You have heard or seen me mention the turnaround story at Wells Fargo (WFC) under President and CEO Charles Scharf often enough.
Scharf has been hampered since he took the job in September 2019 by the bank's reputation and by the Fed's imposition of a hard $1.95 trillion asset cap in the wake of the fake accounts scandal, not to mention the onset of a global pandemic. Steadily, Scharf set out to change the culture, and reduce spending. Slowly, it now becomes apparent that, perhaps, there is a light at the end of this bank's long tunnel.
In banking, the "efficiency ratio" is the metric that measures operating expenses as a percentage of revenue generation. This is how investors gauge how "lean and mean" a bank is running. For the second quarter reported Wednesday morning, Wells Fargo ran with a 66% efficiency ratio, down from 77% a quarter earlier. That's a lot of progress in three months.
The light at the end of this tunnel may or may not be all that near, but we can see it from here. First time in a while.
In the second quarter, Wells Fargo reported earnings of $1.38 per share, crushing estimates that for the most part ran below a buck. Revenue generation landed at $20.27 billion, beating Wall Street estimates by more than $2.5 billion, and good for year-over-year growth of 10.9%.
Similar to other banks such as JPMorgan Chase (JPM) and Bank of America (BAC) , Wells Fargo released a large chunk of cash ($1.64 billion) from reserves set aside last year in preparation for pandemic-related loan losses that never materialized. This greatly enhanced profitability. On that note, one year ago, for second-quarter 2020, WFC reported a loss of $0.66 per share, so this was a quarter of positive reversal comparatively.
Unfortunately, also like other big banks, loan growth has been tough, falling from $971.3 billion a year ago to $854.7 billion, while deposits increased from $1.39 trillion to $1.44 trillion. This left net interest income at $8.8 billion, flat sequentially, but down from $9.89 billion a year earlier. Net interest margin decreased to 2.02% from 2.05% for the first quarter and 2.25% for second-quarter 2020..
The plan all along has been to reduce what was the bank's $54 billion annual expense base over several years. There has been talk that Wells Fargo might recognize as much as $3.7 billion this year. That's where Scharf has made the most progress. Branches have closed. Office space has been reduced. Non-core businesses are being sold, and unfortunately some people have lost their jobs. Headcount shrank by a rough 5,000 for the three-month period.
Readers will see the stock rallied from a low of $20.76 last October to a high of $48.13 this past May, picking up a cool 132% over that time. A 38.2% Fibonacci retracement would take the shares down to about $37.62.
A funny thing happened on the way.
At first glance, I thought I saw a consolidating base pattern forming after the peak in May. Zooming in, however, I think I see a closing pennant, as support has moved from $41.50 to $42, and as the 21-day exponential moving average (EMA) formed short-term resistance.
I think Wells Fargo is setting up for an explosive move.
Reminder, explosives for WFC would be a couple of bucks, not $10 or $20. Yes, theoretically, the move could be down to the Fib level below $38. However, I believe that the 21-day EMA at $4 and the 50-day simple moving average (SMA) at $45 are lining up as either a brick wall, or potentially a catalyst.
I am long the stock. My price target is $49. Right now the WFC $37.50 puts are worth about $0.70. That sounds like a worthy sale to me.