When Wells Fargo (NYSE:WFC) posted higher credit provisions, cut its dividend by 80% and posted weak profits and revenue, investors did not react. Wells Fargo stock largely priced in the deep dividend cut. It already expected the revised capital requirements imposed by the Federal Reserve would hurt results.
At these levels, the stock may not have more downside and is worth a second look.
Credit Losses Add Up
Wells Fargo added $8.4 billion to the allowance for credit losses. Its charge-offs rose $204 million to $1.1 billion. Due to the unfavorable interest-rate environment, net interest income fell 13% sequentially. Further, the asset cap constraints hurt the bank’s ability to offset lower rates with balance sheet growth. So, the bank limited its loan and deposit growth.
The balance sheet cap is a major headwind that Wells Fargo must overcome. Unfortunately, CEO Charlie Scharf said, “the balance sheet cap exists because leadership failed to both oversee and build the appropriate infrastructure of the company and our financial underperformance is because leadership didn’t make the difficult decisions necessary.” Having the CEO own up to the bank’s past mistakes is a start.
To steer the company forward, Wells Fargo added executives to oversee risk. For example, the new chief operational risk officer will prevent the bank from making another mistake in the future. Still, it adds another layer to the management level instead of cutting the barriers between it and the staff.
Missteps in Second Quarter
The bank said it donated around $400 million in the fees it collected from the payroll protection plan to help businesses affected by the pandemic. This is a noble gesture but comes at a big cost to investors. Wells Fargo could have used those funds to sustain a higher dividend rate. On the positive side of things, helping its customers survive the downturn will pay off in the long term. It will earn higher customer loyalty and reduce insolvency risks.
Wells Fargo also tightened its credit standards to adjust for the current economic environment. In addition to adhering to asset cap constraints, it stopped buying jumbo mortgage loans. It also stopped accepting home equity and personal line of credit applications.
Opportunity for Wells Fargo Stock
The economy will inevitably rebound and sustain a better growth rate. When that happens, investors have an opportunity to ride that rebound by holding Well Fargo stock.
Consumers will drive the economic rebound. For example, they may want to buy bigger ticket items like automobiles.
In the second quarter, the bank took action to improve its spreads on new originations. This will mitigate its potential losses in the future. Also, as consumers spend more, they will increase their loan balance. This trend will increase Wells Fargo’s consumer loan portfolio.
Aggressive cost-cutting is another near-term catalyst that will lift margins. Wells Fargo may reduce a substantial number of facilities. This will contribute to its total $10 billion or so in cost-cutting efforts.
The Verdict on Wells Fargo Stock
On Wall Street, the average price target is $29.41 (according to Tipranks). Twelve of the 22 analysts offering stock rating rank Wells Fargo as a “hold.” Conversely, stockrover offers a discounted cash flow analysis to determine the intrinsic value. That fair value is almost $35 a share.
With Wells Fargo stock trading sharply below fair value, investors could start a small position in the bank today. Building a bigger position will depend on the bank posting better quarterly results in three months.
Until then, keep the bullish bet as a small position in the portfolio.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns. As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.
