Following a financial sector rebound after five days of losses, Wells Fargo (WFC) is showing a stock price close to its three-year high. Its fourth-quarter earnings statement shows that the bank has risen above the limitations of the economy and the struggling banking industry. With the bank netting $15.9 billion in profit in 2011, 28% above 2010, and with a strong first-quarter report, the bank is a healthy buy.
In part due to improving credit quality and real estate recovery, as well as speculations that China will report stronger-than-anticipated economic growth, the nation's Big Four banks - Wells Fargo, Bank of America (BAC), Citigroup (C) and JP Morgan Chase (JPM) - will have a strong showing when each reports its first-quarter results. According to Gary Townsend, an analyst from Maryland-based Hill-Townsend Capital, Wells Fargo's results could "look more and more like pre-2008 types of results." Regardless of the bank's earnings gain, a direct correlation between earnings and stock prices is not guaranteed, Townsend said, due to the fact that this is an election year and due to market instability in Europe and Asia.
Wells Fargo is the country's biggest home lender. With its mortgage business contributing a fifth of its total value, the gains in the housing market have directly improved Wells Fargo's bottom line. The average outstanding balance on the company's loans is projected to increase from its 2011 levels at $320 billion by an average growth rate of 7%. Analysts also predict that Wells Fargo's credit losses on its outstanding home mortgage loans as a percentage of the loans will fall to around 0.85%. Finally, there are forecasts that Wells Fargo's commission and fee revenue from its asset management and brokerage business will rise from $7.2 billion in 2011 to around $12 billion at the end of its forecast period.
The housing market gains are welcomed, but certainly won't set Wells Fargo apart from its competitors. Home lender JPMorgan Chase also saw a great boost from its role in the housing market. JPMorgan set a record for home-loan production income in 2011 thanks to new government initiatives and low interest rates.
Of the large banks, Wells Fargo was the best performer during the first quarter. Estimates for Wells Fargo's earnings per share in 2013 is $3.59, compared with KeyCorp (KEY) 2013 EPS of $0.77 and US Bancorp (USB) at $2.93. The latter of these, US Bancorp, was recently sued by a Chicago pension fund that charged the company with refraining from its duties and causing huge losses. The ensuing court battle could cause serious headaches for the banking giant.
While Wells Fargo has had a great first quarter, it will face a remarkable slate of litigation in the near future. One lawsuit, filed in 2010 by the City of Farmington Hills Employees Retirement System as a class action suit on behalf of its more than 100 members, claims that the bank marketed its risky securities-lending program "as a highly-secure way for its institutional clients to maximize portfolio returns." United States District Judge Donovan W. Frank certified the suit a class action on March 27th, indicating that Wells Fargo should have known that the investments "did not comport with investment mandates." The class action members also claimed that the bank concealed investment performance to prevent exit from the lending program. Wells Fargo previously lost a jury verdict in 2010 to four Minnesota not-for-profits that made similar claims against the same lending program. The verdict came down against Wells Fargo for $30 million.
On April 10th, a complaint was filed with the United States Department of Housing and Urban Development by the National Fair Housing Alliance. "We found that with Wells Fargo, there was a neglect of simple things - a lack of routine maintenance and security of the property - that just didn't happen in African American and Latino neighborhoods across the board," said Shanna Smith, president of the National Fair Housing Alliance. According to the complaint, there were disparities between how Wells Fargo maintained and marketed vacant homes in minority neighborhood compared with those in white neighborhoods. In addition, Wells Fargo is facing a government probe over claims that it violated fair-lending laws and encouraged loan discrimination by directing African Americans to subprime loans.
Last week, Elizabeth Magner, a federal bankruptcy judge for the Eastern District of Louisiana, ordered Wells Fargo to pay $3.1 million in punitive damages to a New Orleans man for mortgage servicing misconduct. "Wells Fargo has taken advantage of borrowers who rely on it to accurately apply payments and calculate the amounts owed," Magner writes. "But perhaps more disturbing is Wells Fargo's refusal to voluntarily correct its errors. It prefers to rely on the ignorance of borrowers or their inability to fund a challenge to its demands, rather than voluntarily relinquish gains obtained through improper accounting methods."
These cases bear the potential to shake stockholders' confidence in the management of the company and may scare off casual investors. While the short-term ramifications of all of this is limited to the damages incurred from the judgments, long-term ramifications can include possible power struggles and a mandated corporate restructuring - all of which would be toxic to the integrity of the stock value.
Wells Fargo's Public Image Problems
While Wells Fargo is fiscally healthy, its public identity is duly shaken. In addition to its legal problems, several public relations fumbles have appeared as of recently. On April 12th, Wells Fargo sued the City of Stockton, California, over a missed bond payment for the city's parking garages. The Stockton City Council, facing insolvency, agreed on February 28th to default on $2 million in bond payments and begin mediation with creditors. With many municipalities facing similar money crises, Wells Fargo's actions on this case are being closely watched.
Wells Fargo recently increased its investment with the GEO Group; Wells Fargo is the second-largest investor with the second-largest private jailer in the country. Multiple groups, including Occupy DC, are currently boycotting Wells Fargo, partially because an U.S. Justice Department report found a GEO-run juvenile facility in Mississippi had levels of sexual abuse "among the worst that we have seen in any facility anywhere in the nation."
Wells Fargo is a solid buy. As the economy improves and the housing market stabilizes, Wells Fargo will only benefit and grow. However, Wells Fargo's indiscretions must be reckoned with. Two advisory groups have suggested a severing of the company's CEO and Chairman roles, in order to add more independent control. Continual litigation and eroding public confidence (nearly half of all banking customers distrust the current banking system) will introduce a ceiling to Wells Fargo's potential growth, but that reckoning may be some while away.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.