 5% year over year, primarily owing to rise in service charges on deposit accounts, card fees, net gains from trading activities and equity securities along with elevated other income. These increases were mainly muted by lower mortgage banking revenues and reduced net gains on debt securities.

As of Jun 30, 2019, total loans were $949.9 billion, slightly up sequentially. Higher consumer as well as commercial loan portfolio was recorded. Total deposits came in at $1.29 trillion, up 2.4% from the prior quarter.

Non-interest expense at Wells Fargo was around $13.4 billion, down 4% from the year-earlier quarter. This decline in expenses primarily resulted from lower core deposit and other intangibles, FDIC and other deposit assessments, commission and incentive compensation along with other expenses. These were partly offset by rise in salaries and employee benefits, along with equipment costs.

The company’s efficiency ratio of 62.3% came in below the 64.9% recorded in the year-ago quarter. A fall in efficiency ratio indicates a rise in profitability.

Credit Quality: A Mixed Bag

Wells Fargo’s credit quality metrics was a mixed bag in the June-end quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $10.6 billion as of Jun 30, 2019, down 4.5% year over year.

Net charge-offs were $653 million or 0.28% of average loans in the reported quarter, up 8.5% from the year-ago quarter’s net charge-offs of $602 million (0.26%). Non-performing assets slipped 17.1% to $6.3 billion, in the second quarter, from $7.6 billion reported in the prior-year quarter. Notably, provision for credit losses was $503 million, 11% higher.

Strong Capital Position

Wells Fargo has maintained a sturdy capital position. During the April-June quarter, the company returned $6.1 billion to shareholders through common stock dividends and net share repurchases.

Wells Fargo’s Tier 1 common equity under Basel III (fully phased-in) decreased to $149.2 billion from $153 billion recorded in the prior-year quarter. The Tier 1 common equity to total risk-weighted assets ratio was estimated at 12% under Basel III (fully phased-in) as of Jun 30, 2019, in line with the year-earlier quarter.

Book value per share advanced to $40.10 from $37.41 recorded in the comparable period last year.

Return on assets was 1.31%, up from 1.10% in the prior-year quarter. Return on equity was 13.26%, up from 10.60% in the comparable last year quarter.

Our Viewpoint

Top-line headwinds, along with lower net interest income woes, are expected to prevail. Furthermore, flaring up provisions is another drag, along with slowdown in the mortgage business. Nevertheless, lower expenses reflect prudent expense management. Further, improving fee income is a tailwind.

Despite several legal tensions, Wells Fargo remains focused on maintaining its financial position. This banking giant is on track with its cost-cutting targets. Moreover, the company is working on strategic initiatives, which might help regain the confidence of its clients and shareholders.

We believe, over the long term, investors will not be disappointed with their investment in Wells Fargo, given its diverse geographic and business mix, which enables it to sustain consistent earnings growth. We also anticipate strategic acquisitions and the bank’s efforts to address current adversities will help it expand its business and enhance profitability.