Wells Fargo (NYSE:WFC) stock closed down close to 10% on June 11 as Federal Reserve Chairman Jerome Powell reconfirmed his commitment to be accommodative, in light of a negative outlook for the economy. That’s a dark omen for bank stocks in general. Although he stated the pace of monetary policy changes will be data-dependent, signs indicate a possibility that the Federal Funds target rate will be between 0 and 0.25 until 2022.
He also anticipates that the recovery may start towards the second half of the year, but does not expect unemployment will be lower than 9% by year-end. This is especially difficult for Wells Fargo, as the general health of the overall economy is key to profitability in their business’ lines.
To expand on that, on June 10 CFO John Shrewsberry spoke about the current state of the bank at the Virtual U.S. Financials Conference. He stated that in first-quarter demands for mortgages, and credit card activity was down, but auto loan demand is starting to increase.
Earlier in the quarter, commercial clients drew down their credit lines to create cushion, but that pattern of behavior has abated save for the replacement of other debts on their balance sheets.
Wells Fargo Stock May Get Volatile
Rising rate expectations are generally seen as a sign of a strengthening economy. When people are more confident, they are more likely to borrow, which creates revenue for banks.
The opposite is also true. It’s no surprise that, with 20 million jobs lost since February, revenue dependent on those incomes has declined. Credit card volumes are down 30% compared to the same week a year ago, and down in tens of percent for credit card spend. The usual areas are showing stress. Oil and gas retail corporate clients are asking for covenant relief and loan workouts. Wells services higher proportion of GNMA mortgages than average banks, and because they make it easier to request through simpler underwriting, they have had a higher ratio of forbearance rate than other banks. In total, about 20% of the balance of accounts are in forbearance.
Wells Fargo stock will be in for some volatility in the near term as the bank focuses on becoming more defensive. The bank expects the need to modify some mortgages, but the impact will hopefully not be as bad as it was during the great recession. Home equity loan origination will be curtailed, and it has stopped working with smaller independent auto dealers. Generally, it will be taking a more defensive posture on underwriting.
The biggest news is that more cash will need to be put aside for loss reserves in Q2 in an amount greater than anticipated.
Profitability will be predicated on where the 10-year treasury rate will trend. At 1%, the bank expects to receive between $41 billion and $42 billion in net interest income, which would be 11% lower year over year.
CFO John Shrewsberry stated the company is “doing everything they can to delivering against the commitments they made to the satisfaction of the fed” referring to the 1.952 Trillion asset caps. There is no specific timeframe. There is nothing new they have to do. Those commitments are “uniform high-quality operational risk and compliance activity” across the company. They must also manage risk appropriately.
Addressing Their Costs
There is some good news. There is an expectation that refinancing activity will further strengthen. They expect investment banking to outperform expectations in Q2, just like Q1.
Moving forward, CEO Charles Scharf recognizes that they improving operating efficiency, and thus reducing expenses is their key to “winning” in the future. They may be looking at layoffs in the latter part of the year. They are looking closely at how automation can drive some cost containment projects, but they will need to make sure they have proper mechanisms to manage risk and control correctly through that transition.
As investors digest the possibility of a second wave of Covid-19 outbreaks, it appears that they are discounting heavily cyclical stocks like Wells Fargo. Although management is looking at the right things, they will need help through a change in consumer confidence, raising rates, and a reprieve from their asset-cap-penalty-box. For these reasons WFC may not be a good opportunity now, but looks to be a good opportunity from a value standpoint over the long-run, once the health crises is abated.
As of the time of writing of this article, Emmanuel Henson did not own share in Wells Fargo.
