Is Wells Fargo a Buy After Third-Quarter Earnings?

The financial sector has been beaten down tremendously in 2020, and Wells Fargo (WFC 0.18%) has been hit harder than most. And this is after already-poor performance in its recent scandal-plagued years. In this Fool Live clip from the October 19, 2020 Industry Focus: Financials recording, host Jason Moser and Fool.com contributor Matt Frankel, CFP, take a closer look at the bank's latest numbers and whether it could be finally worth a look.

Jason Moser: Well, let's move over to Wells Fargo. This is the one that has taken Bank of America's (BAC 1.00%) place as being the financial media's whipping post, so to speak. It just seems like they can't really do anything right. It wasn't one of the greatest quarters in the world; I think we all expected that. But then of course, you have that whole PPP loan scandal or you've got employees lying to obtain loans. It seems like it's just one thing after another.

A quote that came from the call basically said their top priority continues to be the implementation of risk control and regulatory work. I feel like that maybe is top priority 1A and 1B, clearly is the culture. There's stuff going on within this company that hasn't fully really been fixed yet. But let's talk a little bit. Let's go "glass half full" here first. What about this quarter for Wells Fargo did you like?

Matt Frankel: Well, to be fair, they're more closely scrutinized than every other bank right now, so you're going to find a lot more.

Jason Moser: Seems like they earned it, but go on.

Matt Frankel: They absolutely did. Like Buffett says, when you find a cockroach in the kitchen, there's usually not just one. So now that they found the cockroach in the kitchen, which was the fake account scandal, now everything else they do is really scrutinized. The latest thing was purely employees doing things on their own, it's worth mentioning. They didn't defraud anybody; it didn't affect any of Wells Fargo's customers. It was employees behaving badly.

Jason Moser: It likely wasn't even really a faulty incentive structure. It seems like it really was just like you said, just a few bad apples.

Matt Frankel: Right. Because Wells Fargo is scrutinized, things just fell under the microscope. But this is a stock that trades for 60% of its book value. Not a while ago, Wells Fargo was the most valuable bank stock by price-to-book. They were regularly trading at one and a half times book or even more. They're trading for literally about less than half of what they used to.

Jason Moser: That's amazing.

Matt Frankel: But going into this quarter, their net interest income was down by 90%, which Wells Fargo is purely a commercial bank. So that's to be expected in a low-interest environment. They missed earnings, but they were profitable, which is definitely a good sign.

I'm sorry. The second quarter, they had a big, big red arrow there with the profitability, and remember they had to cut their dividend because they had to set aside so much in reserves.

That wasn't the case this quarter. They were profitable, they earned enough that if this continues, they'll be able to reinstitute their dividend where it was. They did set aside loan losses. They were the only of the big banks I think that actually had to build their reserves this quarter. But it was by less than was expected. They were expected to set aside about $1.8 billion; they set aside about $0.8 billion. That was good news. That's compared to $9.5 billion in the second quarter that they had to set aside for losses.

Jason Moser: Holy cow.

Matt Frankel: This is definitely an improvement. But like I said, Wells Fargo is out of the five we're talking about. The closest thing to a pure savings and loan that we're getting out of the big banks. They are the most affected by the pandemic because they don't have that investment banking revenue to really boost their bottom line in tough times like all the other big banks do, and it's really weighing on them.

The fake account scandal was Chapter 1, and then the COVID pandemic was Chapter 2 in terms of just their underperformance of the market. It doesn't seem to be letting up anytime soon. Although this quarter didn't look as bad as expected, it's still worse than the other banks because they are purely on the commercial side of the business, and the low interest rates are just punching them in the face right now.

Jason Moser: Yeah. I was looking at this earlier, before we started taping, just taking a look at our five of these banks, a year-to-date performance. No one's lightening in the world on fire, and you got Morgan Stanley (MS 1.07%) leading the pack, and they were essentially flat for the year. All of them trailing the market. But Wells Fargo just having just a really tough year, shares down close to 60 percent.

I guess my question with Wells Fargo, before we move on, you have to believe, given the scale of this bank, given its presence in the mortgage space, given its presence in the consumer banking space, I mean, this is not a bank that's just going to go away. It can't happen. It feels like this really is a value play. I don't feel like this is a value trap. It may take a little bit longer, but given how far the stock has fallen, I mean, how are you looking at this? You looking at this more as a value player? Do you feel like this is more like a value trap?

Matt Frankel: For all of their flaws, Wells Fargo has a pretty impressive history of low-risk lending. This is how they were able to pick up Wachovia at a fire-sale price during the financial crisis, so their stock hit worse than most in the '08/'09 period. They have had a long history of responsible risk management. I don't think that's changed. We saw the reserves they had to set a side were a lot less than expected this quarter, because we're seeing the COVID losses play out a little bit more favorably than expected.

I see them definitely at 60% of book value as a value play. I don't think Wells Fargo is going to go away. I don't even really think there's a good chance that any of the big banks are going to get acquired. I just think they are going to survive this storm and move on. I don't really think it's going to be that much permanent damage to their profitability.

I mean, the bigger issue is the interest rates for them. The low-interest environment is killing them. The Federal Reserve penalty, the restriction where they're not allowed to grow, I think is still in place. I know it was lifted temporarily for PPP reasons, but I think generally, that Fed restriction is still in place. But I think they're going to make it. They're not going to go away anytime soon.