Fed Stress Test Shows Wells Fargo's Main Overhang Is Gone, Morgan Stanley Says In Upgrade

Banking giant Wells Fargo & Co WFC removed a major overhang last week, as it not only passed the Federal Reserve's stress test, but announced a much better than expected capital return program, according to Morgan Stanley.

The Analyst

Morgan Stanley's Betsy Graseck upgraded Wells Fargo from Underweight to Equal-weight with a price target lifted from $57 to $62.

The Thesis

Heading into the Federal Reserve's 2018 stress test, Wells Fargo was given a 50-50 chance of passing on a qualitative basis, Graseck said in the Monday upgrade note. Success in the stress test requires the bank to succeed in some of the areas that were flagged in the Fed's consent order for Wells Fargo, including governance and risk management, the analyst said.

Nevertheless, Wells Fargo handily passed the stress test and approved a stock buyback program worth $24.5 billion, which was nearly twice the amount expected, Graseck said. The analyst's takeaways from the stress test are as follows:

The Fed is receptive to changes the bank is making within its governance and risk management departments.
The Fed is more pragmatic in the regulatory actions it takes.
Wells Fargo should be able to exit the asset cap stipulation put in place by the Fed by the second quarter of 2019, if not sooner.

A bullish stance on Wells Fargo's stock can't be made, as the bank is unable to grow its balance sheet above 2017's year-ending level of $1.95 trillion, Graseck said. This implies the bank can't "go on the offensive" and fully take advantage of the superior economic growth occurring after the federal tax cut, she said.