Wells Fargo's Valuation Discounts Regulatory Concerns, RBC Says In Upgrade

Wells Fargo & Co WFC shares are trading at a level which fully discounts the bank's regulatory problems stemming from a cease-and-desist order from the Federal Reserve, according to RBC Capital Markets.

The Fed's action in early 2018 forced the bank to improve its internal governance and risk management policies as the result of "widespread consumer abuses and compliance breakdowns," according to the sell-side firm.

The Analyst

Analyst Gerard Cassidy upgraded Wells Fargo from Underperform to Sector Perform with a price target lowered from $50 to $48.

The Thesis

Wells Fargo shares dipped below RBC's prior $50 price target in December, which prompted the research firm to drop its bearish stance for valuation reasons, Cassidy said in the upgrade note.

The upgrade doesn't imply the bank is "out of the woods yet," as it still faces regulatory concerns, the analyst said.

The original C&D order limits the size of the balance sheet to the levels in the fourth quarter of 2017, and it's likely the cap will remain until 2020 despite management's prior comments that it expects the ban to be lifted in the first half of 2019, according to RBC.

Aside from regulatory concerns, RBC lowered its Q4 EPS estimate for Wells Fargo from $1.20 to $1.15, while the full-year EPS estimate was lowered from $4.46 to $4.41 and 2019 EPS estimates were lowered from $5.05 to $4.46.

The revisions are due to the bank's exposure to weakness in both the residential mortgage and retail investment brokerage businesses, Cassidy said.

The rollout of Current Expected Credit Losses next year could result in volatility in 2020 earnings estimates for the entire banking sector, the analyst said.

Bottom line, expectations for Wells Fargo's regulatory concerns to "hang around" for the full year coupled with industry-wide concerns prompted RBC to lower its price target on the stock to $48 per share.