Wells Fargo Earnings Preview: Net Interest Income May Decline, Non-Performing Assets Soar

According to Bloomberg consensus estimates, Wells Fargo's total operating revenue for Q1 2024 is expected to be $20.2 billion, a year-over-year decrease of approximately 2.5%, but remaining stable on a sequential basis. The overall revenue change is anticipated to be minimal.

Wells Fargo's core businesses can be categorized into personal banking and loan services (45.91%), corporate and investment banking services (23.23%), wealth and investment management services (17.79%), commercial banking services (16.28%), and corporate/private equity earnings and reconciling items.

Chart: Composition of Wells Fargo's Core Businesses

Due to increased global and domestic economic uncertainty, which has led to a decline in underwriting and advisory fees in the company's investment banking business, along with scandals involving Wells Fargo creating fake accounts to collect insurance and management fees, market assets have grown distrustful of Wells Fargo. In Bloomberg's consensus estimates for Q1 2024, both corporate and investment banking services, as well as wealth and investment management services, have seen a slight decline, expected to be $4.8 billion and $3.7 billion, respectively. This indirectly contributed to the slight pullback in the expected total revenue.

However, because Wells Fargo offered higher deposit interest rates than its industry competitors as well as lower thresholds compared to its peers, it mitigated some of the losses from depositors who abandoned deposits or loans due to the scandal. Therefore, Bloomberg anticipates that Wells Fargo's personal banking and commercial banking deposit businesses have not experienced a significant decline, but rather maintained a stable expected total deposit amount of around $1.35 trillion, with no significant changes year-over-year or quarter-over-quarter.

Thanks to the stability of deposit amounts, in the Bloomberg consensus estimates for the personal banking and commercial banking sectors, the former is expected to maintain around $9.4 billion, stable year-over-year, with an anticipated slight decline of about 1% quarter-over-quarter. The expected revenue for the commercial banking business is projected to be $3.3 billion, a 1% increase year-over-year, with an expectation to remain stable quarter-over-quarter.

In summary, it is expected that the company's total revenue and the revenue from various business segments are likely to experience a slight decline, but overall, the company is still expected to maintain a stable development trend.

Figure: Wells Fargo Revenue Changes (Millions of USD)

(1) Interest Income and Net Interest Margin (NIM): As a bank, interest income is one of its primary sources of revenue, including interest from loans, bond investments, and so on. The net interest margin reflects the bank's funding costs and lending efficiency.

(2) Non-Interest Income: This includes fee and commission income (such as credit card fees, wealth management service fees), investment banking business income (underwriting, advisory, trading commissions, etc.), asset management, and insurance business revenues.

Interest Income: Looking at specific businesses, Wells Fargo's interest income business includes loan services, investment securities, deposit services, money market operations, among others; non-interest income comprises fees and commission income (such as investment banking, asset and wealth management, transaction services, credit card services, etc.), and trading income. In terms of profits, Q4 2023 net interest income accounted for 62.36% of the total, already becoming a major component of revenue.

The U.S. rate hikes have led to a slight increase in the lending rates across the banking sector, with banks charging higher interest on customer loans and credit cards, driving interest income upward. According to Bloomberg consensus estimates, Wells Fargo's interest income is projected to be $23 billion, a year-over-year increase of 19% and a sequential increase of 1%.

At the same time, due to the impact of the Federal Reserve's high interest rates, the interest expense paid by Wells Fargo to depositors is expected to see significant growth. According to Bloomberg estimates, Wells Fargo's interest expense for Q1 2024 is expected to be $10.3 billion, a year-over-year increase of 72.37%, and a sequential increase of 3%.

Chart: U.S. Benchmark Interest Rate and Real GDP Growth(black)

As the increase in interest income is not sufficient to offset the significant growth in interest expenses, Wells Fargo's net interest income is expected to show a downward trend. According to Bloomberg consensus estimates, Wells Fargo's net interest income for Q1 2024 is anticipated to be $12.5 billion, a year-over-year decline of 7% and a quarter-over-quarter decline of 3%, with the bank's net interest margin also expected to drop from 3.2% in the same period last year to around 2.8%.

Non-Interest Income: Although trading activities may experience a sequential decline due to seasonal factors, the growth trend in investment and advisory fees is expected to continue. Bloomberg consensus estimates for Q1 2024 predict Wells Fargo's non-interest income to reach $7.8 billion, a year-over-year increase of 5%, with investment and advisory fee income expected to reach $2.2 billion, a year-over-year increase of 7%. Considering that this segment's income represents less than 40% of profit share, the upward trend in non-interest income will not offset the negative impact of the decline in net interest income on net profits.

On the expense side, primary costs come from non-interest expenses and compensation costs. With a slight decrease in revenue, Wells Fargo's compensation expenses may also experience a slight decline, which could include a reduction in the Federal Deposit Insurance Corporation (FDIC) assessment reserves; at the same time, as Wells Fargo has not announced any significant layoffs in Q1 2024, there are no expected costs associated with employee severance; additionally, Wells Fargo has not incurred any substantial fines from regulatory authorities for Q1 2024. According to Bloomberg consensus estimates, Wells Fargo's non-interest expenses for Q1 2024 are projected to be $13.9 billion, remaining stable year-over-year, with compensation costs further reduced to $8.9 billion, a year-over-year decrease of 2%.

Overall, with expense expectations remaining stable, the significant decline in net interest income has led to a decrease in net profit. According to Bloomberg consensus estimates, Wells Fargo's net profit for Q1 2024 is expected to be $2.02 billion, a year-over-year decline of 2.5% and remaining stable quarter-over-quarter. The bank's profitability is expected to be relatively weak, potentially posing significant risks to the bank's performance.

Chart: Wells Fargo Profit Changes (Millions of USD)

Based on historical financial data, Wells Fargo has a substantial amount of non-performing assets and bad loans, and since Q2 2023, the overall scale of bad debts has shown a rapid upward trend.

In 2023, Wells Fargo was exposed to multiple instances of misconduct, such as employees opening fake accounts without customer consent to meet sales targets. This not only damaged the bank's reputation but may also indirectly lead to persistent asset quality issues. Additionally, as one of the largest residential mortgage lenders in the United States, according to documents from the Federal Deposit Insurance Corporation (FDIC), Wells Fargo's delinquent commercial real estate debts doubled in size compared to the previous year, reaching $9.3 billion in 2023. It is expected that delinquent commercial real estate debts will continue to pose a significant challenge for the company in Q1 2024.

According to Bloomberg consensus estimates, Wells Fargo's non-performing assets for Q1 2024 are expected to reach $8.6 billion, a year-over-year increase of 40%; among these, non-performing loans are expected to amount to $8.4 billion, a year-over-year increase of 40%.

Chart: Wells Fargo's Non-Performing Assets and Loan Situations (Millions of USD)

Additionally, since 2016, Wells Fargo has been embroiled in a series of scandals, including the significant scandal of opening accounts for customers without their permission in order to charge insurance and management fees. This indicates serious corporate culture issues within Wells Fargo. Long-term shareholder Warren Buffett even liquidated all of his Wells Fargo assets in 2022 due to severe management problems. In response to the severe operational management scandals, the Federal Reserve set an asset cap for Wells Fargo at $1.95 trillion five years ago, and this restriction has not been lifted to date. This policy has greatly restricted the development of Wells Fargo's on-book assets and is unfavorable to the company's performance in Q1 2024.

In the context of high interest rates and substantial amounts of bad debts, Wells Fargo's interest expenses are expected to increase significantly, leading to a noticeable decline in net interest income, impacting the company's performance for Q1 2024. We expect the company's performance to see a significant downturn, with a clear decline in net profit and a double-digit year-over-year decrease in EPS for Q1 2024.

So, in the bearish trend where the stock price is expected to drop, how should options be traded?

1. Considering that the company's performance for Q1 2024 may not be very optimistic, investors can purchase put options on the company. If the stock price falls as expected, the value of the put options will rise, allowing investors to profit by selling the options or exercising them.

2. If investors already hold Wells Fargo stock, they can employ a Reverse Conversion strategy. This strategy is adopted when investors anticipate a potential drop in the stock price but do not want to short the stock directly or wish to limit downward risk. The Reverse Conversion strategy is a bearish stance as it primarily benefits from a decline in the stock price. By buying put options, investors can protect themselves from a sharp fall in the stock price, while selling the stock provides immediate cash flow.

The figure below shows the current market option positions, which investors can also refer to as a basis for risk hedging or arbitrage, making reasonable investment decisions.

Chart: Wells Fargo Bank's call and put option trading volumes over the past 30 days as of April 7th

Chart: Top five options trades as of April 7th, predominantly bearish.