Morgan Stanley upgrades Wells Fargo due to the bank’s 'positive stress test results'

Wells Fargo Building Salt Lake City

Morgan Stanley raises its rating to equal weight from underweight for Wells Fargo shares, predicting the Federal Reserve will likely lift its asset limit for the bank next year.

Morgan Stanley says the passage of Wells Fargo’s capital return plan by the Federal Reserve is a significant positive event for the company.

On Thursday, the Fed approved Wells Fargo’s plan in the second part of its annual bank stress tests. Earlier this year, the central bank ordered Wells Fargo to cap its assets until it could improve its operational controls amid revelations of sales practice abuses.

Wells Fargo shares rose 3.4 percent on Friday, the day after the stress test announcement.

Morgan Stanley raised its rating to equal weight from underweight for Wells Fargo shares, predicting the Fed will likely lift its asset limit for the bank next year.

"Wells' Qualitative Pass in the stress test, coupled with 70% higher capital return approval y/y, eliminates one of our major downside concerns," analyst Betsy Graseck said in a note to clients on Monday entitled “Positive Stress Test Results Lift Overhang.” "This also gives us more conviction that asset cap will be lifted by 2Q19.”

Graseck raised her price target to $62 from $57 for Wells Fargo shares, representing 12 percent upside to Friday’s close.

The analyst said she estimated Wells Fargo had a 50 percent chance to pass the Fed’s stress test.

“Not only did Wells pass the test, approved buybacks were almost 2x our estimates,” she said. “This tells us two things that make us more positive on the stock: 1) The Fed is receptive of the changes Wells is making to their governance and risk management issues; 2) The Fed is being more pragmatic in its regulatory actions.”

Wells Fargo shares are lagging the market this year. The stock is down 9 percent through Friday versus the S&P 500’s 2 percent gain.

— CNBC's Michael Bloom contributed to this story.

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