Avoid Wells Fargo (WFC), Buy These 3 Bank Stocks Instead

Shares of Wells Fargo & Company WFC have lost more than 11.9% in the last three months amid the coronavirus crisis and the bank’s involvement in legal issues compared with the industry’s growth of 4.7%.

While this San Francisco, CA-based banking giant recorded growing deposits and loan balances, displayed a strong capital position and remained focused on acquisitions in the past, the prevailing low-rate environment and volatile fee income have primarily challenged its profitability. Notably, following the “unprecedented challenge” from the coronavirus pandemic, the bank has suspended share buybacks which would continue for the third quarter as well. Now, the expectation of a cut in the third-quarter dividend, following the Federal Reserve’s move to restrict payouts of large banks post the stress test results, is likely to act as a blow to the bank on investor disappointment.

The central bank has provided a grim outlook for 2020. It projects GDP to contract 6.5% this year (against growth of 2% estimated in December 2019) due to the coronavirus-induced economic slowdown in the United States. Further, unemployment rate and inflation will be 9.3% and a mere 0.8% (way below the central bank’s target of 2%), respectively. For 2021 and 2022, the Fed estimates GDP growth rate of 5% and 3.5%, respectively. Fed Chair Jerome Powell has said, “We're not even thinking about thinking about raising rates.” This has come as a big blow to bank stocks. Therefore, the near-zero interest rates will hurt banks’ net interest margins (NIM).

Wells Fargo entered into a deal this February with the U.S. Department of Justice and the Securities and Exchange Commission (“SEC”), in order to settle a fake account openings scandal. Remarkably, troubles mounted for the Wall Street biggie, following the revelation of opening of millions of unauthorized accounts in 2016. ‘Cross-selling’, which has been the company’s key strength in recent years, drew regulators’ attention as they discovered that thousands of employees of the bank had unlawfully enrolled consumers in products and services without their knowledge or consent, in order to receive incentives for meeting sales targets.

Further, the bank has been slapped with new sanctions, including a cap on the assets position by the Federal Reserve. Notably, having assessed the need to help small firms amid economic uncertainty caused by the coronavirus mayhem, the central bank has allowed Wells Fargo to "narrowly” cross the $1.95-trillion asset cap.

In addition to the above, revenue growth has become challenging at Wells Fargo. Amid the pandemic, loan and deposit growth rates, pricing spreads, the level of interest rates and the shape of the yield curve remain decisive factors for the top-line performance in the coming quarters.

Also, persistent rise in operating expenses over the last few quarters with some volatility has been another concern for Wells Fargo. Notably, the enhanced benefits and payments provided by the company to employees this March due to the COVID-19 crisis did not significantly impact the expenses in the first quarter. However, management expects greater impact beginning in the second quarter and through the remainder of this year, adding to the expense base.

Moreover, mortgage banking income witnessed a negative three-year (2016-2019) CAGR of 23.6%, hurting overall top-line growth, despite reversal in mortgage market, with the trend continuing in the March-end quarter. Wells Fargo, which was the largest mortgage originator in the United States as of 2017, has been witnessing lower mortgage servicing income and decline in originations, which is a concern.

At some virtual conferences this year, top executives of Wells Fargo also provided the second-quarter outlook. CEO Charlie Scharf anticipates provisions to be “quite significant” as the operating backdrop has worsened from the end of March. Furthermore, the bank is likely to record more than $500 million “of expenses this quarter that we didn't anticipate because of COVID.” At the another conference, John Shrewsberry — chief financial officer (CFO) at Wells Fargo — stated that interest income for this year will decline more than 11% year over year. Moreover, loan loss reserve in the second quarter is expected to exceed the first, in which results were marred by the coronavirus mayhem.

Additionally, Wells Fargo’s high debt burden remains another headwind. The company has a debt-to-equity ratio of 1.47 compared with the industry average of 1.06. It underlines the financial instability of the company in a turbulent economic environment.

In addition, Wells Fargo has been witnessing downward earnings estimate revisions for the last 90 days. The Zacks Consensus Estimate moved down 77.5% to 71 cents for 2020 and 31.1% for 2021 during this time period.

With Wells Fargo currently carrying a Zacks Rank #3 (Hold) and a Growth Score of D, we don’t see it as an attractive investment option. Our research shows that stocks with a Growth Score of A or B, when combined with a Zacks Rank #1 (Strong Buy) or 2 (Buy), offer the best upside potential.

Investing in large cap stocks is often perceived as a safe strategy to stay afloat amid market turmoil. However, it might not meet expectations at all times.

Selecting the Winning Stocks

With the help of the Zacks Stock Screener, we have zeroed in on three bank stocks with market capitalization of more than $5 billion. All these stocks carry a Zacks Rank #1 or 2 and have expected long-term (3-5 years) EPS growth rate of 5% or more. Further, these have recorded positive price performance in the last three months.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Here are the three stocks that met the criteria:

State Street Corporation STT, with a market cap of $22.2 billion, currently carries a Zacks Rank #2 and has rallied 12.5% in the last three months. The bank has an expected long-term (3-5 years) EPS growth rate of 9.08%.

First Republic Bank FRC carries a Zacks Rank of 2, currently, and has appreciated 16% in three months’ time. The company has a projected long-term (3-5 years) EPS growth rate of 5.22%. It has a market cap of $17.9 billion.

Prosperity Bancshares, Inc. PB presently carries a Zacks Rank #2 and has gained 16.9% in the last three months. The company has an expected long-term (3-5 years) EPS growth rate of 10%. It has a market cap of $5.31 billion.

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Wells Fargo Company (WFC) : Free Stock Analysis Report
 
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