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Stock Analyst Update

Fees Are Good, Expenses Remain on Track for Wells Fargo

Wells remains our top pick among the traditional U.S. banks.

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Wide-moat Wells Fargo (WFC) reported OK second-quarter earnings. While the bank easily exceeded FactSet consensus of $0.98 with reported EPS of $1.38, the beat was primarily driven by reserve releases, which is only a temporary source of higher earnings. Reported return on tangible common equity was 16.3%. The bank continued to release reserves, releasing another $1.6 billion in the quarter. If we assume provisioning would have been closer to the 2019 run rate of roughly $670 million, ROTCE would have been closer to 12%, and if we bring the gains on equity securities down to a $500 million run rate, we estimate the ROTCE would fall closer to 8.4% . This is an improvement over the 8% normalized rate we calculated last quarter, but the bank still has a way to go to hit the short-term goal of 10%. Now, while 10% may seem like a long way off, keep in mind that bringing capital levels down to management’s goal of a 10.5% common equity Tier 1 ratio should improve ROTCE by roughly 100 basis points, give or take, which gets the bank within spitting distance of the 10% goal. Management did say that it expects to hit a 10% ROTCE at some point in 2022.

Overall, results largely fit within our projections, and after making some minor adjustments, we are increasing our fair value estimate to $55 per share from $52. This is primarily related to slight adjustments to credit costs and fees, and to the time value of money. We’ve also moved up rate hikes to late 2023 from 2025. Wells remains our top pick among the traditional U.S. banks, and we think it has unique, idiosyncratic upside compared with peers as more expense savings play out over 2021 and beyond, and we think the asset cap gets lifted sometime in the fourth quarter of 2021 or the first quarter of 2022. Meanwhile, we view most of the rest of our banking coverage as fully valued.

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Eric Compton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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