With A Consent Order Limiting Wells Fargo's Growth, Morgan Stanley Issues Downgrade

The Federal Reserve issued a consent order Friday that limits Wells Fargo & Co WFC's average asset size to its fourth-quarter 2017 levels of $1.95 trillion. The move is expected to cost the bank $400 million in earnings this year and prompted Morgan Stanley to drop its bullish stance on the stock. 

The Analyst

Morgan Stanley's Betsy Graseck downgraded Wells Fargo's stock rating from Overweight to Underweight with a price target lowered from $75 to $64.

The Thesis

The Federal Reserve has issued consent orders before, but the order against Wells Fargo is unique in that it forbids growth, Graseck said in the downgrade note. (See the analyst's track record here.) 

"Given that bank asset growth is a function of deposit growth, and deposits grow 4-6 pertcent per year, this Fed consent order will force Wells to shrink some businesses in order to keep their assets flat," Graseck said. 

While Wells Fargo does have some flexibility, it must now manage its balance sheet duration and the liquidity tied to the LCR — liquidity coverage ratio — and living wills process, the analyst said. The company is unlikely to be able to take full advantage of stronger economic growth and its "significant" excess capital position, Graseck said. 

Morgan Stanley's lowered its 2018 end-of-period loan growth estimate for Wells Fargo from 3.4 percent to 2 percent; average loan growth from 1 percent to zero percent; and securities growth from 3 percent to negative 1 percent.

Even if the consent order is removed in the first quarter of 2019, the bank's loan growth rate would likely only be 2.5 percent in 2019, which is half the growth rate for the bank group, Graseck said. 

Price Action

Shares of Wells Fargo were trading lower by nearly 2 percent early Tuesday morning.

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