The banking industry has been under pressure during the COVID-19 pandemic, as low interest rates to stimulate the broader economy have hurt the industry's ability to grow profits. Wells Fargo (WFC 0.67%), in particular, has suffered as a result, in part because it faces restrictions that other banks don't.
Wells Fargo is set to release its second-quarter earnings report on Tuesday, July 14. Investors expect a tough quarter that's likely to include a significant loss and declines in key revenue figures. Yet there are still some bullish investors who think that Wells Fargo is a smart value play at current prices. Here's what Wells Fargo bulls need to see in order for the stock to start gaining ground again.
1. Wells Fargo needs to limit the size of its dividend cut
Wells Fargo disappointed investors in June by signaling that it would need to cut its quarterly dividend. Unlike the other big U.S. banks, which explicitly said that they would keep their dividends unchanged, the California-based banking giant failed to come out with a defense of its quarterly payout.
Instead, CEO Charles Scharf warned shareholders that Wells Fargo would likely need to increase its allowance for loan losses to a much greater extent that in did in the first quarter. The bank's move three months ago was big enough to wipe out almost all of Wells Fargo's profits, and analysts expect this quarter's allowance to push earnings into negative territory.
Image source: Wells Fargo.
If that happens, Wells Fargo will have to reduce its dividend. New Federal Reserve rules will mandate a reduction based on the corresponding fall in net income.
How big a cut depends on what Wells Fargo's financials look like, but bulls need that reduction not to be too big. The stock's current 8.5% yield already reflects expectations of a cut. As long as the reduction keeps yields at respectable levels around 3% to 4%, like its peers, then Wells should be able to overcome downward pressure from disappointed dividend investors.
2. Wells needs to get the Fed to let it grow again
From a long-term perspective, Wells Fargo investors need to see light at the end of the COVID-19 tunnel. Yet the bank still faces a monumental hurdle in the cap on assets that the Fed has imposed on it.
Wells was required to keep its assets from growing beyond a fixed maximum amount as part of regulators' response to the multiple scandals that the bank faced in recent years. Wells hit that limit toward the end of 2019, and for the most part, that has required it to give up on growth opportunities that other banks have been able to pursue more effectively.
Wells has gotten some relief from the asset cap. In order to participate in programs designed to help Americans deal with the financial impacts of the coronavirus pandemic, Wells asked the Fed for approval to make loans under the federal government's stimulus measures. The Fed granted that request, but only enough to let Wells lend $10 billion out of the $350 billion authorized under the legislation.
With rates at such low levels, growing assets is one of the only ways for banks to boost their profits. Wells needs to convince the Fed to undo its punishment for its past practices, or else it'll be doomed to second-rate status behind the unrestricted growth of its primary rivals.
3. Wells needs Warren Buffett to stay confident
Warren Buffett has been a longtime investor in Wells Fargo and other banks and remains a major shareholder in several financial institutions. However, his Berkshire Hathaway (BRK.A 0.70%) (BRK.B 0.73%) has reduced its position in Wells stock significantly in recent years, going from nearly 480 million shares in early 2017 to just 323 million currently.
Berkshire sales of Wells Fargo were especially significant late last year, with declines of more than 31 million shares in the third quarter of 2019 and more than 55 million shares in the fourth quarter. Since then, Buffett has held pat.
It's important that it stay that way. If Berkshire reports more Wells Fargo stock sales in mid-August, then it would send a definite signal that the Oracle of Omaha has lost faith in the bank.
A key time for Wells Fargo
Banking stocks have been under pressure in 2020, and few have seen more difficulty than Wells Fargo. Bulls need to see some good news from Wells soon, and these three items will be critical in determining the future of the California-based bank.
