Wells Fargo still has billions of dollars to release in its profits
After building up billions of dollars in reserves last year to prepare for loan losses from the pandemic, most banks have released reserves into profits as profits in recent quarters, largely because that the losses that were expected never materialized. But a bank that has been slower on reserve releases is Wells fargo (NYSE: WFC). That’s why, when CEO Charlie Scharf told investors at an industry conference in June to expect a “significant release of reserves” in the second quarter, I was expecting something quite significant given the amount of reserves Wells Fargo has accumulated and the vastly improving credit outlook. .
But instead, the bank released a much smaller amount than I expected. This isn’t necessarily bad news given that the bank has had a decent quarter, but it does mean that it has potentially billions of dollars left in its earnings to unlock if the economy stays on its current path.
Slackening on reserve versions
In an improving economy and the rollout of COVID-19 vaccines, banks started releasing reserves in Q4 2020, so there really have been three quarters of releases now for a lot of banks. Here’s how much each of the Big Four banks has released reserves since the fourth quarter of 2020 on a gross basis.
|Bank||Gross reserve releases since Q4 2020 (billions)|
|JPMorgan Chase (NYSE: JPM)||$ 11.1|
|Bank of America (NYSE: BAC)||$ 5.73|
|Citigroup (NYSE: C)||$ 7.6|
|Wells fargo||$ 4|
As you can see, Wells Fargo released $ 1.7 billion less than its next closest competitor, Bank of America. And in Q4 2020, he only released $ 757 million because he sold his student loan portfolio. The disparity doesn’t make a lot of sense to me right now because Wells Fargo has arguably one of the best credit qualities of these four banks. Look at the net write-off rates (unlikely debt to be collected and a good indicator of real losses) of these four banks at the end of the second quarter.
|Bank||Q2 2021 net withdrawal rate|
|Bank of America||0.27%|
Additionally, non-performing assets, those at risk of default, are also down at Wells Fargo compared to the first quarter. Although you never know the whole credit picture, I have no reason to believe that credit conditions are any different at Wells Fargo than at any of these other banks. Scharf said the bank maintains high reserves to account for the risks and uncertainty that still exist in the environment, but added that if things continue to move forward there should be future releases of reserves.
How much more could Wells Fargo release?
The short answer is a lot. A key credit-related measure to watch in banks is called the allowance for credit losses (ACL), which measures the capital that banks have in loan loss reserves as a percentage of their total average loans and other liabilities. The ACL obviously increased a lot during the pandemic, but it has since declined as banks released reserves. Yet many banks’ ACLs remain above what they were before the pandemic.
We can look at the ACL at the end of the second quarter and compare it to what it was before the pandemic to get a sense of how much reserve banks could still release. However, keep in mind that they may never fully return to this pre-pandemic level.
|Bank||ACL in Q2 2021||LCA 01/01/2020|
|JPMorgan Chase||2.02%||1.80% *|
|Bank of America||1.55%||1.27%|
Wells Fargo has the biggest cushion above its ACL before the pandemic. Currently, its ACL is 1.92% of average loans compared to 0.90% before the pandemic, and credit metrics are better now than they were before the pandemic. There are still uncertainties associated with the pandemic, and credit quality could deteriorate once stimulus funds decline and interest rates rise, but ACLs still presently represent losses that are not expected to materialize again.
If you look at Wells Fargo from a dollar perspective, the bank’s ACL at the end of the second quarter was nearly $ 16.4 billion, while its pre-pandemic ACL would have been $ 9.3 billion. dollars, which means the bank is currently booked over $ 7 billion. on ACL levels before the pandemic.
A boon for earnings
Given the pace at which management changes with reserve releases, don’t expect this to happen all at once, but more gradually over the next year, reserves should continue to decline as long as the economy continues to evolve in a positive direction. Loan growth might offset some of the release and I doubt Wells Fargo ever hits that $ 9.3 billion level as it will always want to keep some margin to account for the uncertainty.
But remember, Wells Fargo is also currently limited in the extent to which it can increase its balance sheet due to the $ 1.95 trillion asset cap currently in place. So I think additional billions from reserves will likely be pumped back into profits over the next year, which should increase profits significantly.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.