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Praveen Chawla
Praveen Chawla
Articles (46) 

Wells Fargo Is Bracing for the Recession

The bank is building up its loan loss reserves to weather harsh economic conditions

May 06, 2020 | About:

Wells Fargo & Co. (NYSE:WFC) has been mired in a governance scandal for the last few years after the company was found to have created thousands of fake accounts and unauthorized charges to meet unrealistic cross-selling sales targets. On top of fines and litigation, the Federal Reserve had imposed a punitive $1.95 trillion asset cap restriction.

Associates were under sales pressure in a program that Wells Fargo has since abandoned. The company has sustained severe reputation damage because of this scandal, which has driven the stock price down.

The Fed has temporarily removed the asset cap so that Wells Fargo can participate in the government lending programs to help individuals and businesses during the Covid-19 crisis. However, Wells Fargo will not be able to keep any profits from this increased lending, if there are any resulting profits at all. In fact, Wells Fargo reported a sharp earnings decline due to higher loan loss provisions during the first quarter of 2020 as it braces for a full-blown recession.


Revenues have also gone down, as have net-interest margins. It is very likely that even more provisions will be required in the next few quarters as allowances for loan loss are still much below what was needed in 2007 to 2010. In the last recession, provisions reached over 3% of outstanding loans due to the housing crisis.

While I personally doubt we will reach that level due to the unprecedented fiscal and monetary stimulus provided by the Fed, I do think that over 2% may be likely. A couple of more quarters of provision buildup should be required.

Dividends are being maintained at Wells Fargo for now, even though they exceeded income for the quarter.


However, despite the headwinds, the stock price has fallen drastically. In my opinion, this more than makes up for short-term losses. In times like this, it makes more sense to keep an eye on the balance sheet than worry about income and dividends. The common equity cushion is alright for now, and as long as the balance sheet remains solid, income and dividends will recover when the economy stabilizes.

Wells Fargo has traded at a price-book ratio of around 1.51 over the last 15 years. It's now trading at a price-book ratio of 0.68, which makes it undervalued, in my view. Once the recession is over, it should recover.


Fundamentally, Wells Fargo continues to compound retained earnings while paying out copious dividends and buying back stock. However, the stock price has not done well since hitting its peak in 2017. This dichotomy can be observed in the diagram below, which shows retained earnings, cumulative dividend payout and stock buybacks (treasury shares) over the last 20 years plotted against market capitalization. In spite of the company's creditable fundamental performance, reputation and regulatory damage sustained due to the governance scandal and now the Covid-19 recession have dragged down the company's market capitalization to below tangible book value.


Disclosure: The author is long WFC stock.

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