Banks are in trouble, but this solution would make Elizabeth Warren’s head explode
Mass unemployment. Mounting bankruptcies. And fears of negative interest rates. It’s a nightmarish time for America’s banks.
The mood is so dire that there’s even buzz about a blockbuster merger that would marry the “vampire squid” of Wall Street with the king of banking scandals.
But don’t hold your breath for a tie-up between Goldman Sachs and Wells Fargo, two lightning rods in the industry.
Such a deal would create an uproar in Washington, especially among critics of big banks such as Sen. Elizabeth Warren. Regulators would be unlikely to even bless a merger given Wells Fargo’s troubled past and sanctions against the bank for its fake-accounts scandal.
“I can’t see [Rep.] Maxine Waters or Elizabeth Warren backing that,” said Kyle Sanders, analyst at Edwards Jones. “They are advocating for breaking up the banks, not letting the banks get bigger and more powerful.”
Yet shares of Wells Fargo surged 7% on Thursday after FOX Business reported the San Francisco banking giant could be a merger target of Goldman Sachs. Other Goldman Sachs partners reportedly include PNC and US Bancorp. CNN Business has not verified that report.
Wells Fargo is still in trouble
It’s not even clear that joining forces would make sense right now, for either company.
Teaming up with Wells Fargo would only increase Goldman’s exposure to the risk of negative interest rates, which have doomed banks in Europe. And because these two companies have so little overlap on the retail banking front, there may be little room for the kind of cost-savings that often motivate these deals.
“Why would you want to double down in this space?” asked Nicholas Colas, co-founder of DataTrek Research. “It’s not like you can close a bunch of Goldman branches and save money. There aren’t any.”
Regulatory obstacles are clearly very high for a Wells Fargo-Goldman Sachs deal.
First, Wells Fargo already owns more than 10% of all bank deposits in the United States. That legally prevents the bank from acquiring another deposit-taking institution, unless the rules were changed or the banks sold enough deposits to satisfy regulators.
Second, Wells Fargo is still stuck in the penalty box with regulators.
In 2018, the Fed imposed an asset cap on Wells Fargo that prevents the bank from growing above $2 trillion in assets. Last month, the Fed eased these growth restrictions, but only to allow Wells Fargo to aggressively lend to small businesses. Acquiring Goldman Sachs would add another $1.1 trillion to Wells Fargo’s balance sheet.
Bank stocks are getting crushed as economy tanks
Still, the fact this is even being talked about underscores how bad sentiment is toward big banks right now, and these lenders in particular.
Wells Fargo’s stock has plummeted 56% this year, including a 19% loss this month alone. Wells Fargo closed at $22.53 on Tuesday, its weakest finish since June 2009, long before the 2016 fake-accounts scandal.
Goldman Sachs has lost a quarter of its value so far this year and trades at just 80% of its book value. The Wall Street bank’s once-vaunted capital markets business has struggled for years, and its Marcus retail division is hurting from the weak interest rate environment.
The KBW Bank Index, which includes Wells Fargo and other big banks such as Citigroup and Bank of America, has lost more than 40% of its value this year as the economic picture continues to darken dramatically.
More than 36 million Americans have filed initial unemployment claims as of Friday and retail sales have crashed. Small businesses are struggling to stay alive. And bankruptcies are on the rise.
Big banks are building massive loan loss reserves designed to cushion their looming losses, which analysts warn could just be the tip of the iceberg. Additional reserve builds are likely to wipe out bank profitability during the second quarter.
‘Extremely damaging’
The mood in the banking industry is further darkened by speculation that the Federal Reserve could follow in the footsteps of Europe and Japan by dropping interest rates below zero. President Donald Trump is rooting for that — even though critics say that negative rates have done more harm than good.
Although Fed chief Jerome Powell and other Fed officials have insisted they aren’t considering going negative, investors fear it could still happen.
“If you asked me six months ago if we would ever have negative rates in the United States, I’d say, ‘No, you’re crazy,'” said Sanders, the Edward Jones analyst. “But now I do think it’s possible, though a low-probability event.”
Negative rates are the last thing banks need given the challenging environment and the problems they have posed for European lenders. Consider that European bank stocks recently dropped to levels unseen since 1988.
“Everyone looks at that experience and says if you replicate that here, you just can’t own banks. It would just be extremely damaging to banks,” said Colas of DataTrek.
Dividend pressures mount
Even without negative rates, big bank dividends are under financial and political pressure.
Former banking regulators Janet Yellen and Sheila Bair have urged the Fed to force banks to suspend their dividends so they have enough firepower to help consumers and businesses ride out the economic storm.
Big banks have already suspended their share buybacks but have so far resisted touching their coveted dividend payouts. But analysts are warning that could change in coming weeks as the Fed puts banks through their annual stress tests.
Wells Fargo didn’t make enough money to cover its dividend payouts during the first quarter. KBW estimates that the bank’s dividend payout will amount to 221% of its earnings in 2020, compared with just 59% for the median big bank.
Although KBW maintains that Wells Fargo has the resources to keep its dividend intact, the firm is warning that there is a risk regulators might force a change.
“If they want to, the Fed could reverse engineer specific banks to cut dividends. It’s their stress tests. It’s their black box,” said KBW banking analyst Brian Kleinhanzl.
