Bank stocks did not have a great day Tuesday. Despite a roaring rally for the stock market overall, bank shares, as measured by the Financial Select SPDR ETF (NYSEARCA:XLF) were essentially flat. And some leading banks suffered big sell-offs. Wells Fargo (NYSE:WFC) was one such example; WFC stock sank 4% after releasing its quarterly numbers.
It’s not surprising that Wells’ earnings disappointed. After all, the company announced a huge decline in earnings. Its headline EPS figure came in at a pitiful 1 cent per share.
If annualized, that would result in a stratospheric P/E ratio. Regardless of the Federal Reserve’s efforts to pump up the economy, banks like Wells Fargo are certainly going to endure a rough year or two dealing with this economic crisis.
That said, before everyone runs out and dumps their shares of Wells Fargo, let’s take a look at the bull case. Here are some positives to keep in mind.
The Bull Case for WFC Stock
There’s an important banking distinction to note here. Looking at the earnings figure, you might assume Wells Fargo took major loan losses this quarter. It didn’t. Instead, it greatly boosted its loan allowances for potential future problems. Loan allowances are a bank’s estimation of potential future losses and serve as a sort of reserve fund to cover defaults that haven’t happened yet.
Wells Fargo actually only took $909 million in net loan losses this quarter – a manageable figure for a bank of its size. However, it built in another $2.9 billion of loan loss reserves to cover upcoming defaults and bankruptcies later in 2020 and 2021. That $2.9 billion immediately is taken out of earnings right now. However, it can be used to offset losses as needed going forward.
And, potentially, if the bank doesn’t end up taking as big a hit as expected, it can later reclaim those loan loss allowances. In the future, they would then turn back into a boost to Wells Fargo’s earnings in upcoming years.
Much of the rebound in bank earnings following the financial crisis came precisely because of this. Banks reserved way up in 2009 and 2010 and then slowly recaptured those credits as housing prices bottomed and the economy turned the corner.
In any case, it’s encouraging that even in a dismal quarter with a massive $3 billion loan allowance, Wells Fargo still broke even on an EPS basis. If this is the worst that it’s going to get, Wells Fargo will get through this just fine.
Wells Fargo has been quick to assist its clients during the novel coronavirus pandemic. It has taken decisive steps to ease economic pain.
Among these, it is giving 90-day waivers on mortgage payments, stopping foreclosures and auto repossessions, and other such measures to avoid immediate economic harm to vulnerable individuals.
In its quarterly earnings report, Wells Fargo revealed that it has already helped more than 1 million individual customers through programs such as fee waivers and allowing people to delay mortgage and other payments temporarily. This would be good business practice during any crisis, however, it’s especially important for Wells Fargo as it strives to repair its reputation.
WFC Stock and Brand-Building
Wells Fargo is also taking care of its own employees during the crisis. For example, in Tuesday’s earnings report, they highlighted various benefits to help their team during the virus outbreak. 165,000 workers will be receiving immediate extra pay this week; front-line workers that interact with the public will be paid additional bonuses.
Wells Fargo is waving co-pays for any Covid-19 related health care. It’s also giving folks paid time off and child care assistance as needed.
More broadly, the company is raising its internal minimum wage from $15 to $20 per hour, giving a huge permanent pay boost to more than 20,000 of its employees.
These sorts of moves are a key step in repairing Wells Fargo’s reputation. Customers and investors alike have viewed the bank as a pariah following all the fake account scandals a few years ago. While the company changed management, the scandal’s after-effects have lingered. This crisis is giving Wells Fargo a crucial moment to restore its image as a responsible member of the community.
WFC Stock Verdict
Wells Fargo will take a while to get back to its pre-crisis peak. The stock market is surging back already, but within the banking sector, this economic hit isn’t going to repair itself overnight. And by doing the right thing with payment waivers and a temporary stop to foreclosures, Wells Fargo will see softer earnings for at least a few quarters.
It’s the right move, both from an ethical standpoint and in terms of building shareholder value, however. And Wells Fargo positioned itself sell heading into this downturn.
Given that it has operated under an asset cap for years, Wells Fargo had already pruned some inferior lines of business. It has high-quality loans and excellent capital reserves to deal with a potentially extended economic slowdown. When the banking sector recovers, expect Wells Fargo to be one of the leaders.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned Wells Fargo.