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Here's Why the Stimulus Will Hurt Wells Fargo as Well as Help It

By Brent Nyitray, CFA – Apr 25, 2020 at 12:29PM

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The government gives; the government takes away and that will mean lots of changes for Wells Fargo in 2020.

With the economy in a deep freeze due to the COVID-19 pandemic, the government passed the CARES Act to help mitigate the negative financial effects created by having so many people out of work. Part of that act funded a Federal Reserve initiative called the Main Street Lending Program to provides loans to small businesses to help them make payroll for the short term. Other measures in the act addressed mortgage forbearance and increased lines of credit from the Federal Reserve.

All these initiatives are likely to have a big effect on the entire banking industry over the coming months (and perhaps years). But how will Wells Fargo (WFC 1.70%) specifically be affected?

Wells will be allowed to temporarily grow its balance sheet

Wells Fargo was penalized by the Federal Reserve in the aftermath of the bank's fake-accounts scandal in 2016. The Fed imposed a cap of $1.95 trillion in assets, essentially freezing the bank's growth potential. But as part of coronavirus relief efforts, the Fed will allow Wells to increase the size of its balance sheet so the bank can participate in the Small Business Administration's Paycheck Protection Program.

On int first-quarter 2020 earnings conference call, CEO Charlie Scharf said: "And I just want to make sure that it's clear for everyone else is that we have no restrictions on participating in these programs. What the Fed did is they allowed us to go above the existing balance-sheet cap, so that we could participate in a more holistic way without having to adjust other items, which as you know is difficult to do in a shorter period of time." 

Picture of skyscrapers

Image source: Getty Images.

Severe measures for the mortgage industry

The CARES Act includes some provisions that are quite draconian for mortgage bankers and servicers, and as one of the largest mortgage lenders in the U.S., Wells Fargo has heavy exposure to its provisions. The CARES Act will allow homeowners to skip paying their mortgages for up to a year without having to prove any sort of hardship.

With over 26 million people filing initial unemployment claims over the past five weeks (more than the entire population of Florida), many borrowers will be seeking mortgage forbearance. The Mortgage Bankers Association's latest survey shows roughly 3 million borrowers (representing about 6% of total mortgages) have requested forbearance. While some states are beginning to plan for a phased reopening of businesses, nothing is imminent and the social distancing lockdown will remain in force for a while yet. Forbearance requests are undoubtedly going up. 

Mortgage servicing assets are trading well below modeled values

Mortgage servicers, who collect mortgage payments on behalf of the ultimate investor, must reach into their own pockets and pay the investor if the homeowner doesn't pay. This creates a huge cash drain on mortgage servicers since they generally do not keep that kind of cash on hand. Because this has the potential to bankrupt nonbank servicers, the value of servicing has plummeted in the market.

While banks have access to funds to make advances, most nonbanks do not. Wells won't be directly impacted by this, but the company still has $9.5 billion in mortgage servicing assets on its books. With rising costs to service and higher delinquency rates, servicing values will be falling. 

So, is this good or bad for Wells Fargo?

This economic crash is reminiscent of the 2008-09 crash, but it really isn't the same. The financial system is in much better shape than it was then, as real estate assets are holding up and the banks are well-capitalized. Long-term investors should still feel comfortable owning most of the big bank stocks in the U.S.

It's possible this financial event could actually pave the way for Wells Fargo to get back into the government's good graces and allow it to grow again. That would be a game-changer for the company and its stock. 

Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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