Wells Fargo: Something To Build On

About: Wells Fargo & Company (WFC), Includes: JPM
by: John M. Mason

In the past couple of years, most of the attention given to Wells Fargo has focused upon its scandals, and rightly so.

First-quarter earnings indicate that Wells Fargo still has something very substantial to build upon, indicating that the bank can still execute its basic functions.

An organization's culture is built from the top: Wells Fargo needs a new leader, preferably a non-Wall Street outsider, that can change the bank's culture, building on its current strengths.

Wells Fargo & Company (NYSE: WFC) has certainly received its share of ridicule and criticism recently. And, I have not been absent from the fray.

Top executives have resigned, the government has put limits on its growth, and Senator Elizabeth Warren has let her feelings be known about the running of the institution.

There is no question that Wells Fargo created its own problems and is suffering the consequences.

Bank management was not the only source of the problems, as I write about in my post linked above, because for the scandals to have gotten as far as they did, the Board of Directors certainly let down the shareholders as well.

But, there still seems to be a “good” bank left.

For years, Wells Fargo was considered to be one of the best-run large commercial banks in the country.

One piece of evidence of this standing is the fact that Wells Fargo during the economic recovery from the Great Recession posted a return on shareholder’s equity that exceeded the benchmark cost of capital for the largest commercial banks in the United States of 10.0 percent.

Starting in 2009, except for 2017 when the scandals were breaking, the return on equity dropped below 10.0 percent only once, in 2010, when it came in at 9.8 percent and reached a high of just under 13.0 percent in 2013. Even in 2017, the bank’s ROE was 9.9 percent.

All during this time, Wells Fargo set the standard for the largest commercial banks in the country.

In the first quarter of 2019, Wells Fargo posted a return on shareholder’s equity of 12.7 percent, well in line with the bank’s earlier performance and well above most of its largest competitors.

It should be noted here that JPMorgan Chase (NYSE: JPM) produced a 16 percent return on shareholder's equity as it posted historically high results for the industry.

The point is there still appears to be a lot of solid performance residing within the Wells Fargo bank. For example, the bank posted a return on assets of 1.26 percent, an outstanding result. Wells Fargo also earned $1.20 per share, coming in above the expectations of analysts, which was $1.09.

Total revenue came in at $21.61 billion, a number that was almost $600 million more than was projected. Asset quality remains strong as net charge offs and delinquent loans fell in the quarter. And, net interest margin at Wells Fargo was 2.91 percent, same as the average net interest margin for the year, quite strong.

To provide some comparison, JPMorgan Chase only turned in a net interest margin of 2.56 percent for the quarter. This was up for the 2018 yearly average of 2.50 percent.

A chart of these numbers can be found in the article by Aaron Back in the Wall Street Journal.

It should also be noted that Wells Fargo has done a little financial engineering to help keep its stock price up. As reported in the Motley Fool:

“The bank spent $6 billion on dividends and buybacks, with about two-thirds of this amount being spent on the latter. This means that Wells Fargo spent about $4 billion to take advantage of its depressed share price, which could add significant shareholder value over the long run. In fact, over the past year, Wells Fargo's share count has declined by 7%. That's an aggressive buyback.”

Bottom line, Wells Fargo seems to have a lot going for it, in spite of the scandals.

The “key” going forward is the Board’s choice of a new chief executive officer.

Warren Buffett, who owns almost 10 percent of the company’s stock, valued somewhere around $22 billion, has put in his two cents.

Mr. Buffett “now prefers the new leader to be an outsider and one who has not worked in investment banking….”

The problems that have been troubling Wells Fargo are not ones of execution. Even in terms of the “scandals,” the executives performed well.

The current strength of the bank, as described above, speak to superior execution.

The problem is one of culture, and the culture of an organization comes from the very top. When I was at the helm of several financial institutions, I always believed and advocated the idea that the CEO of an organization was the prime source of the culture of that organization.

If something is wrong with the culture of an organization, then go right up to the top to assess blame.

Therefore, I strongly support Mr. Buffett’s advice. Wells Fargo needs to go outside the current organization to find its future leader, and, given the turmoil that is in Washington D.C. these days, the Board should avoid bringing in someone from the highly criticized Wall Street breed.

Wells Fargo must hire an outsider that is capable of changing the current culture of the bank. The Board cannot take a chance on an insider at this time because he or she will immediately be felt to be too close to the existing culture and, hence, will be seen as being limited on the amount of change that is needed.

Wells Fargo may be a very good investment in the future. Its basic fundamentals are excellent and form a base that can be really productive in the new banking era we are entering.

Wells Fargo needs a new culture to combine with its ability to execute in order to take full advantage of the future. Investors need to keep an eye on this opportunity in the future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.