FBR Capital Markets upgraded its rating on shares of Wells Fargo & Co. (NYSE: WFC) to "outperform" from "market perform" while maintaining its price target of $31 as valuation was too attractive to ignore.

"We are also adding Wells Fargo to the FBR Top Picks list and removing PNC Financial Services (PNC)," said Paul Miller Jr., an analyst at FBR Capital. "Our rating change presumes that bank investors will flock to quality names that can best weather the adverse effect of a flattening yield curve."

Miller said the company's strong deposit franchise, diverse business lines, and solid mortgage origination platform position it well to sustain a healthy net interest margin. Wells' low-cost, core-heavy deposit base and branch network provides the bank with cheap and stable funding.

As such, Miller believes that it has significant long-term value as it will support the company both in times of market dislocation and once the economy begins to improve.

Additionally, the company's largely domestic footprint coupled with its best-in-class deposit franchise, shelters it from wider market turmoil, making it an attractive holding relative to peers in a volatile market, Miller said.

With 77 percent of its funding base coming from core deposits and total cost of deposits at 29 basis points, Wells Fargo's best-in-class deposit franchise positions the company well to compete with banking peers.

Miller believes that the deposit base puts the company at an advantage, especially in times of market dislocation, as it provides the company with stable, low-cost funding and supports core operations.

Miller said Wells Fargo demonstrated last quarter that it is able to maintain pre-tax, pre-provision earnings (PTPP) even as mortgage originations decline. The relatively flat PTPP in the second quarter benefited from a decline in non-interest operating expenses, coupled with lower net interest income offset lower mortgage banking income.

Considering the historically low mortgage interest rates and seasonally strong third quarter, Miller expects mortgage banking to show some strength this quarter compared to the first two quarters of this year.

The efficiency ratio for Wells Fargo remained elevated in second quarter of 2011 at 61.9 percent compared to 62.9 percent in first quarter of 2011 and an average of 57.2 percent through fiscal 2010.

Miller said this dynamic is more of a revenue than cost issue, and the company has recognized that the current revenue run-rate could continue given the economic environment.

As a result, the company is addressing the cost side and plans to cut $1.5 billion out of the quarterly non-interest expense run-rate over the next six quarters to get to $11 billion from $12.5 billion in second quarter of 2011.

While it remains to be seen whether Wells Fargo can attain that level of cost cuts given the push to sustain loan balances and revenue targets, Miller does not believe that the cost cuts are necessary to warrant current price target.

The brokerage maintained its fiscal 2011 operating earnings estimate for Wells Fargo of $2.66 per share and its 2012 estimate of $3.25 per share.

Wells Fargo stock closed Monday's regular trading down 9.04 percent at $22.93 on the NYSE, while in the pre-market the stock rose 0.31 percent to $23.