Stock Analyst Update

A Year of Recovery for Undervalued Wells Fargo

Jim Sinegal

 Wells Fargo (WFC) generated acceptable results in its first quarter, producing a 1.15% return on assets and a 13.85% return on tangible equity despite growing expenses. We are maintaining our $66 fair value estimate for the wide-moat bank and believe Wells Fargo’s recent troubles will not have long-lasting effects on growth and profitability.

That said, there were several negatives in the quarter. Wells Fargo tightened its credit standards in auto lending and borrowers paid down credit card balances with the bank, leading to a decline in consumer loan balances. It would not be surprising if part of this decline stemmed from customers taking their business elsewhere--management attributed part of the decline to a slowdown in new account openings and lower branch-driven loan originations. At the same time, noninterest expenses grew 6%, and management expects that the firm will have a hard time meeting its efficiency targets for the year. Wells Fargo could spend as much as $320 million this year related to the 2016 sales scandal alone. The banking industry as a whole appears to be nearing the end of the line with respect to cost-cutting benefits; management expects to reduce expenses by $2 billion a year over the next 18 months but reinvest virtually all of those savings in the business. Furthermore, the business lending environment was surprisingly weak in the first quarter. Wells Fargo experienced a decline in commercial and industrial loan balances, though we think it’s too early to read much into first-quarter activity, given the changes in the political and market environments over the past six months.

The company is showing some signs of stabilization, however. Total branch interactions were down only 4% from March 2016 and account closures actually declined from the year-ago period.  Average deposit balances--the key source of Wells Fargo’s competitive advantage--expanded 7% over the last 12 months and 1% in the first quarter.

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Jim Sinegal does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.