Following the market's reaction after three of the largest banks in the U.S. reported earnings on Jan. 14, it was clear that Wells Fargo (WFC 2.73%) won the day with investors boosting the stock nicely, as Citigroup fell and JPMorgan Chase dropped more than 6%. Wells Fargo not only beat estimates soundly but also gave guidance that suggested the bank will likely increase earnings in 2022, a feat that may not be so easy for its competitors.
Continuing to drive efficiency
Since CEO Charlie Scharf came aboard in 2019, one of his main priorities (beyond addressing the bank's extensive regulatory issues) has been to reduce annual expenses and cut the bank's efficiency ratio. That metric measures expenses as a percentage of total revenue, so lower is better. Management set a goal early last year of cutting $8 billion of gross expenses over a three- to four-year period.
Image source: Wells Fargo.
So far, the bank has done a good job of moving toward those goals. Expenses, which came in at $57.6 billion in 2020, were cut to about $53.8 billion in 2021. Part of that drop was because some pandemic-related expenses from the prior year did not continue, but the reduction also included $3.7 billion related to the bank's efficiency initiatives, which involved optimizing the organizational structure, branch rationalization, and further automating loan platforms, among other things.
Heading into 2022, the bank expects to trim annual expenses to $51.5 billion. That sum should include $3.3 billion of cost savings from efficiency initiatives, which will be partially offset by investments into the bank, revenue-related expenses, and wage and benefits growth.
Image source: Wells Fargo Q4 2021 investor presentation.
Furthermore, while management had previously identified $8 billion worth of potential gross cost savings that it could accrue via the bank's multiyear efficiency initiative, CFO Mike Santomassimo said on the bank's fourth-quarter earnings call that it had now found a total of $10 billion in cost reduction opportunities.
This is impressive considering that many banks are dealing with elevated wage expenses due to the competitive labor market right now. Wells Fargo's peers are largely reporting higher expenses -- JPMorgan Chase, for example, told investors that it expects its expenses will grow by $6 billion this year.
Lots of tailwinds for earnings
As capital markets revenue normalizes and reserve releases of capital due to loan losses that never materialized wind down, banks like JPMorgan, Citigroup, and potentially Bank of America may struggle to increase their earnings this year. But Wells Fargo definitely looks poised to boost its earnings from the $4.95 per share it reported in 2021.
On the revenue side, management is projecting net interest income -- the profits banks make on loans and securities after covering their costs to fund those assets -- will rise from $35.8 billion to potentially $38.7 billion as the institution takes advantage of higher interest rates and other tailwinds. Keep in mind, that forecast is based on the assumption that there will be three 25-basis-point hikes in the benchmark fed funds rate this year. Many experts and economists now expect more.
Also, only about 17% of Wells Fargo's total revenue comes from its corporate and investment banking division. That's a much smaller portion than its competitors. As certain divisions within investment banking and capital markets normalize this year, it will have less of an impact on Wells Fargo than its competitors.
There are a few other factors that may benefit Wells Fargo as well. For one, the bank continues to have a huge amount of excess capital. Wells Fargo's common equity tier 1 (CET1) capital ratio, a measure of core capital expressed as a percentage of risk-weighted assets like loans, ended 2021 at 11.4%. Starting in 2022, its regulatory CET1 minimum is only expected to be 9.1%. Given the amount of excess capital management will have to work with, investors can expect the bank to keep repurchasing shares and to raise its dividend this year.
Additionally, Wells Fargo still has a ton of capital held in loan loss reserves it built up in 2020, when banks were worried that the recession that accompanied the start of the pandemic would lead to unusually high levels of borrowers defaulting on loans. By and large, those loan losses never materialized, and now, Wells Fargo's loan loss reserves are still almost $5 billion above pre-pandemic levels. It seems unlikely that management will ever bring the reserve level back below those 2019 levels, given how slowly they have gone about releasing those funds, and given that the credit situation in the bank's commercial loan portfolio may have changed. But there is still potential for the bank to release more of its reserves this year.
Lastly, in its projections, Wells Fargo assumes that the $1.95 trillion asset cap that regulators put on the bank in 2018 as punishment for its phony-accounts scandal will stay in place this year. At this point, no outsiders can know how close the bank is to getting that asset cap removed, but if it does get removed, the bank could see some added benefits on expenses and revenue.
Earnings growth looks very possible
If the bank adds more than $5 billion to its profits this year and continues to buy back stock, that sets it up to significantly grow earnings per share. There are a lot of moving pieces here, including normalization in some divisions of the bank, interest rate hikes, credit costs, and the asset cap. But the bottom-line outlook is much better for Wells Fargo right now than it is for many of its big-bank peers.
