After the solid results from both JPM, Goldman, and BofA (which saw strong equity trading offset by a slump in FICC) we got the now traditional disappointment from Wells Fargo which reported Q2 earnings that were mixed at best.
While the bank reported Q2 total revenue of $20.270BN, up 11%, and beating estimates of $17.75BN, with EPS of $1.38 also stronger than the 0.98 expected (a number which included a $147M Gain on Sale of Student Loans, and a $79M Write-Down of Related Goodwill), the reality is that the same issues that have plagued Wells for years remained front and center, including slugging loan growth and depressed net interest income. And while CEO Charlie Scharf said that "Wells Fargo benefited from the continued economic recovery, strong markets that helped drive gains in our affiliated venture capital businesses, and our progress on improving efficiency" he cautioned again that "the headwinds of low interest rates and tepid loan demand remained.”
And, like all the other big money-center banks, a bit portion of the bottom line EPS print - and beat - came from reserve releases, $1.639 billion, or $0.30/share, to be precise.
Digging a bit below the surface reveals that once again not all was well with the bank missing across all key operating metrics:
- Net Interest Income $8.80B, Est. $8.97B
- 2Q Net Interest Margin 2.02%, Est. 2.05%
- Efficiency Ratio 66%, Est. 76.6%
- Loans $854.75B, Est. $855.72B
- Total Average Loans $854.7B
- Recovery of Credit Losses $1.26B, Est. Recovery $545.4M
- Wells Fargo Expect Charge-Offs Will Increase at Some Point
- Wells Fargo Continues to See Strong Trends in All Businesses
To be sure, the top line improvement was a welcome change for a company whose revenue have stagnated for the better part of a year...
... helping lift Net Income to pre-covid levels.
A quick note on taxes: readers may recall that last year the bank benefited form an artificially low 6.4% effective tax rate. Well, no more, and in Q2 it bounced back over 19%, with the bank saying that it “retroactively changed the accounting for certain tax-advantaged investments to better align the financial statement presentation of the economic impact of these investments with the related tax credits.”
That means changing the bank’s accounting for low-income housing tax credit investments from one kind of accounting (“equity method”) to another (“the proportional amortization method.”). As Bloomberg notes, the bank also shifted the presentation of investment tax credits related to solar investments -- reclassifying investment tax credits (“from accrued expenses and other liabilities to a reduction of the carrying value of the investment balances.”). "All that actually had an impact: Quarterly results for last year’s second and third quarters changed, because the new system “improved our efficiency ratio and generally increased our effective income tax rate from what was previously reported."
Looking at the big picture, there were a number of asterisks here:
First, both the top and bottom line included a net gain from equity securities of $2.7 billion, up from $533 million in 2Q20 and $392 million in 1Q21.
Second the bank's net income of $6 billion was boosted by a larger-than-expected release of loan-loss reserves. To wit, the bank noted that results included a $1.6 billion pre-tax reduction in the allowance for credit losses, and charge-offs continued to decline. Here, Scharff cautioned that even though he continues to see strong trends in all of our businesses, he expects charge-offs to increase at some point. Meanwhile, the bank's provision for credit losses decreased by $10.8 billion.
Things were especially ugly in net interest income, which tumbled a whopping 11% to $8.8BN from $9.9BN and flat sequentially. The bank blamed the fall on lower interest, lower loan balances due to weak demand and elevated prepayments. But it’s “stable” compared with last quarter, per the release. As a result, Net Interest Margin also slumped, dropping from 2.05% to 2.02%, missing expectations and another all time low.
Commenting on this ongoing decline in Net Interest Income, the bank blamed it on lower rates even though rates actually jumped substantially in Q2 both sequentially and Y/Y.
- Net interest income decreased $1.1 billion, or 11%, YoY reflecting the impact of lower interest rates, lower loan balances due to soft demand and elevated prepayments, as well as higher mortgage-backed securities (MBS) premium amortization, partially offset by a decline in long-term debt
- Net interest income was stable compared with 1Q21 as favorable hedge ineffectiveness accounting results, higher Paycheck Protection Program (PPP) income, and one additional day in the quarter were offset by lower loan balances and the impact of lower interest rates
Taking a deep dive into Wells Fargo’s consumer banking and lending, showed total revenue of $8.7 billion was up 14% year over year, and up just a tad from the first quarter. Consumer and small business banking’s $4.7 billion was up 40% year over year “driven by higher servicing income and higher mortgage origination and sales revenue,” but was also down 7% from last quarter.
Why? Wells explains “Lower retail held-for-sale originations and gain-on-sale margins were partially offset by higher income related to the re-securitization of loans purchased from mortgage-backed securities.”
Looking at the bank's bread and butter, Bloomberg notes that average loan balances of $331.9 billion were down from $353.1 billion last quarter (and $369.6 billion a year ago), while Wells Fargo’s $835.8 billion of average deposit balances were up from last quarter’s $789.4 billion $715.1 billion a year ago, all thanks to QE (more on this in a subsequent post).
And this was the main reason for our downbeat take on Wells' results: the bank's average loans tumbled (again) in the second quarter as consumers and businesses, buoyed by pandemic stimulus programs, refrained from more borrowing. As shown below, the average balance of the bank’s lending book dropped 12% to $854.7 billion. The result mirrored a similar decline at Bank of America Corp., which said earlier that loans and leases in its consumer-banking unit also fell 12%.
Needless to say, you can't have a broad economic growth without loan growth.
This brings up the $64K question: with Investors and analysts asking where’s loan growth, Wells still can't answer, and it certainly wasn't to be found in the bank's commercial banking business: The firm saw middle-market banking revenue fall 9% year-over-year, with the decline driven by reduced client demand and line utilization.
On credit performance, net charge-offs (as a percentage of average loans) hit 0.43%, up a tiny bit from last quarter’s 0.42% -- but down from last year’s 0.6%.
While interest income missed expectations, expenses also declined, and were down $1.2 billion Y/Y to $13.3 billion, thanks to a 1% drop in personnel expense, while non-personnel expenses were down $1.1 billion, or 20%, "due to lower operating losses, as well as lower professional and outside services expense reflecting efficiency initiatives to reduce our spend on consultants and contractors."
It looks like Wells Fargo’s dealmakers weren’t as prosperous as the investment bankers over at JPMorgan and Goldman Sachs who stole the show yesterday with a flurry of deals driving the firms’ results. Wells Fargo saw investment banking revenue weaken by $37 million from the same time last year. It’s interesting because Scharf has taken steps to strengthen that division, even as he’s gone about pruning businesses deemed inefficient. Out of the six largest U.S. banks, Wells Fargo’s investment banking division is the smallest in terms of market share.
Taking a quick look at the bank's modest corporate and investment banking division, which is far less material than its peers, we find that Wells bankers were not nearly as prosperous as the investment bankers over at JPMorgan and Goldman Sachs who stole the show yesterday with a flurry of deals driving the firms’ results. Wells Fargo saw investment banking revenue weaken by $37 million from the same time last year, even though Scharf has allegedly taken steps to strengthen that division, even as he’s gone about pruning businesses deemed inefficient. Out of the six largest U.S. banks, Wells Fargo’s investment banking division is the smallest in terms of market share.
Finally, in a testament to how the bank sees its own futures, headcount fell to 259,000 from 276,000 a year ago. That reduction helped to drive noninterest expenses at the bank down 8% from the same time last year. This was perhaps to be expected: Scharf has made trimming costs a priority, and the bank broke with competitors by resuming job cuts in August.
The bottom line: as Bloomberg summarizes, consumers are still keeping up with their bills and employment has been improving, allowing banks to once again release billions in reserves they’d set aside during the worst of the pandemic. That’s bolstered profits. Still, the massive stimulus the U.S. government has pumped into the economy means there’s little demand for loans, hindering revenue especially at loan-intensive banks such as Wells.
In immediate response, the market pushed WFC stock higher, but having time to digest the results, the stock is now again drifting lower.
The full Q2 presentation is below (pdf link).