Stock Market Wrap-Up: Wells Fargo Gets Coronavirus Relief, but Will Bank Earnings Get Crushed?

Wednesday was another extraordinarily positive day for the stock market, with major benchmarks once again seeing dramatic gains. Market participants seem optimistic that even with earnings season looming, the economic fallout from the coronavirus pandemic will be short-lived. The Dow Jones Industrial Average (^DJI -0.11%) and S&P 500 (^GSPC 0.02%) led the way higher with gains between 3% and 4%, with the Nasdaq Composite (^IXIC 0.10%) lagging slightly behind with a rise of 2.58%.

Today's stock market

Data source: Yahoo! Finance.

Part of the reason there's so much optimism about the prospects for the U.S. economy is that the federal government has made financial assistance available to small businesses to help them weather the coronavirus storm. Wells Fargo (WFC -0.56%) added some potential liquidity when the Federal Reserve granted it some additional relief. But financial stocks have generally lagged behind the broader market, and with earnings set to start off next week, some are nervous about just how bad the impact on the sector might be.

Wells gets to make more loans

Shares of Wells Fargo were higher by 5% Wednesday. The banking giant got permission from its chief regulator to make more loans to help small businesses and nonprofit organizations, and it intends to make use of the expanded lending capacity.

Image source: Wells Fargo.

Wells Fargo has been subject to a consent order from the Federal Reserve that has limited its ability to grow its assets. That includes making new loans, and so Wells had said that it intended to limit its relief to small businesses and other entities to roughly $10 billion in order to avoid going over the asset cap.

But the Fed offered a temporary exemption to the asset cap to allow Wells to participate more fully in the Paycheck Protection Program. In response, Wells will offer loans to a larger set of its small business and nonprofit clients than it had originally expected to be able to do. Wells said that it has received more than 170,000 requests from customers about the program, so the bank knows there's plenty of need out there, and it will try to meet it.

CEO Charlie Scharf was also appropriately deferential to the Fed, noting that Wells still has a lot of work to do to meet the requirements for the Fed to lift its asset limits permanently. That's a welcome change in attitude from the past, and it speaks well of the CEO's approach toward righting the ship at Wells Fargo.

Can banks bounce back?

Yet even the gains for Wells Fargo haven't changed the fact that bank stocks have underperformed the broader market all year. Even before the coronavirus bear market began, investors were nervous about the declines in interest rates and the flattening of the yield curve, both of which tend to hurt bank profits.

The biggest threat banks face now is the potential for rising default rates among their borrowers. We'll get a first look at what steps big banks are taking to bulk up their loan-loss provisions when they start reporting earnings next week.

Yet there's reason for optimism. First, regulators have forced big banks to keep their balance sheets in better shape than they were in the late 2000s, and that should help them get through tough times even if they lead to a recession. Also, the flood of federal assistance to consumers and businesses alike should leave them better able to meet their financial obligations, indirectly helping the banks minimize possible losses.

Bank stocks face tough times right now. But if the coronavirus pandemic starts to ease fast enough for the economy to get on track, then valuations for banking institutions will look quite attractive at current levels.