(Forbes) -- 2018 was a difficult year for Wells Fargo, with the Fed’s enforcement order adding to the bank’s woes as it struggled to win back customer support and worked its way through the long list of improper practices revealed over recent years.
To make things worse, the continued weakness in the bank’s core mortgage business since 2016 has also had a tangible impact on the top line. Things are unlikely to get much better for Wells Fargo in 2019.
We highlight our forecasts for full-year 2019 in our detailed valuation dashboard for Wells Fargo, based on which we arrived at a $57 fair value for the bank’s stock.
The key reason for this weak outlook is the fact that Wells Fargo’s asset cap is expected to remain in place for the entire year.
The bank had been able to create some room for organic growth in core loans and deposits over 2018 by getting rid of non-core loans and deposits.
But with this low-hanging fruit exhausted last year, the bank will now have to sacrifice growth in some core business units to accommodate growth in priority areas. This will put added pressure on the bank’s top line for 2019 – especially because this will force its net interest margin figure lower over the year. And the accompanying need to rein in costs will also have a negative impact on fee-based revenues.
Taken together, this will result in operating profits stagnating for the year.
While the impact of the Fed’s growth restriction will hurt all operating divisions, Wells Fargo should still report a sizable profit for full-year 2019.
This, in turn, should result in the bank returning billions to shareholders through share repurchases to keep its balance sheet size and return on equity metric in check.
Wells Fargo’s Net Interest Income Will Grow At A Significantly Slower Rate Than Peers
The biggest impact of the Fed’s enforcement order on Wells Fargo’s operations over the last several quarters has been the notable pressure on its interest-earning assets – especially its loan portfolio – as the bank shrinks the size of these assets on its balance sheet to make room for new loans, and also to allow it to liquidate non-core deposits.
The bank’s interest-earning asset base shrunk from a peak of nearly $1.8 trillion in Q3 2017 to $1.74 trillion in Q4 2018, and should largely remain stagnant over 2019.
Moreover, the need to rebalance its asset base, coupled with the fact that interest-bearing deposits form the majority of the bank’s funding base, will mute the impact of the Fed’s ongoing rate hike process on Wells Fargo’s net interest margin figure.
We expect the NIM to increase just 2 basis points from 2.91% in 2018 to 2.93% for full-year 2019. In contrast, we forecast the NIM figure for Wells Fargo’s larger peer JPMorgan Chase to increase by 8 basis points for full-year 2019.
Wells Fargo Will Also Have To Contend With Other Industry-Wide Headwinds
Wells Fargo’s business model focuses considerably on the mortgage industry, with the bank making a sizable chunk of its net interest revenues from residential mortgages in addition to generating fees from originating and servicing mortgages.
However, the weak level of activity in the U.S. mortgage industry over recent years has weighed on its top line. With mortgage activity only expected to improve slightly over 2019, mortgage banking fees should remain weak for the year.
At the same time, secular changes in the asset management industry like the rapid growth of low cost exchange-traded funds and shrinking fund expense ratios also means that Wells Fargo’s trust & investment fees will also see very little growth over the year. Headwinds for two of Wells Fargo’s largest revenue driving divisions point to a non-interest income figure for 2019 which is largely identical to that for 2018.
Expect Wells Fargo To Top Its 2018 Share Repurchase Plan
An unexpected side effect of the Fed’s growth restriction plan was the significant increase in Wells Fargo’s share repurchases for 2018. The bank repurchased $17.9 billion in stock over 2018 – a figure that compares with repurchases of $6.8 billion in 2017, and includes repurchases of $14.6 billion over the last six months of 2018 alone.
The need to keep its balance sheet size in check could mean that the Fed might sign off on an even larger share repurchase plan for Wells Fargo in the 2019 stress test cycle – potentially resulting in share repurchases in excess of $30 billion for full-year 2019.
We expect Wells Fargo to report EPS of $4.75 for full-year 2019. Taken together with a forward P/E ratio of 12, this works out to a price estimate of $57 for Wells Fargo’s shares, which is roughly 20% ahead of the current market price.