Goldman Continues To Be A Buyer Of Wells Fargo Despite Recent Scrutiny, Sees 22% Upside

Goldman Sachs remains Buy-rated on Wells Fargo & Co (NYSE: WFC) despite regulatory scrutiny on the bank over the creation of unauthorized accounts and credit cards, which has led to a 7 percent drop in shares.

Wells Fargo hogged limelight in the recent past, but for the wrong reasons. On September 8, the company disclosed a $185 million settlement with the CFPB, OCC and the City of Los Angeles to resolve allegations regarding its cross selling practices in its retail bank.

The Incident And Implications

The company has separately refunded $2.6 million for about 2 million potentially unauthorized accounts opened since 2011. Wells Fargo has fired about 5,300 employees over the creation of the sham accounts.

"While we believe shares may remain volatile near-term, we believe WFC's dividend yield provides support to the stock and see any additional underperformance as a buying opportunity absent a material change to the company's earnings power (which we do not see at this point)," Goldman analysts led by Richard Ramsden wrote in a note.

Related Link: Market Opinion Mixed On Timing Of Wells Fargo Bounce Back

Wells Fargo's dividend yield increased to 3.3 percent from 3.0 percent prior to the settlement's announcement. The company now has the highest dividend yield in Goldman's banks coverage.

On the credit card account fiasco, the analyst said the potential impact would be less than $50 million.

"In a theoretical downside scenario, if we assume all 565,000 investigated credit card accounts belonged to customers that also applied for a mortgage shortly after the credit card account was opened (resulting in an average 10 pt reduction), we estimate the total impact would potentially be <$50 million in higher interest expense for the customers (~25bp of WFC's 2016E earnings)," Ramsden highlighted.

History Tells Us It's Not Over

However, Wells Fargo may incur additional fines over and above the costs borne by their customers. That said, based on the scope of the issue, the analyst feels the potential impact appears "manageable."

But, Ramsden is not denying the fact that the reputational harm from this event would hurt revenue growth at the company's retail bank.

Further, Ramsden compared the incident with other banking scandals such as JPMorgan Chase & Co. (NYSE: JPM)'s "London Whale" in 2012 and UBS Group AG (USA) (NYSE: UBS)'s "Rogue Trader" in 2011. Shares of both firms fell significantly following their respective announcements, with high levels of volatility for the first four months post the announcement.

"In the two historical examples, volatility remained elevated for roughly 4 months following the announcement, albeit at lower levels than the first 10 days (which WFC has almost passed). Absent evidence of a change to the earnings power at WFC, we see any additional underperformance as a buying opportunity," Ramsden added.

Shares of Wells Fargo closed Wednesday's regular trading at $45.83. The analyst has a price target of $56, implying a potential upside of 22 percent.

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