Wells Fargo shares dipped 2% Tuesday after the bank reported mixed third-quarter results. However, we think better days are ahead as management’s efforts to improve returns take hold, and we’re upgrading the stock as a result. Total revenue at the bank increased 2% year over year to $21.9 billion in the third quarter, missing the LSEG-compiled consensus estimate of $22.3 billion. Earnings per share (EPS) for the three months ending Sept. 30 rose 13% to $1.87, beating the $1.85 consensus estimate. Bottom line We’re not surprised to see a bit of weakness on Tuesday due to misses on key operating lines. Revenue missed expectations by $430 million, with shortfalls from both net interest income (NII) and non-interest income, a collection of Wells’ fee-based businesses. Non-interest expenses came in below expectations, which is encouraging, but the $112 million beat versus the FactSet consensus didn’t make up for all of the top-line softness. Given the bank’s sensitivity to interest rates, we should start to see NII trend higher in this higher-rate environment. Net interest margin (NIM) — a key measure of a profitability, measuring the spread between what a bank earns on loans and pays out on deposits — stabilized quarter over quarter at 2.43%. This is in keeping with what CFO Michael Santomassimo said at a Barclays conference last month . The stabilization was a big deal because it ended four straight quarters of sequential declines, and the trend is expected to continue into the fourth quarter. It also beat expectations of 2.41%, which is notable because the bank entered today with misses in nine of the past 10 quarters. The bank said the better-than-expected performance was driven by slightly higher cash and securities balances, slightly lower funding costs, and additional efficiency in the deployment of its markets balance sheet. For Wells, a lot of attention is placed on NII and how the bank’s NIM performs relative to the yield curve. However, we do not think investors should ignore the progress being made in building out a competitive investment bank — a big priority for CEO Charlie Scharf. Within investment banking, Wells Fargo’s dedication to strengthening its client coverage is paying off through improved equity capital market share — up 84 basis points to 3.9% — and an improvement in the announced U.S. M & A volume ranking, going to No. 6 from No. 9 one year ago. Markets revenue within investment banking fell 1% year over year, mostly due to a decline in fixed income, currencies, and commodities, or FICC. Goldman Sachs also experienced a year over year decline in FICC revenue, although its decline was less pronounced than Wells Fargo’s. We upgraded Goldman earlier Tuesday. More broadly in fees, non-interest income declined about 1% year over year despite growth across investment advisory, deposit-related fees, investment banking, and card fees. Lower net gains in trading activities, lower lease income after the sale of its…
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