A grim outlook for Wells Fargo’s commercial loan book

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Wells Fargo had already signaled publicly that its credit outlook deteriorated significantly between March and June. Still, the company delivered a jolt to investors on Tuesday by more than doubling its expected future losses on commercial loans, reflecting its belief that there will be no rapid economic recovery from the coronavirus pandemic.

The San Francisco bank reported weaker loan performance across a range of industries, particularly the energy sector, but also in real estate and construction. Within the commercial real estate sector, loans to hotels and shopping malls fared especially poorly.

Wells is now forecasting that commercial real estate prices will fall by around 10% to 15%, and that the declines will be more substantial for certain industries that have been hammered by virus-induced changes in consumer behavior. Such price declines could be particularly painful for Wells, which is the nation’s largest commercial real estate lender.

“Since the pandemic began, we’ve worked to assist customers on a case-by-case basis. We’ve continued our strict routine monitoring process with the goal of identifying problems early,” Chief Financial Officer John Shrewsberry said during a call with analysts. “However, these are unprecedented times.”

The weaker than expected outlook for commercial loan performance was among several threads in the company’s quarterly earnings report that concerned investors. Shares in the $1.95 trillion-asset bank, which have fallen by more 50% since the start of the year, declined by another 4.6% on Tuesday.

Wells, which had previously announced plans to cut its quarterly dividend, specified that it will slash the payout from 51 cents per common share to just 10 cents. The scandal-plagued bank also set aside another $765 million to pay to customers who were harmed in various ways by its past actions.

Wells Fargo’s allowance for credit losses rose to $20.4 billion, up $8.4 billion from just three months earlier, with commercial loans accounting for 76% of the increase. All told, the company reported a quarterly loss of $2.4 billion, after reporting net income of $6.2 billion in the year-earlier period. It marked the bank’s first quarterly loss since 2008.

For months, CEO Charlie Scharf has been signaling that he is preparing to take an ax to Wells Fargo’s expense base, and he reinforced that message on Tuesday.

“Our expenses are at least $10 billion higher than they should be,” he said during the call with analysts, “and there’s no reason why that should occur. And so we are doing the work to create a road map for the company that is significantly more efficient.”

The company later clarified that Scharf was referring to potential expense cuts of $10 billion a year, which would amount to around 18.5% of the company’s normal noninterest expenses on an annual basis. Reducing expenses by that amount would involve large reductions to the bank’s 260,000-person staff.

It would also likely mean many more branch closures than had previously been discussed publicly. Wells, which had 6,300 branches back in 2014 and now has fewer than 5,500, had previously set a goal of reducing that number to 5,000 by the end of 2020. But Shrewsberry said Tuesday that the company’s eventual goal is more like 4,000 branches.

“Some of that is what we’ve learned during the pandemic about where transactions go and how best to serve customers,” he said during a call with reporters. “And some of it’s for other reasons.”

During the earlier call with analysts, Shrewsberry was asked about Wells Fargo’s recent decision to purchase $14 billion in delinquent government-backed mortgages, which is far more than any other lender has bought since the start of the pandemic.

He said that Wells would bear the accounting consequences of owning the loans whether or not it bought them out of Ginnie Mae pools, which factored into its decision-making. And he said Wells has yet to decide whether to keep repurchasing large volumes of mortgages that have been placed in forbearance.

Nonperforming assets at Wells rose from $6.4 billion at the end of March to $7.8 billion three months later. About two-thirds of that increase was attributable to loans in the oil and gas sector, while almost all of the rest was attributable to other commercial loans.

Shrewsberry said that he expects charge-off rates to continue to rise through the first half of next year before starting to level off.

In the consumer realm, loan performance has been buoyed by various government stimulus programs, including cash payments to U.S. households and expanded unemployment insurance.

But it has been a different story in the commercial arena. Shrewsberry downplayed the impact that the $660 billion Paycheck Protection Program has had on loan performance, saying that many of the businesses that got assistance through Wells Fargo were quite small, and noting that the program was designed to keep employees on the payroll.

Shrewsberry also suggested that the recently opened Main Street Lending Program, a government-backed initiative aimed at helping larger businesses, is likely to be plagued by weak loan demand. “Most of the eligible borrowers would be medium-sized private businesses who wouldn’t know how to handicap whether it was good for them or bad for them to be in a partnership with the Federal Reserve,” he told reporters. “That seems to be what’s playing out.”

JPMorgan Chase, which also reported its second-quarter earnings on Tuesday, did not boost the reserves in its commercial loan portfolio by as much as Wells Fargo did. Still, the New York bank indicated that a wider swath of commercial borrowers now seem likely to default on their loans than appeared to be the case three months ago.

“I'd say in the first quarter, when we were really looking at a deep but short-lived downturn, we were really very much focused on the most impacted sectors,” JPMorgan Chief Financial Officer Jennifer Piepszak said during a call with analysts. “And now that we're looking at a more protracted downturn, we're reserved for a much more broad-based impact across sectors.”

Allissa Kline contributed to this story.

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Commercial lending Wells Fargo Loan-loss provisions Charles Scharf Coronavirus