JPMorgan Downgrades Wells Fargo, Citing “Mounting Public Scrutiny”

Embattled banking giant Wells Fargo & Co (NYSE:WFC) caught some bearish sentiment this morning from analysts at JPMorgan Chase, who noted the company could face additional regulatory actions.

The firm cut its rating on WFC to Neutral and lowered its price target from $53.50 to $48.00, citing “tough Senate hearings and mounting public scrutiny following the opening of fraudulent accounts.” The analyst also notes that yesterday’s “senate hearings are likely to expand probes” against the company.

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From the report:

In our view: 1) Wells will need to spend a lot more on litigation, examining past violations in additional areas, and responding to requirements from more hearings, investigations and lawsuits; 2) revenues will likely face some slowdown in growth including potentially impact on cross-sell in Retail brokerage, a key focus in that area; 3) this is a material reputational hit given the large number of unauthorized accounts (2 million) and how long it went on; and 4) this will likely result in a shift to greater earnings growth from areas such as investment banking which carry lower multiple. Impact on earnings is hard to determine because of uncertainty about likely total expenses – no comparable lawsuit as this matter is very different from the mortgage crisis. The stock has fallen recently but the uncertain timeframe and earnings impact is likely to keep the stock under pressure. $1-2 bil increase in costs would lower EPS by $0.20-0.40 and imply 11.7x-12.3 P/E multiple respectively (if not tax deductible), which is within the range of regional banks – unclear if these penalties would be tax deductible. What is particularly disappointing to us is that we and investors have long held Wells Fargo management in very high regard – they have been smart contrarian thinkers and made thoughtful decisions. We expect management to turn this around but it will likely take some time and expense – hence the downgrade.

WFC is in hot water with its customers, clients, regulators, and the general public over an account-opening scandal where it defrauded millions of customers over a period of several years. Agents of the company opened customer accounts without their consent in order to rack up fees and meet sales goals, according to reports.

The company has admitted wrongdoing and fired over 5,000 employees who engaged in the practice, but the issue is far from being put to bed:

It is unclear whether this will lead to criminal prosecutions and lawsuits will expand – State Attorneys General, SEC, and potentially criminal investigations. Wells Fargo has been viewed as a core long term holding for many investors – uncertainty around these issues could drive more investors to exit.

There is significant uncertainty about some issues – 1) how to compensate customers whose credit scores were increased; 2) how to compensate employees who were fired for not meeting sales targets; and 3) how far back in time Wells will need to go to scrutinize sales. We expect the scrutiny is likely to require lot of investigations and increased compliance and training spending, pressuring expenses.

CEO John Stumpf was grilled by regulators yesterday, but thus far is refusing to step down from his post amid the scandal.

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Wells Fargo shares fell $0.13 (-0.28%) to $46.43 in premarket trading Wednesday. Year-to-date, WFC has fallen 14.35%.