Wells Fargo: Q2 Earnings Suggest NII Drops Are Bottoming (Rating Upgrade)

Core Viewpoint - Wells Fargo & Company (WFC) has shown slight improvements in Q2 earnings, but the market reacted negatively initially due to unchanged full-year guidance for net interest income despite rising probabilities for rate cuts. The analysis suggests a potential shift from a hold rating to a buy rating based on the current financial metrics and market conditions [1][3][8]. Financial Performance - In Q2, Wells Fargo reported total revenue of $20.689 billion, with net interest income (NII) contributing$11.923 billion (58%) and non-interest income contributing $8.766 billion (42%) [4]. - Year-over-year, NII decreased by 9%, while non-interest income increased by 19%, driven by a 70% growth in Investment Banking Fees [4]. - The Consumer Banking and Lending segment remains the largest contributor to NII, with a year-over-year decline of 6% but a quarter-over-quarter drop of only 1%, indicating a potential stabilization [4][5]. Market Reaction - Following the Q2 earnings release, WFC's stock initially dropped by 2.75% but recovered throughout the trading day, contrasting with the SPDR S&P Bank ETF (KBE) which gained 3.63% [3]. - The unchanged full-year guidance for net interest income was a key factor in the initial market reaction, despite a significant increase in the probability of a rate cut by the Federal Reserve [3]. Key Metrics - The net interest margin (NIM) fell to 2.75%, down from 3.20% in Q1 2023, marking the fifth consecutive quarter of decline [5]. - Average deposit costs rose to 1.84%, compared to just 0.04% two years ago, reflecting the competitive pressure for higher-yielding products [5]. - Return on tangible common equity (ROTCE) improved to 13.7%, and the efficiency ratio decreased to 64% [5]. Loans and Deposits - Loan demand continues to decline due to higher interest rates, marking the fifth consecutive month of decreasing loan balances [6]. - Deposits showed signs of recovery with a third consecutive month of quarter-over-quarter growth, although year-over-year growth remained flat at -0.07% [6]. Valuation Metrics - WFC's price-to-tangible common equity (TCE) ratio stands at 1.52x, lower than JPMorgan's 2.30x, indicating a relative undervaluation compared to peers [7]. - The stock trades slightly above its five-year historical average, influenced by past sanctions and scandals [7]. Future Outlook - The potential for rate cuts in September could alleviate funding costs and improve NIM, while non-interest income shows strong momentum, particularly in investment banking [8]. - The shift in rating from hold to buy reflects the belief that the upside potential from monetary policy changes outweighs the associated risks [8].