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Fed Sounds All-Clear on Wells Fargo, but Is It Really?

Dana Blankenhorn

Wells Fargo & Co. (NYSE:WFC) rose sharply on June 29 after regulators gave it an all-clear in its “stress tests,” meaning a higher dividend and more stock buybacks.

Regulators approved 43 cents of dividends each quarter and $25.4 billion in stock buybacks. The dividend hike means the quarterly payout rises 4 cents per quarter, roughly 10%, while the buybacks could retire as many as 450 million shares, depending on how prices move.

Right now, they’re moving higher, as investors queue up for what looks like a forward yield of over 3%.  The Wells yield is the highest among the big banks, by some distance, with JP Morgan Chase & Co. (NYSE:JPM) yielding just 2%.  The Wells price-to-book ratio, at about 1.5%, is also close to that of JP Morgan.

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Healthy Bank?

The stress tests point to a healthy balance sheet and a healthy bank, after years of scandal. Berkshire Hathaway Inc. (NYSE:BRK.A), a big holder of Wells stock, looks like a winner. 

But has Wells learned anything?

Some customers don’t think so. There are new lawsuits over hidden fees, and the investment division has been hit by a Securities and Exchange Commission fine for churning structured notes meant to be held to maturity.

Wells is still in cost-cutting mode, recently selling 52 branches with $2.3 billion in deposits, including 33 in Indiana alone, to Flagstar Bancorp Inc. (NYSE:FBC), a Michigan-based savings bank.

CEO Tim Sloan has warned of a “frothy” commercial real estate market, yet much of the problem is at his own bank, which has seen a sudden rise in delinquencies.

The bank’s ethics hotline is also getting more complains about “bad behavior” by bank managers, including the improper editing of business documents, including those meant to prevent money laundering.

Everybody Does It

The defense of Wells Fargo bulls is that “everybody” engages in some shady practices some time, and regulators have found fake accounts were opened at other banks.

But the negative headlines don’t help a bank that is fighting hard, at least on TV, to get its reputation back, with a big ad buy during the World Cup claiming it has been “re-established” with higher ethics. The dissonance between the ads and news stories is seen as jarring by some.

Buy or Sell Wells Fargo Stock?

While Wells Fargo was deemed a “big winner” in the annual stress tests, it also has the riskiest portfolio and its excess capital would fall 8.6% in an economic downturn, the biggest drop among the big banks.

That’s important because economic risks are rising. Trade wars are unhealthy for economies. Debts must be repaid. There are signs the economy is being pushed hard while undergoing more stress, that we’re in the final stages of the current recovery, and that a downturn may be ahead.

All this could make the latest good news story about Wells a mirage. Regulators want it to look good, and the bank’s managers want to convince customers they have changed their ways. But the evidence is thin in both cases.

More will be revealed July 13, when the bank is due to report earnings for the June quarter. The consensus estimate is $1.12 per share of earnings on $21.54 billion in revenue.  That’s close to what it has been delivering the last several quarters, but the bank has missed estimates three straight times. The earnings estimate for this quarter is, in fact, 5 cents per share higher than the $1.07 estimate of the March quarter — and Wells missed on that one by 11 cents.

There remain hidden risks in Wells stock, even as the apparent rewards look big.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.

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