WFC – Expect Q3 Net Payout Ratio to Exceed Guidance
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October 12, 2015
WFC: Expect Q3 Net Payout Ratio to Exceed Guidance
- The decision by WFC to lengthen its sheet over the last few quarters, albeit while remaining asset-sensitive, looks prescient given that, in Q3, long rates reversed and gave up the increase of Q2. As a result, on Wednesday, we expect WFC to report a gain on its available-for-sale securities portfolio (flowing through other comprehensive income or OCI, not earnings) of $1.5bn or more.
- Given the equity-build needed to support the balance-sheet is unlikely to meaningfully exceed $2bn, this OCI gain makes it difficult for management to avoid breaching the upper-end of its guidance range for the net payout ratio of 55-75% (see Chart below). Specifically, we expect WFC to report a Q3 net payout ratio of ~80% representing a net return of capital of ~$5bn and a net reduction in the stock count of ~50mm. These results assume some deleveraging (with our model lifting the tangible-equity-to-assets-ratio by 10bps sequentially to 8.25%).
Chart: Target and Actual Net Payout Ratio at WFC
- Net payout ratio is the ratio of common stock dividends plus share repurchases net of issuance and stock compensation
divided by the net income applicable to common stock.
- In practice, and despite increasing RWA-intensity as growth in loans exceeds growth in the non-loan assets, WFC does not need to de-lever given both that the fully-phased in CET1 ratio stands at 10.6% (under both standard and advanced approaches) versus the regulatory minimum of 8.0% and that the firm has substantial excess capital under stress on both risk-based and leverage bases. The justification for adjusting leverage is that it provides a buffer to absorb OCI losses when rates do back-up and so tends to smooth the payout ratio over time. Given the sector-wide potential for capital return we are overweight the large-cap banks in general with a preference for C and BAC.
It is difficult to see how WFC will keep its net payout ratio below the top-end of the guidance range of 55-75% when it reports on Wednesday. Treasury yields (10-year CMT) fell from 2.43% at end-June to 2.05% at end-September reversing the back-up in rates in Q2 and suggesting OCI gains of $1.5bn or more or nearly as much as our estimate of the $2bn equity-build needed to support the balance sheet (assuming some deleveraging).
Exhibit 1: Rate on US Constant Maturity – 10 Year
Source: Capital IQ
Specifically, added to consensus estimates for stockholders’ net income of $5.8bn, the OCI gain generates comprehensive income of $7.3bn netting down to $5bn after dividends. With deposit growth slowing, the WFC balance sheet will likely be sequentially flat at $1.72tn and, even allowing for a 10bps increase in the tangible-equity-to-assets ratio to 8.25%, will not require an equity-build of more than $2bn. This leaves $3bn available for net buyback generating, along with the common dividend at 34% earnings, an aggregate net payout ratio of over 80% (and 50mm net reduction in the stock count – see Exhibit 2). We have not included in the analysis ~$870mm raised through a preferred issue on September 15th even though this was likely not used to redeem other preferred stock.
Exhibit 2: Balance Sheet and Payout at WFC
Of course, if rates back-up in the fourth quarter, OCI losses will constrain the net payout possibly to below the lower-end of the guidance-range as modeled above; this provides a justification for the deleveraging assumed this quarter which, in effect, acts as a buffer so that swings in rates are absorbed partially through the balance sheet rather than entirely in the payout ratio. Another justification is the reported purchase of a $30bn specialty finance portfolio from GE (in addition to the $9bn of overseas commercial real-estate loans announced in April). Along with more general loan growth, this will tend to increase the RWA-intensity of the balance sheet.
In practice, WFC does not need additional capital given the fully-phased in CET1 ratio stands at 10.6% (under both standard and advanced approaches) versus the regulatory minimum of 8.0% (see Exhibit 3) and, under the stress-tests, has substantial excess capital on both risk-based and leverage bases (see Exhibit 4).
Exhibit 3: Minimum Risk-Based Capital Requirements across G-SIFI Banks
Exhibit 4: Mid-Cycle Company Stress Tests under Severely Adverse Scenario
Source: Company Reports
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- http://www.reuters.com/article/2015/10/09/us-gespecialtyfinance-m-a-wellsfargo-idUSKCN0S32LZ20151009 ↑