WFC Wells Fargo and Company

By Emily Glazer 

Wells Fargo & Co. struggled Monday to retain the confidence of investors who dumped the stock after the Federal Reserve cast it into a regulatory purgatory and limited the bank's ability to grow its business.

Shares slumped more than 8% as analysts ratcheted down earnings estimates for the third largest U.S. bank by assets. The selloff -- which cut around $27 billion from Wells Fargo's market value -- was especially painful given the outlook for banks has brightened over the past year thanks to stronger economic growth, rising rates and lighter regulation.

Since the start of the year, Wells Fargo's shares have lost nearly 4%, while its biggest peers have gained between 1% and 6%. Meanwhile, the bank's price/earnings multiple has fallen below that of JPMorgan Chase & Co. and Bank of America Corp.

The challenge now facing Wells Fargo was on display Friday night in an analyst call held less than two hours after the Fed announced an unprecedented enforcement action and said the bank would replace four board directors by year-end. CEO Timothy Sloan said five times on the call that the bank is "open for business."

His insistence underscored for investors how hobbled the bank is and the fact that Wells Fargo has yet to move past the sales-practices scandal that engulfed it nearly 18 months ago. Under the Fed's Friday order, Wells Fargo is barred from growing past the roughly $1.95 trillion in assets it had at the end of 2017.

Wells Fargo in its presentation to analysts Friday night said that it expected the Fed action to reduce 2018 after-tax profit by between $300 million and $400 million.

Such a reduction comes at an inopportune time for Wells Fargo. Over the past three quarters, the bank's net interest income has fallen. At the same time, the bank has been in the midst of an effort to cut $4 billion in annual costs by 2019.

In the wake of the Fed's growth cap, half a dozen analysts on Monday cut estimates for 2018 earnings per share to an average of $4.71 from a previous average of $4.83. Some of those analysts trimmed forecasts for 2019 earnings to an average of $5.16, down from an average of $5.40.

KBW bank analyst Brian Kleinhanzl, for example, downgraded Wells Fargo to "market perform" from "outperform" and lowered his 2018 earnings per share estimates to $4.70 from $4.90 and for 2019 to $5.10 from $5.45. "The bottom line is that the [Fed] order will mean Wells will have a harder time maintaining market share and will have to compete more on price or credit terms versus peers," he wrote.

Gerard Cassidy, an RBC Capital bank analyst, also voiced competitive concerns, writing that "existing customers could be pried away from the company by aggressive competitors." He added that given a positive outlook for the banking industry, investors would be better off owning JPMorgan, Bank of America or Citigroup Inc., which "will be able to harness the growth of the U.S. economy."

Wells Fargo executives said Friday that they would use a series of financial maneuvers to limit certain activities so the bank won't have to deny business to its large consumer base. But certain commercial customers could get squeezed.

For instance, the bank may reduce certain commercial deposits known as "nonoperational," of which it had around $200 billion as of the end of 2017. That is a tactic JPMorgan used to lower its asset size a few years ago.

Wells Fargo may also limit financial institutions' deposits, which tallied $149 billion at year-end 2017. And it could also reduce its $92 billion in trading assets and $91 billion in short-term investments as of Dec. 31, 2017.

Some analysts were more sanguine. AB Bernstein John McDonald wrote Monday that the growth cap will be manageable because Wells Fargo "was already planning to continue shrinking...auto and home-equity loans." He estimates the two noncore portfolios will decline by about $15 billion this year, "creating additional flexibility" for the bank.

Overall, Mr. McDonald said he expects the impact of the Fed moves to go away by next year. He added the growth cap hadn't altered his view of the bank significantly, but he had been modeling just 1% loan growth in 2018.

Investors were taken aback by the Fed's action and the fact the bank hasn't fully overcome the sales-practices scandal. Still, many were holding on.

Shareholder David Katz said the Fed's action is "sending another message to Wells that they've got to be more aggressive in getting their act together." But he said he was confident in the bank's approach to how it can "meet all the needs" of clients and manage the balance sheet.

Mr. Katz, who is president and chief investment officer at New York-based Matrix Asset Advisors Inc. that owns around 480,000 Wells Fargo shares, said the firm plans to hold its current position.

"I'm not happy about it," shareholder Bill Smead said of the bank's growth restrictions. But Mr. Smead, CEO of Seattle-based Smead Capital Management, also wasn't planning to sell any of his firm's roughly $78 million worth of Wells Fargo shares because "we haven't been losing money while we waited [for the bank to recover]...it's just been on a continuous march."

Write to Emily Glazer at emily.glazer@wsj.com

(END) Dow Jones Newswires

February 05, 2018 15:05 ET (20:05 GMT)

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