Wells Fargo & Company

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Wells Fargo & Company is a diversified financial services company, providing a range of banking, investment, mortgage, and insurance products and services primarily within the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Wells Fargo’s moat is not wide. It possesses some elements of competitive advantage, primarily stemming from its large scale and established presence, but these aren’t insurmountable by competitors. I’ve ranked it a 2 / 5.

Moat Analysis:

  • Scale Advantage: WFC benefits from its extensive branch network and vast customer base, allowing it to offer a wide range of products and services efficiently. However, many large banks possess similar scale, thus limiting its true moat strength.
    • While they have an extensive branch network with over 5,000 locations, other big banks like JPMorgan Chase also have similar scale.
  • Established Brand: Wells Fargo has a well-recognized brand, which historically instilled customer trust. However, recent scandals and public perception issues have eroded some of that brand strength.
  • Sticky Customer Base (for Specific Businesses): Some segments, particularly consumer banking and wealth management, benefit from a fairly sticky customer base, largely due to high switching costs. These areas are a minor part of the overall WFC business. The majority of WFC’s services do not have strong customer lock-in and they are more vulnerable to competitors.
  • Their Wealth and Investment Management segment faces stiff competition from other firms, both boutique firms and established companies.
  • Lack of Sustainable Competitive Advantage in Most Areas: In a lot of businesses, such as Corporate and Commercial banking, WFC’s competitive advantage is reliant on expertise in the respective area, but is not unique and competitors can easily compete with this by hiring experienced individuals in that area. The company is also trying to grow in newer, fast growing markets like fintech but faces stiff competition there as well.

Legitimate Risks that Could Harm the Moat and Business Resilience:

  • Regulatory Scrutiny: The most serious risk is ongoing regulatory scrutiny, especially given past scandals. The company has had multiple enforcement actions and consent orders, as described in the latest 10Q filing. Further fines, penalties, and restrictions on operations or growth could severely limit the ability of the company to generate profits. WFC’s business is a very highly regulated business.
  • Interest Rate Volatility: Changes in interest rates can dramatically affect their income from lending activities, as seen in the Q1 2024 earnings call and the past years, by rising and falling interest rates, significantly affecting net interest income. A large change in interest rates can easily cause their net income to be lower than expectations.
  • Macroeconomic Conditions: Recessions and economic slowdowns lead to increased credit defaults and reduced loan demand, negatively impacting their bottom line, as seen in the most recent results with high credit loan losses. There is the risk that these trends could continue to affect their profits in a negative way.
  • Technological Disruption: The banking industry is facing increasing competition from fintech companies which are using technology in novel ways to offer financial services. Failure to adopt new technologies can lead to obsolescence and market share loss.
  • Reputational Risk: WFC’s history of ethical lapses and negative press has led to public mistrust. This can affect customer loyalty and their ability to attract and retain talent.

Business Explanation:

  • Revenue Distribution: Wells Fargo’s revenue is spread across different segments, but net interest income from the lending business accounts for the majority. Net interest income, fees and commissions, and trading gains are the three main revenue sources. As of the most recent quarter, the largest portion of revenue is generated from consumer banking. The second largest area is Corporate and Investment Banking. Wealth and Investment Management is a considerable chunk of the revenue too, especially its advisory assets. Finally, there’s a smaller chunk from Commercial Banking.
  • Industry Trends: The banking industry is undergoing a transformation. Interest rates, inflation, and geopolitical factors are causing significant changes in the industry. Many players are shifting towards digital banking, with increased emphasis on user experience and advanced security measures. Competition is intensifying due to the rise of fintech companies, and banks are having to compete not only with other established banks but startups in the fintech and payments space.
    • Most recent Earnings Calls highlight the impact of rising interest rates on expenses, as well as the decrease in consumer activity.
  • Margins: While overall margins are above average, margins fluctuate based on interest rate cycles. Return on assets, return on equity, and return on invested capital fluctuate with macro factors. Overall returns have trended downward since pre-2008 financial crisis.
  • Competitive Landscape: WFC faces stiff competition across all its business segments from numerous companies, including both well-established behemoths like JPMorgan Chase, Bank of America, Citigroup etc, as well as smaller and leaner upstarts.
    • As previously mentioned, there’s the increased risk from new fintech entrants
  • What Makes WFC Different: It has a large retail banking presence with over 5000 branches in the U.S, and over a century of history. WFC has also made considerable advancements in its mobile banking platform and app.
  • Other Relevant Factors: WFC is a systemically important bank, which means it faces tighter regulatory scrutiny and could be subject to increased capital requirements and other regulations in the future. The bank also faces constant scrutiny and monitoring by regulators and various agencies, so any bad news will be amplified and can reduce consumer and investor confidence.
  • Financials in-Depth:
    • Net interest income is the largest revenue source for WFC. It is composed of interest earned on loans, mortgages, and other securities. Net interest income has been very volatile in the past few years, changing with the interest rates. In the latest quarter (Q1 2024), net interest income was down 8%. With the federal reserve hiking interest rates, WFC did see a spike in the net interest income in 2022 and 2023, however the latest results indicate that the effect has cooled down.
    • Noninterest income is the next large revenue component, mostly composed of investment banking revenues, fees from brokerage services, fees from deposit accounts, gains and losses on assets, and servicing revenue. These are more predictable and have grown consistently over time.
    • Provisions for credit losses have been volatile in the past few years. With rising interest rates and fears of a recession, the company increased its provisioning, meaning it took a chunk of its profits to put aside for expected credit defaults. In the latest quarter (Q1 2024), provision for credit losses was at $0.9 billion. In the prior period when there was a more positive outlook, provisions were a negative value, contributing to profits.
    • Net income has seen a lot of volatility in the past few years with rising expenses and changes in interest income. The company has been under constant scrutiny and had to pay many fines. The overall net income has been lower than its peers over the past few years.
    • Total assets have been consistently growing over the years and the company has a robust portfolio of assets including loans and investment securities.
    • Total liabilities have increased too in line with asset growth. The debt-to-equity and debt-to-assets ratios are not extreme, but they are higher than many of its peers, especially with recent increase in risk-weighted assets requirements by the FED.
    • While their tier 1 capital is high, the company faces some volatility in its earnings, which means their capital ratios can drop if they have a bad quarter or year.

Understandability:

I would rate WFC a 3 out of 5 for understandability. The core banking business, while not that complicated to understand, is interwoven with many divisions in the Investment Banking, Wealth Management, and Commercial Banking area, some of which have a lot of complexities. To understand how those work properly requires someone with knowledge in those areas. Further, WFC has a complex loan portfolio, which requires expertise to understand it properly.

Balance Sheet Health:

I would rate the balance sheet health a 4 out of 5. While the bank has been impacted by high inflation, there are also clear signs of stability and strength. The bank does have high liquidity, which means it has assets that it can readily convert to cash. WFC also has a solid capital base, which should give investors comfort in case of any adverse economic scenario.

Recent Concerns/Controversies and Management Response:

  • Regulatory Issues: WFC has faced a number of regulatory probes, including improper account practices, improper foreclosure, and other consumer lending practices in the recent decade. Management has taken steps to improve risk management, and compliance, but the company will likely be subject to close regulatory scrutiny for the coming years as well. They acknowledged these issues in various recent reports and earnings calls.
  • They’ve had multiple consent orders, including recent ones. Management says they’re focused on addressing and solving these issues, but it might take years. * WFC paid $94 million in restitution to former customers in Q1 2024 to resolve a class action lawsuit related to improper loan fees. * The company acknowledged in a 10Q filing that its business practices were being thoroughly investigated by regulators in multiple different legal areas.
  • Credit Losses: The company has increased its provision for credit losses, indicating fears that more defaults are expected in the current interest rate environment. However, those provisions may affect the earnings for some quarters. They’ve also been experiencing a decrease in commercial real estate, which they acknowledged on recent earnings calls.
  • Lower Net Interest Income: WFC net interest income is highly volatile and that creates a concern. As the federal reserve stops interest hikes, that means the company will have to rely more on growing loans and increasing its market share to increase profits, and they will not be able to rely on interest hikes.