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The Real Reason You Shouldn't Own Wells Fargo (WFC) Stock Now

CMA STI STT WFC

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Investors are keeping close tabs on Wells Fargo & Company (WFC - Free Report) , which is currently in deep trouble following the exposure of its sales scandal.

The company’s $190-million settlement to resolve regulators’ claims of illegally opening millions of unauthorized accounts will have no material impact on its financials, but this adds to the issues for which Wells Fargo continues to come under fire. And this is undoubtedly affecting the reputation of the once largest bank in the nation.

Since the announcement of the settlement on Sep 8, shares of the San Francisco, CA-based banking giant lost around 8%. Year-to-date, the company’s shares fell more than 16%, compared with around 3% decrease in the KBW Nasdaq Bank Index.

WELLS FARGO-NEW Price

 

A class of investors sees the current stock price movement as a long-term investment opportunity. However, it is worth analyzing a bit more to understand the real downside.

Fallout from the Scam

Business Impact: ‘Cross-selling,’ which has been Wells Fargo’s key strength in the recent years and contributed to its profits, was at the heart of the regulators’ claim of “widespread illegal practice” of the bank. It was alleged that employees of the bank unlawfully enrolled consumers in products and services without their knowledge or consent in order to receive incentives for meeting sales targets.

In order to address the issue, the bank, apart from terminating the concerned employees and taking necessary steps, also will remove all product sales goals in retail banking, effective Jan 1, 2017. Further, the bank instructed several of its call center employees to temporarily suspend cross-selling of products.

Such measures are likely to slow account openings, which consequently would result in reduced revenues. Eliminating sales targets while adjusting incentives may soften the growth in deposit service charges and credit-card fees.

Litigations & Heightened Regulatory Oversight: The settlement sparked intense public and political outrage as Wells Fargo lost its customers’ confidence and faith. Recently, the company’s board has been hit with a lawsuit alleging breach of duty to investors, according to a Bloomberg report. Last Friday, three customers in Utah filed a lawsuit against the banking giant for fraud, breach of contract and invasion of privacy. The lawsuit is seeking class-action status on behalf of thousands of customers.

The company is under tightened regulatory scrutiny as well. Notably, The U.S. Department of Justice has launched an investigation that may result in civil or criminal charges. Also, the U.S. House Financial Services Committee announced last week that it has commenced an investigation into the bank. As part of the probe, the committee intends to call John Stumpf – Chairman and CEO of Wells Fargo – to testify at a hearing later this month. Stumpf, who has been facing huge criticisms, was grilled by the congress when he testified before the U.S. Senate Banking Committee, earlier this week.

Federal Reserve Chair Janet Yellen recently said that Wells Fargo will remain under regulators’ supervision. She stated, “We have been distressed to see banking organizations responding when a particular problem arises, and what we'd really want to see is robust procedures that ensure that employees are always acting in a legal and ethical manner, and that the incentives that are put in place in these organizations are appropriate and don't serve to foster behavior that could harm the public. And this has been, and will be, a focus of our supervision.”

Wells Fargo is already encountering many investigations and lawsuits from the investors and regulators. The scam will further add to its woes with potential legal actions and more probes, apart from stricter regulations.

Buffett Move: Another key area to watch remains the next move of the legendary investor Warren Buffett, whose Berkshire Hathaway Inc. petitioned the Federal Reserve in July to increase ownership stake at Wells Fargo above 10%.

However, Buffett is largely silent on the recent crisis at Wells Fargo. He told FOXBusiness, “If I start commenting on that or anything else, it will lead down too many paths so I will wait until November to speak about it, the election or any other subject.”

While there is speculation in the market that Buffett may reduce or sell ownership stake, materialization of any such action by the largest shareholder of Wells Fargo may further affect the stock price.

Existing Troubles

Wells Fargo’s revenues are already under pressure amid a stricter regulatory landscape and a persistent low interest rate scenario. Notably, Wells Fargo lowered its return on equity and return on assets targets at its annual Investor Day held in May this year.

The Dec 2015 rate hike was not enough to result in a significant boost. During the first six months of 2016, increased net interest income and non-interest income boosted revenues, but net interest margin contracted 8 basis points on a year-over-year basis to 2.88%.

As the U.S. Federal Reserve kept interest rates unchanged on Wednesday, Wells Fargo should continue to face margin pressure in the near term.

Downward Estimate Revisions: Over the past 90 days, the Zacks Consensus Estimate for 2016 fell 2.4% to $4.04 per share while it declined 5.6% to $4.18 for 2017.

As a result, Wells Fargo currently carries a Zacks Rank # 4 (Sell). Along with a Sell rating, it has a VGM score of D, which is not desirable for investing in a stock.

Where to Invest Instead

With the help of the Zacks Stock Screener, we have zeroed in on three major bank stocks. All these stocks have witnessed at least 15% upward price movement over the past six months and sport highly desirable Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Comerica Inc. (CMA - Free Report) : The Dallas, TX-based company currently carries a Zacks Rank #2 with a long-term expected EPS (earnings per share) growth rate of 5.4%. Over the past 90 days the Zacks Consensus Estimate for 2016 advanced nearly 8% to $2.72 per share.

SunTrust Banks, Inc. (STI - Free Report) : Based in Atlanta, GA, the company has a long-term expected EPS growth rate of 5.9% and carries a Zacks Rank #2. Over the past 90 days the Zacks Consensus Estimate for 2016 moved up nearly 1% to $3.53 per share.

State Street Corp. (STT - Free Report) : The Boston, MA-based company currently carries a Zacks Rank #2 and has a long-term expected EPS growth rate of 7.3%. Over the past 90 day the Zacks Consensus Estimate for 2016 increased more than 5% to $5.03 per share.

 


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