Wells Fargo turns weak on increasing litigation costs

Scandal hit Wells Fargo & Company (NYSE: WFC) has warned in its quarterly filing on Friday that litigation costs could run up to $2 billion, up $200 million from the prior estimate issued three months earlier.

In another development, Warren Buffet, the legendary investor and the largest shareholder of Wells, had stated that the bank’s approach to the scandal was totally wrong.

We anticipated the stock, which closed at $54.68 yesterday, to remain bearish in the short-term.

Last month, Wells Fargo reported mixed fiscal 2017 first-quarter results. The revenue in the latest quarter was $22 billion, down from $22.2 billion reported in the same period of 2016. The revenue estimates of Thomson Reuters was $22.32 billion.

CNNMoney

For the first-quarter of 2017, net income was almost flat at $5.457 billion, compared with $5.462 billion in the first-quarter last year. On a per share basis, Q1 2017 earnings of $1.0 per share were higher than $0.99 per share reported in Q1 2016 and exceeded Wall Street consensus estimates of $0.97 per share.

The fake account scandal, which involved more than 5,000 of the former bank’s employees opening as many as two million checking and credit card account without authorization from the customers, continues to haunt the $277 billion bank. Lawsuits continue to pile up against the bank.

Investors have filed a consolidated securities fraud class action suit against the bank in California. Additionally, shareholders have filed cases in Delaware, underlining the failure of former directors and executives to identify and prevent the fraud in its early stage. Employees who have lost their jobs for failing to achieve sales targets have also filed lawsuits in New York and California.

The directors of the bank, including Chairman Stephan Sanger narrowly escaped from being voted down by shareholders in the annual meeting held in Florida last week.

Fortunately, Berkshire who holds a 10% stake (~500 million shares valued at $25 billion) voted in favor of the board. However, Warren Buffett was quite critical of the bank’s response to the scandal. Wells Fargo has responded saying that necessary measures are being taken to rectify the shortcomings.

The bank has acknowledged that there is no clear estimate of the losses that can arise from the lawsuits. In such circumstances, investors would wait for clarity to emerge. The bank’s new CEO Tim Sloan is scheduled to meet the senior managers in a special investor day meet scheduled next week at San Francisco. The executives are expected to chalk out a detailed plan to resolve the issue. Until the details of the plan emerge, fundamentally, Wells Fargo would remain range bound with bearish bias.

The stock is trading below the resistance level of 55.80. The momentum is declining. Likewise, the descending money flow index shows an outflow of money from the stock. Thus, technically, it is wise to hold a short position in the stock.

The impending downtrend can be capitalized by investing in a put option contract. Choosing an expiry period of one week would increase the chances of succeeding in the trade. It is also advisable to purchase the contract when Wells Fargo trades at about $55 in the NYSE.

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