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Wells Fargo's Biggest Risk Might Not Be What You Think

Wells Fargo (NYSE: WFC) has fallen hard. Only a handful of years ago, it was Warren Buffett's favorite bank; he lauded the company's culture and its leadership's skill at navigating banking cycles.

Yet things have changed. Since 2016, the "fake accounts" scandal has cost Wells billions in fines, legal fees, and restrictions on its ability to grow. Wells has struggled with bigger losses than its megabank peers this year, and faces rising default risk as the coronavirus pandemic worsens and again threatens to derail the economy.

On the Oct. 14 edition of "The Wrap" on Motley Fool Live, Motley Fool contributor Jason Hall explained why defaults might not actually be the biggest threat to Wells Fargo's prospects.

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Jason Hall: Wells earnings fell almost by half, somewhere in the 40% area. Big part of the reason they felt was they took about $1.7 billion in expenses and accruals, they were a one-time thing. The reason I wanted to see Wells' report is because this is definitely the big bank that's had the toughest time in the past couple of years. The fake account scandal that just really undermined this idea that this was the best big bank with the best culture, and here we stand, the bank trades for 65% of the book value of its assets. What I really wanted to see is how did those assets hold up? How did its assets perform and its loan book? We really didn't get a ton of new information because the Fed has pumped so much money into the economy, and the federal stimulus, the trillions of extra dollars that have gone to individuals to help pay bills, there's all these forbearance things for banks to foreclose in different areas, so there's all these things that insulate its loan book at this point. But we did see that with interest rates falling, the upshot is that its mortgage, a lot of its fees, but its mortgage business generated like $1.3 billion, $1.4 billion in earnings because people are refinancing, people are buying homes. The housing market is absolutely booming right now, and that's a good trend.

The bad side though is net interest margin, which is the spread between what it earns on loans it issues and what it pays on deposits, shrank pretty substantially. It was almost 2.7% a year ago, and it's just a little bit over 2.1% in the third quarter. That's really important for Wells because Wells really, really makes a lot of money on its mortgage businesses. Mortgage business is a really, really big percentage of its operations, especially when you compare it to like Bank of America, JPMorgan Chase that have really big investment banking operations that can do well in this kind of year. Another big bank that reported today, Goldman Sachs, which is the biggest investment bank in North America, I think their earnings like tripled because investment banking can actually go really well in volatile markets. So it's just interesting to see how Wells is going to continue to plod along, and it's going to continue to face some challenges in the (low-interest) rate environment.

Jason Hall owns shares of Bank of America and Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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