Wells Fargo & Co (WFC): Why The Stock Is In Trouble

bankJim Bach:  But right now, Wells Fargo & Co. (NYSE:WFC) is trading at close to $55. From its lows near the tail-end of the recession, to the highs reached just this month, the Wells Fargo stock price is up almost 700%.

This monster rise has already seen its best days – even with Wells Fargo earnings today (Tuesday) besting analyst expectations.

The story behind the Wells Fargo stock price delivers an important lesson for big bank investing. There are only very specific instances where big bank stocks are worth an investor’s time.

“You catch them on the downside every time there’s a huge correction and a financial panic and the banks get hit – that’s when you buy them,” Money Morning Capital Wave Strategist Shah Gilani said. “They’re too big to fail; they’re not going to fail. So anytime they get pounded, you buy them and you ride them back up to maybe their old highs or somewhere where you’ve got nice profits.”

But the Wells Fargo stock price is simply not sending out this kind of signal right now.

“Why would you go into a bank, really? There are plenty of other places you can go in the stock market where you can get much better yield and have a safer investment,” Gilani said.

With a 700% gain already since 2009, it doesn’t have much further to climb.

And it simply isn’t an attractive enough income investment to justify buying a stock that will, for the foreseeable future, likely trade in a narrow range at best.

Wells Fargo stock price

The Wells Fargo dividend yield is 2.58%. That’s just about on par with the industry average. But if you’re looking for dividends on a stock with no true growth prospects, a cigarette company is a better bet than a big bank. Try Altria Group Inc. (NYSE: MO) with its 4% yield. Or Phillip Morris International Inc. (NYSE: PM) at 5.2%.

Simply put, big bank stocks are not stocks to buy right now.

“I don’t see a positive for them,” Gilani said. “People are sick of big banks.”

And it’s not just that there’s little room for growth.

We are entering a new era for consumer lending, and that will only put further pressure on the already unimpressive big bank stocks like WFC…

How Rising Interest Rates Will Hurt Well Fargo Stock Price

Low interest rates hurt banks, particularly in their commercial lending segments.

Banks like Wells Fargo will take in deposits, issue bonds, or borrow at low rates from the U.S. Federal Reserve, and pay interest to hold those funds. They will then lend that money out at higher interest rates and pocket the spread. These are Wells Fargo’s net interest margins.

When the Fed is putting downward pressure on rates and loan demand falls, this will shrink Wells Fargo’s net interest margin and hit their commercial lending income.

In fact, net interest margins for Wells Fargo were 3.1% for 2014. This compares to a historical average of around 4.6% for the company. And it’s the lowest their margins have been in 40 years.

So, you would expect that Wells Fargo is eagerly awaiting a Fed rate hike to reverse this collapse.

And while higher interest rates will certainly help Wells Fargo further down the road in widening these margins, it’s the transition to a higher rate environment that’s going to be tough…

You see, Wells Fargo borrows in the short-term – through the repo market, the overnight to short-term loan market, or through commercial paper. It will then lend long-term – for example, with a seven-year car loan. Wells Fargo will pay back those short-term debts at low rates and continue to roll them over at maturity, while still collecting higher interest from the longer-term loan.

In this scenario, the borrower has locked in their interest rate for years to come. But Wells Fargo will have to be continuously rolling over its short-term debt at rates that are expected to increase. This will further squeeze margins.

“It may be a low interest loan, which was a nice profit margin for them, but that will completely erode if rates rise,” Gilani said.

But it’s not just Fed interest rate hikes that are going to affect Wells Fargo’s interest income – which comprises 52% of total income.

In fact, the whole lending game is beginning to change, and it is shifting away from the big banks like Wells Fargo.

Here’s what the new paradigm in consumer lending looks like, and how it could ding the Wells Fargo stock price moving forward…

Wells Fargo Stock Price to Feel Pressure in Consumer Lending Shift

The consumer lending business is seeing a new entrant into the market: non-traditional lenders. This is happening through online peer-to-peer (P2P) lending.

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