Wells Fargo: Shareholder distributions, regulatory relief could boost further growth

Wells Fargo (NYSE:WFC) has recently experienced strong commercial growth and is well positioned to deliver additional benefits through strategic changes to its business operations, significant investment in growth areas and ongoing transformation under the leadership of CEO Charlie Scharf. As WFC continues to execute on its strategic priorities, including (1) expanding and diversifying revenue, (2) driving operational efficiencies, and (3) demonstrating regulatory compliance, the bank is expected to generate approximately $23 billion in pretax income in 2024 and $25 billion in 2025.

Strong earnings power combined with a solid CET1 should enable the bank to distribute close to 10% of its market capitalization to investors annually. Finally, one of the most important potential catalysts for Wells Fargo is the expected lifting of regulatory restrictions, including the Fed’s asset limit. The lifting of these restrictions will enable the bank to expand balance sheet and pursue growth opportunities more aggressively. While the date for the lifting of regulatory restrictions is still unknown, I argue that it could happen in 2024. As such, I reiterate my “Buy” rating on WFC stock.

For context, Wells Fargo shares have outperformed the broader U.S. stock market this year. Year-to-date, WFC shares are up about 21%, compared with a gain of nearly 15% for the S&P 500 (SP500).

Strategic Change and Leadership Transformation

Since Charlie Scharf became CEO in 2019, Wells Fargo has undergone significant changes to address past regulatory challenges and position the bank for future growth. In that context, Scharf’s leadership has been instrumental in transforming Wells Fargo from a regional bank into a more competitive institution with a business structure more in line with larger peers like JPMorgan and Bank of America. A reorganization of the leadership team, with 11 of the 15 members of the operating committee hired after Scharf’s appointment, has brought fresh perspectives and expertise, particularly in risk management and technology.

Addressing regulatory headwinds and risk management, Wells Fargo has made significant investments in key value-adding growth areas such as credit cards, capital markets and wealth management. For example, the bank has significantly expanded its credit card portfolio, with card balances increasing 30% from FY19 to FY23. This growth is being driven by new product offerings and a focus on high-quality customers, with more than 80% of credit card customers having FICO scores above 660.

Meanwhile, in the capital markets sector, Wells Fargo has invested in expanding its trading and investment banking capabilities. This includes structural changes to how the bank manages its capital markets and advisory businesses. This effort is reflected in a 10% increase in investment banking revenue year over year, reaching $2.1 billion in Q1 2024. Additionally, trading revenue increased 15% year over year, reaching $1.8 billion in the same period. Remarkably, Wells Fargo achieved this growth while still adhering to its $2 trillion balance sheet limit.

Improved performance

Another critical aspect of Wells Fargo’s long-term capital story is improving efficiency and expense management. The bank’s efficiency ratio is currently below 70% and could fall below 60% by 2026, according to consensus estimates compiled by Refinitiv. In my view, as a leading retail bank, Wells Fargo is well-positioned to generate massive efficiency gains by leveraging GenAI capabilities. In particular, Wells Fargo has significant scope to apply AI to reduce its bloated expense base in customer service and back-office (compliance) labor costs. This positive outlook for streamlined operations, combined with revenue expansion, should notably boost operating leverage and ROIC.

NII to remain high…

I personally do not share the concerns about NII declining amidst pressure on deposit costs. Investors should consider that Wells Fargo has one of the best core retail banking and deposit franchises in the US, which is evident in its low deposit costs relative to its peers. In my opinion, this competitive advantage allows the bank to maintain a stable funding base and better manage its NII. In fact, over the past few quarters, WFC has shown strong NII momentum by reinvesting maturing securities at favorable yields while maintaining stable commercial deposits and funding. For fiscal years 2024 and 2025, I am projecting around $48-49 billion of NII.

…offering a solid foundation for generating and distributing capital

In addition to NII, I am forecasting $28-30 billion in noninterest income for both 2024 and 2025 (2025 likely at the higher end of the range due to falling interest rates). That said, at a 65% cost-to-income ratio, Wells Fargo should have the earnings power to generate around $25 billion in annual pre-tax profit.

Wells Fargo’s strong capital position provides investors with a solid backdrop for capital distributions. The bank’s Common Equity Tier 1 (CET1) ratio currently stands at 11.2%, well above the regulatory minimum of 8.9%. The strong capital thesis was supported by the recent results of the Fed’s annual stress test. In fact, following the stress test results, which proved that WFC remains resilient even in the face of severe economic headwinds, Wells Fargo’s board increased its quarterly dividend by 14% to 40 cents per share ($1.6 per share annualized, nearly a 3% dividend yield). In addition to the dividend, WFC is on track to distribute close to $20 billion of capital through repurchases (nearly 10% of market capitalization), following $6.1 billion in gross repurchases in the first quarter of 2024 and a projected $5 billion in repurchases in the second quarter. Overall, Wells Fargo stock investors can expect a >10% stock return in 2024, which is significantly higher (3x) than the broader S&P 500 stock index.

Lifting of regulatory restrictions in 2024 increasingly likely

One of the biggest potential catalysts for Wells Fargo is the expected lifting of regulatory restrictions, including the Fed’s asset cap. The lifting of these restrictions will allow the bank to expand its balance sheet and more aggressively pursue growth opportunities. That said, recent analyses and reports suggest that Wells Fargo has made significant progress in addressing regulatory concerns, which increases the likelihood of the asset cap being lifted in the near future. In fact, during the recent earnings call, CEO Charlie Scharf stepped up his commentary on increased confidence in the bank’s efforts to address risk control gaps, which is a positive sign toward the lifting of restrictions. While the date for the lifting of regulatory restrictions is still unknown, I would argue that it could happen in 2024.

Conclusions for investors

I see Wells Fargo’s strong commercial momentum continuing and I predict that future growth will be supported by strategic investments in growth areas, increased efficiency, a competitive deposit franchise, and the anticipated easing of regulatory constraints. The bank’s solid capital position and attractive valuation support the case for shareholder rewards: As Wells Fargo continues to generate strong earnings, also supported by ongoing NII strength, the bank is well-positioned to deliver higher shareholder returns—likely in excess of 10% ROE. Finally, a key potential catalyst for Wells Fargo is the anticipated easing of regulatory constraints, most notably the Fed’s limit on WFC’s balance sheet. While no specific date has been set for when these constraints will be lifted, it is likely that this could occur in 2024. “Buy.”