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Why Wells Is a ‘Sell’

Pedestrians pass an ATM outside Wells Fargo & Co.'s San FranPedestrians pass an ATM outside Wells Fargo & Co.'s San Fran
Pedestrians pass an ATM outside Wells Fargo & Co.'s San Francisco headquarters on Friday, December 24, 2004. Companies in the finance industry such as GE Capital and Wells Fargo & Co. accounted for about 52 percent of fixed-rate investment-grade bond sales in 2004, according to Merrill Lynch.Photograph by Getty Images

More often than not, when banks initiate coverage on a company, it’s a call to buy. That’s because “buy” ratings motivates investors to buy shares of the company and continue coming back for more bank analysis. A sell rating on the other hand results in just one trade.

So when Swiss investment banking giant UBS (UBS) initiated coverage on fellow financial firm Wells Fargo (WFC) Thursday morning, their call to sell the stock was unexpected.

A team of UBS analysts led by Brennan Hawken released the report tagging Wells Fargo with a price target of $45, saying, in short, that investors have overestimated Wells Fargo’s business model due to the company’s reputation for being a capable underwriter and risk manager. In fact, according to UBS, Wells Fargo seems to be consistent with, rather than beating, the performance of its fellow banks in several arenas. In short, when the Wells Fargo wagons comes down your street, UBS is saying investors should run the other way.

Shares slid 2.2% in trading Thursday to $48.66.

Here’s what investors aren’t pricing into the stock, according to UBS: Wells Fargo has a loan portfolio that’s potentially risky. At the same time, it lacks the type of fee growth that could make up for lending losses, or just reduced lending profits coming from low interest rates. The result: That could lead to Wells Fargo to miss high price expectations in the future.

“We see risks to WFC’s revenue growth and credit performance, which coupled with a valuation on the high end of peers and consensus estimates that have not come down much, puts WFC shares at risk of underperformance in our view,” UBS analysts wrote.

UBS noted that Wells Fargo is heavy on high-yield, high-risk bonds, even to those exposed to the energy sector—a problem that has already dried up stock prices for many other Wall Street banks in the first quarter of 2016. Wells Fargo is also the second behind J.P. Morgan in underwriting high-yield or leveraged loans, with 825 deals since 2011, according to data from Dealogic reported by UBS.

 

Moreover, Wells Fargo’s large auto lending portfolio also seems to be in a riskier position than it reports. The Wall Street bank reported that just 10% of its auto portfolio is subprime, though when looking at FICO scores, over 25% of customers have a FICO score below 640—the rough cutoff for what the industry considers subprime, according to UBS.

Fee revenue on the other hand represents a whopping one-third of the bank’s total revenue, but according to UBS, that’s unlikely to grow, as the wealth management business “is facing challenging market conditions.” UBS forecasted a 2.4% decline in fee revenues for Wells Fargo in 2016.

Shares of Wells Fargo have slid 11% since the start of the year, and 17% down from its all time high of $58.77 in July. That performance is worse than the performance of stocks of other banks, which have risen fallen nearly 9% in the past year.