March 04, 2015 Wells Fargo & Company Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation N/A Date of Last Change 04/07/2000 Current Price (03/03/15) $55.45 Target Price $58.00 52-Week High $55.71 52-Week Low $46.05 One-Year Return (%) 22.68 Beta 1.17 Average Daily Volume (sh) 13,665,426 Shares Outstanding (mil) 5,188 Market Capitalization ($mil) $287,675 Short Interest Ratio (days) 1.89 Institutional Ownership (%) 76 Insider Ownership (%) 1 Annual Cash Dividend $1.40 Dividend Yield (%) 2.52 5-Yr. Historical Growth Rates Sales (%) -1.8 Earnings Per Share (%) 21.2 Dividend (%) 63.2 using TTM EPS 13.5 using 2015 Estimate 13.3 using 2016 Estimate 12.3 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Risk Level * (WFC-NYSE) Wells Fargo s fourth-quarter 2014 earnings surpassed the year-ago quarter results. However, the reported figure was in line with the Zacks Consensus Estimate. Results reflected growth in total loans and deposits amid a challenging economy and top-line growth. However, the company experienced a slight rise in non-interest expenses and provision for credit losses. In the long term, we remain optimistic about the company, based on its diverse geographic and business mix. Strategic acquisitions and a solid capital position are expected to improve profitability going forward. Yet, we believe top-line headwinds would persist, given the protracted economic recovery. The company s unrelenting legacy mortgage issues and regulatory pressure also remain concerns. Low, Type of Stock Large-Value Industry Banks-Major Reg Zacks Industry Rank * 171 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 21,259 A 21,378 A 20,478 A 20,665 A 83,780 A 2014 20,625 A 21,066 A 21,213 A 21,443 A 84,347 A 2015 21,064 E 21,623 E 21,874 E 22,707 E 87,268 E 2016 92,571 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.92 A $0.98 A $0.99 A $1.00 A $3.89 A 2014 $1.05 A $1.01 A $1.02 A $1.02 A $4.10 A 2015 $0.98 E $1.03 E $1.06 E $1.11 E $4.18 E 2016 $4.52 E Projected EPS Growth - Next 5 Years % 13 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW San Francisco-based Wells Fargo & Company is one of the largest financial services company in the U.S. with $1.7 trillion in assets and over $1.2 trillion in deposits. The company provides banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage services and consumer and commercial finance through over 8,700 stores, 12,500 ATMs, the internet and other distribution channels to individuals, businesses and institutions across North America and globally. Moreover, the acquisition of the Wachovia Bank in Dec 2008, transformed it into a premier coast-to-coast financial services franchise. The company is a result of the 1998 merger between Norwest Corporation and the former Wells Fargo (founded in 1852), as well as the merger with Wachovia Bank. The company provides its services through three broad segments: Community Banking, Wholesale Banking, and Wealth, Brokerage and Retirement. REASONS TO BUY Community Banking (contributed 57% of the total revenue in 2014) offers a complete line of diversified financial products and services to consumers and small businesses, including investment, insurance and trust services. It also offers mortgage and home equity loans through its Regional Banking and Wells Fargo Home Mortgage business units. Wholesale Banking (27%) offers financial solutions to middle market and large corporate customers with annual revenue generally in excess of $20 million. Products and businesses include commercial banking, investment banking and capital markets, securities investment, government and institutional banking, corporate banking, commercial real estate, treasury management, capital finance, international, insurance, real estate capital markets, commercial mortgage servicing, corporate trust, equipment finance, asset backed finance, and asset management. Wealth, Brokerage and Retirement (16%) provides a full range of financial advisory services to clients. The Wealth Management division offers high net worth clients with a range of wealth management solutions. The Brokerage division serves customers advisory, brokerage and financial needs. The Retirement division provides institutional retirement and trust services (including 401(k) and pension plan record keeping) for businesses, retail retirement solutions for individuals, and reinsurance services. Wells Fargo holds a strong position among the large-cap banks, with cross-selling being its key strength. The company successfully dealt with the financial crisis. We believe that the company s diverse geographic and business mix enable it to sustain consistent earnings growth, while its strong consumer franchise allows it to offer a vast range of products to households. The company is balanced between fee and spread income while sources of fee generation are diversified. Wells Fargo has implemented company-wide expense management initiatives. In addition, with the completion of the integration process and the continuance of the economic recovery, expenses are anticipated to decrease, thereby providing opportunities for future improvement in operating leverage. Notably, efficiency ratio in 2014 was 58.1%, within the targeted efficiency ratio range of 55 59%, reflecting expense management efforts. Management targets return on assets of 1.3% to 1.6% and return on equity of 12% to 15%, subject to the economic and regulatory environment. This is likely to support a shareholder payout ratio of about 55% to 75%. Notably, Wells Fargo s average return on assets was 1.45% and Equity Research WFC Page 2
REASONS TO SELL average return on equity was 13.41% for 2014. We believe its solid fundamentals would help achieve the higher end of the target over time. Wells Fargo experienced strong growth in year-end loans, despite the planned runoff from nonstrategic/liquidating portfolios. Further, reflecting commercial and consumer businesses growth, core deposits also grew. Despite the overall sluggish economic environment, the company s core deposits and loans reflected a 5-year CAGR of 7.2% and 3.3%, respectively, in 2014. Therefore, both loan and deposit balances are poised to grow amid an improving economy. Wells Fargo s growth plans have historically included a large number of acquisitions, Wachovia being the largest addition in Dec 2008. Moreover, since 2011, the company has completed a number of transactions, which include both loan portfolio purchases and business unit acquisitions. The company plans to expand its operations in international markets and augment its asset management business. It has demonstrated its ability to assimilate local franchises, offering a wider range of products than the acquired company could have, thus increasing the number of options for customers. This has been the driving force behind its growth in the recent years. Despite the macro pressure, Wells Fargo s credit quality continues to normalize. Credit metrics continued to improve in 2012, 2013 and 2014 as the overall financial condition of businesses and consumers strengthened and the housing market in many areas improved, except for the third quarter of 2012, as a result of the new regulatory guidance. This trend is expected to continue, thereby providing room to drive future earnings. Wells Fargo remains focused on managing capital levels efficiently. This is well evident from the clearance of the 2014 stress test and estimated Tier 1 common equity under Basel III increasing to 10.43% as of Dec 31, 2014, under advanced approach (fully phased-in). Recently, in Apr 2014, the company increased its dividend by 16.7%. Further, Wells Fargo is persistently returning more capital to shareholders through dividends and share repurchases. We anticipate such capital deployment activities to boost investors confidence. Going forward, we believe that the top-line headwinds would persist, given the protracted economic recovery. A low interest-rate environment would keep its margin under pressure. Notably, the net interest margin of 3.11% in 2014 was down from 3.39% in 2013, 3.76% in 2012, 3.94% in 2011 and 4.26% in 2010. Though growth in balance sheet is likely to benefit its net interest income, the pressure on net interest margins would hamper such a positive impact. Wells Fargo s unrelenting legacy mortgage issues also remain a concern. Its significant mortgage banking operations and considerable variability in mortgage servicing operations might hamper expansion in the near term. Management anticipates mortgage repurchase liability to remain volatile from quarter to quarter. The repurchase liability for the company totaled $619 million in 2014, $899 million in 2013 and $2.2 billion in 2012. Though it is decreasing, an escalation in the repurchase requests will require Wells Fargo to increase its repurchase reserve further, which will adversely affect its profitability. Wells Fargo continues to encounter many investigations and lawsuits from the investors and regulators. Though the company resolved certain litigations related to the sale of risky mortgage backed securities, many of the cases are yet to be resolved. All these factors are expected to lead to increased expenses and litigation provisions in the near term. Equity Research WFC Page 3
RECENT NEWS We are also concerned about the regulatory issues, which are expected to pose as headwinds for the company s profitability going forward. Such regulations are likely to reduce fee income growth prospects, increase compliance costs and subject the company to a number of restrictions. Moreover, stricter capital norms are being proposed for the banking industry. Though such measures are aimed at improving the overall health of the banking system, we believe that such stringent capital norms might somewhat limit the company s flexibility with respect to its lending volumes and investments in growth initiatives in the medium term. Wells Fargo Q4 Earnings Meet Estimates, Revenues Up Y/Y Jan 14, 2015 Amid a challenging industry backdrop, Wells Fargo s fourth-quarter 2014 earnings met expectations. The financial bigwig came out with earnings per share of $1.02, meeting the Zacks Consensus Estimate. Also the reported figure came above the year-ago figure of $1.00. For the year ended 2014, earnings per share were $4.10, in line with the Zacks Consensus Estimate. When compared with the prior-year figure, it increased 5%. The company recorded higher revenues and total loans and deposits continued to exhibit growth in this quarter as well. Also the company recorded reserve release of $250 million, reflecting an improving credit quality. However, higher expenses and increased provision for loan losses were on the downside. Fourth-quarter net income applicable to common stock came in at $5.4 billion, stable year over year. The quarter s total revenue came in at $21.4 billion, marginally outpacing the Zacks Consensus Estimate of $21.2 billion. Moreover, revenues jumped 4% year over year. Revenues for the year ended 2014 were $84.3 billion, up 1% year over year. Additionally, it surpassed the Zacks Consensus Estimate of $84.1 billion. Furthermore, segment-wise, on a year-over-year basis, Community Banking, Wholesale Banking and the Wealth, Brokerage and Retirement segments total revenue increased 5%, around 1% and 6%, respectively. Performance in Detail Wells Fargo s net interest income for the quarter came in at $11.2 billion, up 3% on a year-over-year basis. Increased interest income from trading assets and investment securities, along with lower deposits costs, aided the results. However, net interest margin decreased 23 basis points year over year to 3.04%. Non-interest income at Wells Fargo came in at $10.3 billion, up 4% year over year, mainly due to higher net gains on debt securities and equity investments, card fees, trust and investment fees as well as other income. These positives were partially offset by lower service charges on deposit accounts, insurance income, lease income, reduced net gains from trading activities and net gains from equity investments. As of Dec 31, 2014, total loans were $862.6 billion, increasing 5% on a year-over-year basis. Growth in both the commercial and consumer portfolios contributed to the rise. Total deposits were $1.16 trillion, up 8% from the prior-year quarter. Equity Research WFC Page 4
Non-interest expense at Wells Fargo was $12.6 billion, up 5% from the prior-year quarter. The rise in expenses was primarily attributable to higher commission and incentive compensation, FDIC and other deposit assessments along with other expenses. These were partially offset by lower core deposit and other intangibles as well as reduced employee benefits. The company s efficiency ratio was 59.0%, up from 58.5% in the prior-year quarter. A higher efficiency ratio indicates a fall in profitability. Wells Fargo expects to maintain its targeted efficiency ratio in the range of 55% 59% for full year 2015. Credit Quality Wells Fargo reported improved credit quality metrics in the quarter. Allowance for credit losses, including the allowance for unfunded commitments, totaled $13.2 billion as of Dec 31, 2014, waning from $15.0 billion as of Dec 31, 2013. Net charge-offs were $735 million or 0.34% of average loans in the reported quarter, down from the prioryear quarter net charge-offs of $963 million (0.47%). Nonperforming assets fell 21% to $15.5 billion in the quarter from $19.6 billion in the prior-year quarter. Capital Position Wells Fargo has maintained a solid capital position. The company purchased 61.6 million shares of its common stock in the fourth quarter. During 2014, the company repurchased 183.1 million shares of common stock in open market transactions, private transactions and from employee benefit plans, at a cost of $9.2 billion. The company also entered into a forward repurchases transaction for an additional estimated 14.3 million shares, which settled in Jan 2015. Additionally, the company entered into another $750 million forward repurchase contract with an unrelated third party in Jan 2015, which is anticipated to settle in secondquarter 2015 for about 14.3 million shares. Management expects share count to continue to decline in 2015 as a result of anticipated net share repurchases. As of Dec 31, 2014, Wells Fargo had remaining authority to repurchase approximately 240 million shares, subject to regulatory and legal conditions. Wells Fargo s Tier 1 common equity under Basel III (General Approach) increased to $137.2 billion from $135.9 billion in the prior quarter. The Tier 1 common equity to total risk-weighted assets ratio was 11.04% under Basel III (General Approach) as of Dec 31, 2014. The company s Tier 1 common equity ratio was an estimated 10.44% under Basel III (Advanced Approach, fully phased-in). The Tier 1 leverage ratio was 9.45% as of Dec 31, 2014, down from 9.60% as of Dec 31, 2013. Tier 1 capital ratio was 12.45% as of Dec 31, 2014 compared with 12.33% as of Dec 31, 2013. Book value per share increased to $32.19 from $28.48 in the prior-year quarter. Outlook According to management, a number of expenses including equipment expense, which was up in 4Q14, primarily due to annual software license renewals, higher outside professional services including elevated project related spending on business investments as well as risk related initiatives and advertising expenses will be lower in 1Q15 though seasonally higher personnel expenses might be recorded, reflecting incentive compensation and employee benefits expense. Equity Research WFC Page 5
Dividend Update On Jan 27, Wells Fargo announced a quarterly common stock dividend of $0.35 per share. The dividend was paid on Mar 1, 2015 to shareholders of record as of Feb 6. Ocwen, Wells Fargo MSR-Related Deal Terminated Nov 13, 2014 Wells Fargo and Ocwen Financial Corp. mutually cancelled the deal entered in Jan 2014 under which Ocwen was to buy residential mortgage-servicing rights (MSRs) on 1,84,000 loans with total principal balance of about $39 billion from Wells Fargo. Notably, the portfolio represented 2% of the bank's total residential-servicing portfolio as of Dec 31, 2013. However, such a move will not have a material effect on Wells Fargo s financial results. Moreover, Ocwen will get back its deposit worth $25 million. The cancellation followed, superintendent of New York s Department of Financial Services (DFS), Benjamin Lawsky s restriction on the proceedings of the cash-deal in Feb 2014. Driven by concerns over the mortgage servicer's ability to handle the increase in servicing volume, Lawsky halted the Ocwen deal indefinitely. Therefore, Ocwen put the deal on hold at regulator s request and was cooperating to resolve his concerns regarding its ability to service portfolios. Equity Research WFC Page 6
VALUATION On a price-to-book basis, Wells Fargo trades at 1.7x, which is at a 30.8% premium to the industry average of 1.3x. The valuation on a price-to-earnings () basis looks attractive, as the shares currently trade at 13.3x the Zacks Consensus Estimate for 2015, which is at a 2.2% discount to the 13.6x for the industry average. Moreover, Wells Fargo has a trailing 12-month ROE of 14.2%, compared with the industry average of 9.6%. This implies that the company reinvests its earnings more efficiently than its industry peers. Our six-month target price of $58.00 equates to about 13.9x the Zacks Consensus Estimate for 2015. Combined with a quarterly dividend of $0.35 per share, this price target implies an expected return of 5.9% over that period. This is consistent with our long-term Neutral recommendation on the stock. Wells Fargo currently carries a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Wells Fargo & Company (WFC) 13.3 12.3 13.0 11.3 13.5 19.0 8.9 Industry Average 13.6 11.9 8.9 11.2 15.3 35.5 9.0 S&P 500 16.8 15.7 10.7 14.9 18.5 18.4 12.0 Citigroup Inc. (C) 10.0 9.2 10.5 10.6 14.2 14.8 6.9 JPMorgan Chase & Co. (JPM) 10.6 9.5 5.6 8.7 11.7 17.5 6.4 US Bancorp (USB) 13.7 12.7 7.4 12.7 14.6 25.3 10.6 The PNC Financial Services Group, Inc. (PNC) 12.8 11.8 7.4 9.7 12.7 23.6 7.5 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Wells Fargo & Company (WFC) 1.7 1.7 1.0 14.2 1.1 2.6 2.9 Industry Average 1.3 1.3 1.3 9.6 0.9 2.0 3.9 S&P 500 6.2 9.8 3.2 25.4 2.0 Equity Research WFC Page 7
Earnings Surprise and Estimate Revision History Equity Research WFC Page 8
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of WFC. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform - 15.5%, Neutral - 75.6%, Underperform 8.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11B Kalyan Nandy Priti Dhanuka Priti Dhanuka Ishani Mukherjee N/A Equity Research WFC Page 9