Wells Fargo hits rock bottom. Can It Get Worse?

Trader Talk

To get a sense of analysts’ expectations heading into Wells Fargo’s second-quarter earnings results, released on Tuesday, look no further than this backhandedly optimistic perspective from Credit Suisse’s Susan Roth Katzke: “A ‘broken’ bank can be fixed.”

The third-largest U.S. bank by assets has been in turmoil relative to peers for years, ever since a 2016 fine for improper sales practices damaged the company’s image consumer-facing image and helped spur CEO Tim Sloan to resign in March 2019 after less than three years on the job. The economic fallout from the coronavirus pandemic only made matters worse; Wells Fargo was in the unenviable position last month of announcing it would have to cut its third-quarter dividend from 51 cents a share to comply with the Federal Reserve’s stress tests. The only question heading into its earnings report this week was how deep. Some analysts warned the probability of no dividend at all was “not zero.”

It wasn’t quite that dire, but it was undeniably bad: Wells Fargo announced that it would drop its dividend to 10 cents, lower than the projection from Bloomberg’s Dividend Forecast team of a cut to 20 cents and a mean consensus estimate of 30 cents. It was part of a report that disclosed the first quarterly loss in more than a decade, causing shares to tumble in pre-market trading. The results indicate the bank, whose stock price has declined by more than 50% in 2020, has nearly reached rock bottom. The natural question is whether there’s much more room to fall, or if there’s nowhere to go but up.

On its face, a reduced dividend doesn’t provide much confidence for investors, particularly when competitors like JPMorgan Chase and Citigroup left theirs unchanged. Yet it’s unquestionably the prudent move, with so much uncertainty about the trajectory of the economic recovery. More than a few onlookers argue that the Fed should have halted payouts across the board rather than run any risk that banks could find themselves undercapitalized.

The same longer-term view holds true for the news last week from Bloomberg’s Hannah Levitt that Wells Fargo is set to cut thousands of jobs starting later this year in the face of mounting pressure to reduce costs drastically. Yes, that doesn’t indicate much in the way of resilience in the face of an economic downturn. Yet the harsh reality is it’s also the largest employer among U.S. banks, with a workforce of about 263,000, and is much less efficient than its competitors as measured by a ratio of compensation to revenue. As Levitt noted, Wells Fargo has only modestly reduced its staff over the past decade, in contrast to Bank of America, which shrank by some 80,000 employees.

CEO Charlie Scharf, who took the position in October and is developing changes to the bank’s long-term strategy, has little choice but to take what Evercore ISI called a “rip off the Band-Aid” approach. At this point as an investor, it’s obvious Wells Fargo comes with its own set of issues. It would be worse to see the bank’s new leadership — especially someone like Scharf who has a reputation as a cost-cutter — taking tentative steps to right the ship during a recessionary environment rather than making the unpopular decisions needed to ensure it bounces back with the economy in the coming years.

Like its peers, Wells Fargo set aside a huge sum this quarter to cover potential credit losses: $9.5 billion, blowing away estimates for $4.86 billion and roughly 17 times the amount taken a year ago. That, in turn, creates bleak headline numbers that give management the cover needed to move ahead with sweeping job cuts and other longer-term changes.

Now, just because a company’s stock appears cheap doesn’t mean it’s a good investment, nor is an expensive one necessarily bad. Just ask shareholders of J.C. Penney and Tesla. Even after this round of earnings, Wells Fargo’s path forward is murky at best.

“We are extremely disappointed in both our second-quarter results and our intent to reduce our dividend,” Scharf said in a statement. “Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter.”

At the most fundamental level, the company counts on capturing the spread between what it earns on loans and what it pays on deposits, referred to as net interest income. Chief Financial Officer John Shrewsberry said on June 10 that the metric might fall by 11% or more, to $41 billion to $42 billion, after dropping by 6% in 2019, more than it did for competitors. Its second-quarter NII was $9.9 billion, compared with $12.1 billion a year ago. There’s no strategic initiative that can undo the Fed’s near-zero short-term rates, nor lift 30-year mortgage rates from record lows. And the bank doesn’t have Wall Street trading operations that can offset weakness elsewhere.

Still, heading into earnings season with shares at close to the lowest price in a decade set a decidedly low bar for Wells Fargo to clear. At first brush, it couldn’t even manage to do that. But Scharf still has a chance to prove he’s the right person to forge a path forward for the 168-year-old bank. A concrete plan with tangible financial targets might be enough to reassure investors that it’s a long-term bargain in an equity market where few seem to exist.

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