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Though the S&P 500 recorded 18.4% total return for 2020 on the strong rebound in equity markets post the intensified sell-off in March on the coronavirus crisis, some of the stocks in the basket performed dismally. This was due to the global economic uncertainty that hampered business activities.
Among others, Wells Fargo WFC, the third largest U.S. bank (in terms of assets) was the worst performer in the Finance sector. Shares of the company lost more than 43% in 2020 amid the bank’s issues related to the sales scandal, revenue challenges, changes in management along with suspended buybacks and capped asset growth by the regulators, compared with the industry’s decline of 18.2%.
While this San Francisco, CA-based banking giant witnessed growing deposits and remained focused on acquisitions in the past, the prevalent low-rate environment and soft loan growth have primarily challenged its profitability. Notably, following the “unprecedented challenge” from the pandemic, the Federal Reserve’s move to restrict payouts of large banks post the stress test results which was followed by a cut in the Wells Fargo’s third-quarter 2020 dividend acted as a blow to the bank on investor disappointment.
Nevertheless, considering the ongoing economic uncertainty triggered by the COVID-19 pandemic and to preserve the banking sector’s strength, the existing restrictions on distributions of capital by banks has been extended by the Fed but with some modifications. For the first quarter of 2021, big banks including JPMorgan JPM, Citigroup C and Bank of America BAC have been permitted for capital deployment, including both dividends and share repurchases, but limited to the amount based on income over the past year.
The Federal Reserve has provided updated economic expectations for the end of 2020 as well as for 2021, per the central bank’s Summary of Economic Projections released recently. For 2020, the real gross domestic product is expected to fall just 2.4%, while the same has been upped for 2021 to 4.2% from the previous expectation of 4%. The upward revision is commensurate to the revised unemployment and inflation rates. The unemployment rate fell to 6.7% in 2020, down from the projected figure of 7.6% and is expected to fall further to 5% in 2021. Also, inflation stood at 1.2% for 2020 and PCE inflation is estimated to reach 1.8% this year.
With the pandemic hampering business activities across the globe and resulting in economic slowdown, banks have been hit hard. This, coupled with low interest rates, (the Federal Reserve cut the rates to near-zero in mid-March to support the U.S. economy) has been weighing significantly on bank stocks. Therefore, positive economic data and optimism related to the coronavirus vaccine are being seen as hopes for restoration of normal activities. If these happen, economic recovery will likely speed up and chances of banks facing high level of delinquent loans will lower. This will also reduce loan-loss uncertainty, which had led banks to built billion of dollars of reserves, including Wells Fargo.
Further, as the economy recovers, demand for loan (which had been faltering of late due to less appetite among businesses to grow) should rise. This will, in turn, support Wells Fargo’s net interest income and net interest margin despite the low rate environment.
Wells Fargo entered into a deal last February with the U.S. Department of Justice and the Securities and Exchange Commission (“SEC”), in order to settle a fake account openings scandal. Since the breakout of the bogus account openings scandal in late 2016, Wells Fargo has been involved in a number of probes and lawsuits, which have kept its expense level elevated and eroded earnings. Moreover, the bank’s assets position has been capped at $1.95 billion by the Fed. Notably, having assessed the need to help small firms amid economic uncertainty caused by the coronavirus mayhem, the central bank allowed Wells Fargo to "narrowly” cross the $1.95-trillion asset cap. Nonetheless, the financial services firm has diligently undertaken several remedial measures and initiatives to remain afloat, which include divestiture/closure of non-core operations, along with expansion moves for revenue diversification.
However, Wells Fargo expects to bear the brunt of asset growth restrictions for a little longer, as the company still has work to do for improving its control systems.
In addition to the above, revenue growth has become challenging for Wells Fargo. Amid the pandemic, loan and deposit growth rates, pricing spreads, the level of interest rates and the shape of the yield curve remain decisive factors for the top-line performance in the coming quarters.
Though mortgage banking income recorded growth in the first nine months of 2020 on reversal in the mortgage market, it witnessed a negative three-year (2016-2019) CAGR of 23.6%, hurting overall top-line growth due to considerable write-downs of its mortgage-servicing rights asset on higher projected defaults and faster prepayment assumptions. Wells Fargo, which was the largest mortgage originator in the United States as of 2017, has also been witnessing lower mortgage servicing income, which is a concern.
Additionally, Wells Fargo’s high debt burden is another headwind. The company has a debt-to-equity ratio of 1.34 compared with the industry average of 0.79. It underlines the financial instability of the company in a turbulent economic environment.
Moreover, Wells Fargo has been witnessing downward earnings estimate revisions for the last 30 days. The Zacks Consensus Estimate moved down slightly to 40 cents for 2021.
With Wells Fargo currently carrying a Zacks Rank #3 (Hold) and a Value Score of D, we don’t see it as an attractive investment option. Our research shows that stocks with a Value Score of A or B, when combined with a Zacks Rank #1 (Strong Buy) or 2 (Buy), offer the best upside potential. You can see the complete list of today’s Zacks #1 Rank stocks here.
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