Wells Fargo: Time For That Dividend Hike (NYSE:WFC) (2023)

In January, we laid out what would work in favor of Wells Fargo (NYSE:WFC). For the bulls to be right, we had to be right about one key fact. Back then we laid this out as follows.

We think higher rates are poised to come down the line and WFC could deliver strong earnings in 2022 and beyond. We have multiple leading indicators that suggest this and we show just one below.

As such, WFC, and many other banks, are attractive on pullbacks

Source: Making The Bull Case

Investors may fret and obsess about a multitude of different factors, but at the end of the day, banks are tied at the hip with interest rates. If you don't believe that, then you should be seated for the next chart.

Obviously the higher rates case worked beautifully for the bulls. We look at what is next in light of the Q1-2021 results.

Q1 2021

Banks broadly beat earnings estimates and WFC was no different. Banks also beat earnings by mainly reversing previous loan loss provisions, and again, WFC was no different.

Source: WFC Presentation

The $1.57 billion change in allowance for credit losses is a pretty huge delta by itself. In the absence of that, WFC would have made closer to 70 cents a share. We're not suggesting that WFC should not have reversed those provisions. Based on our analysis of the balance sheet and the macro backdrop, they do appear to be adequate at present.

Source: WFC Presentation

We're simply suggesting that these changes (and there might be one quarter of this) should simply be ignored to reach your conclusion on the earnings. What's important to WFC is the size of the portfolio and the yield on that portfolio. Both those marked another quarter of declines.

Source: WFC Presentation

Net interest income took another 8 basis points dive.

Source: WFC Presentation

Investors may wonder what is going on here considering the lofty jump in 10-year interest rates. There are a few different factors at play. The first is that there's a big lag between rates rising and rates rising for WFC. We estimate that this interest rate rise will help WFC in about two quarters. The second is that the large influx of stimulus payment is allowing consumers to pay down their most expensive sources of debt and WFC is still suffering from prepayments on its highest rate loans. Finally, with the Federal Reserve committed to keeping shorter rates at zero, we think some consumers are opting for shorter maturity loans versus the longer dated loans which have repriced higher. But all these forces will likely be offset by the sheer rise in the 10 year rates and net interest income should start moving up gradually.

On the expense side, WFC has done a good job (euphemism for job cuts).

Source: WFC Presentation

Headcounts have moved lower and we think there is more room to get expenses down.

Valuation

WFC's earnings estimates are all over the place and currently 2022 shows a range of $2.75-$4.60.

Source: Seeking Alpha

If you went and asked these analysts why they came up with those earnings, you would decipher that the key difference was again, 10-year interest rates. The high end likely believes that 10 year Treasury rates go whizzing past 2.5%. They also likely believe that the Federal Reserve will keep looking at 3% plus CPI a year out and keep calling it "transitory." Neither of those two scenarios are farfetched to us, so bulls may have more to juice down the line.

But investors should use caution in using raw P/E numbers to make a valuation case for banks. The reason for that is that P/E will almost always make financials look "cheap." They tend to trade at a discount to the market and that won't change. A more sensible look comes from examining price to tangible book value for WFC. Based on that metric, only Citigroup (C) among the big banks is cheap.

Both JPMorgan Chase (JPM) and Bank of America (BAC) are now at the highest levels in the last decade. WFC is a bit in the middle of the road. It's neither compellingly cheap, but at the same time, bulls can see some expansion in this multiple. Based on WFC's asset quality and size, we think 1.5X would be close to fair value.

Conclusion

Banks have rallied sharply since the vaccine news and that rally is intricately tied to interest rates. A longer term call on interest rates is still looking at 2.5% on 10-year yields with overshoots possible to 3.0%. WFC will likely trade alongside those bond yields and that's the single biggest factor in making a directional call.

WFC's CET1 ratio reached 11.8% at the end of the quarter, despite deploying cash towards repurchasing 17.2 million shares for almost 600 million. The CET1 ratio bodes well for the future but we see little point in repurchasing shares above tangible book value. WFC needs to refocus on the dividend and a hike to at least double the current dividend rate is strongly called for. Management is thinking about it and discussed it on the conference call.

Charles Scharf

Sure. Mike, why don't I start and then you can pick up? I guess we'd start with the dividend. It's not lost on us that our dividend is quite low, certainly relative to where we're earning today and as we look forward. And we all know that that's a consequence of two things. It's a consequence of the restrictions that were put in place by the Fed in terms of what those limitations were, but it was also a point of view that we had, which was we didn't want to have to, if the environment even would get worse from that point in time, be in a position to have to reduce the dividend again.

So we would like to increase the dividend to a more reasonable level. We think about it as targeting a payout ratio, excluding reserve releases and things like that. And then beyond that, it is investment in the business. It's deploying our capital for our clients and the difference being buybacks ultimately, just given the amount of excess capital that we have today.

Source: WFC Q1-2021 Conference Call Transcript

It may seem strange that WFC would not get permission to pay out even 30% of their earnings by the Federal Reserve. We think WFC is itself using an abundance of caution. This also may be influenced by its ongoing efficiency enhancement (again a euphemism for job cuts) and WFC wants to be cautious on how its dividend hikes are perceived in light of that. But a hike is coming regardless, and we would look for Q3-2021 to at least double the dividend.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.