Wells Fargo and the Future of Monster Banking

The future for monster banks like Wells Fargo (NYSE: WFC) is both perilous and bright.

On the perilous side, there’s a horizon full of disruptive new technologies and aggressive next-generation competitors. PayPal (NASDAQ: PYPL), Visa (NYSE: V), MasterCard (NYSE: MA), American Express (NYSE: AXP), Goldman Sachs (NYSE: GS), Walmart (NYSE: WMT), Ant Financial, Alphabet (NASDAQ: GOOG), and Apple (NASDAQ: AAPL) are just a few of the companies taking on traditional banking functions.

Those competitors are being enabled by new technologies such as blockhain, cryptocurrencies, smartphone apps, Ethereum, digital wallets, artificial intelligence (AI), and machine learning. A world in which anybody can access almost any financial service ranging from a payday loan to a hedge-fund investment through her phone is almost here.

The bright side includes a growing economy and financial services market. Integration with some of the new technologies might create new revenue streams and markets for Wells Fargo.

For example; people that do all their banking on an app will still need to get or deposit cash occasionally, Wells Fargo’s automatic teller machine (ATM) network can solve that problem. Around 5,000 of the bank’s 13,000 ATMs now work with Apple Pay, Android Pay, and Samsung Pay, MacRumors reported.

Wells Fargo’s Revenue is shrinking

The potential challenges Wells Fargo faces are vast. The greatest of these is falling revenues, which probably reflects the growing implosion of the mortgage market.

Wells Fargo’s revenues fell for three of the last four quarters, ycharts data revealed. The company began 2016 with $88.27 billion in revenue in December; that fell to $88.07 billion in March, rose slightly to $8.08 billion in June, and fell again to $87.68 billion in September.

The likely cause of the revenue decline is a tightening in the mortgage market; particularly a falling demand for refinancing. Demand for all types of mortgages in third quarter 2017 was lower than for the same period 2016 and 2015, Fannie Mae Mortgage Lender Survey indicated. Most mortgage lenders reported four quarters of negative profits between fourth quarter 2016, and third quarter 2016.

Not even the easing of credit-standards was able to increase mortgage demand, Fannie Mae noted. The volume of mortgage originations is falling fast; the value of residential mortgages in first quarter 2017 was $111 billion less than in the first three months of 2016, Forbes’ Great Speculations blog reported.

That is problematic because Wells Fargo had a 16.3% share of the mortgage origination market in first quarter 2017, Great Speculations noted. That means it is far more exposed to mortgages than almost any other company.

Is Wells Fargo Making Money?

Wells Fargo’s revenue drop should concern value investors because its net income has taken a nosedive in recent months.

Back in June Wells Fargo reported a net income of $22.18 billion that dropped to $21.14 billion in September. Income fell by $1.04 billion in just three months, which indicates the decline mortgages and other problems are being felt at Wells Fargo.

An even greater problem at Wells Fargo that reflects the collapse of the mortgage market is cash from financing. Back in September 2016, Wells Fargo generated an astronomical $155.24 billion in cash from financing; that fell to $29.13 billion in September 2017. This indicates WFC will have to learn to adjust to a world without a profitable mortgage business.

Wells Fargo Still has a Lot of Value

The good news is that the drop in income is not reflected elsewhere in the earnings report. For example, cash from operations went from -$9.54 billion in September 2016 to $10.55 billion a year later.

That was an increase in $20.09 billion which indicates that Wells Fargo’s business model is sound. The growth in cash from operations also indicates that changes such as the adoption of new technologies and the closing of branches might be paying off.

There is still a lot of value at Wells Fargo despite the collapse in mortgages and financing. The bank reported assets of $1.935 trillion on September 30, 2017, up slightly from the $1.942 trillion a year earlier. The company also reported $19.21 billion in cash and short-term investments in September 2017. That was down slightly from $19.29 billion a year earlier.

Those two figures mean that Wells Fargo’s value is stable and it has the resources to weather the mortgage storm. They also show us that much of Wells Fargo’s core business is very stable.

That means the $616.30 billion enterprise value recorded on November 3, 2017, is legitimate. It also means that Wells Fargo was definitely undervalued at a market capitalization of $277.54 billion and a share price of $56.32 on the same day.

Is Wells Fargo a Good Investment?

Wells Fargo is a good investment because of the problems it is having. Troubles like last year’s Fake Account Scandal and the implosion of the mortgage market are forcing the bank to make painful but necessary reforms.

For example, the Fake Account Scandal is forcing the closing of branches, the streamlining of processes, and encouraging the adoption of new tech like machine learning. The collapse in mortgages is encouraging the company to look to new sources of revenue and growing markets like digital payment and lending.

More importantly, investors can make some money from Wells Fargo. Shareholders were rewarded with a return on equity of 11.88% on September 30 a dividend of 39¢ on November 2, 2017. The dividend has risen by 1¢ this year, it was 38¢ on May 3, 2017.

Therefore, Wells Fargo is a prime example of a moneymaking company in trouble. Value investors should take a close look at this troubled monster bank.