Wells Fargo Remains a Buy Despite Lawsuits

NEW YORK (TheStreet) -- "Wells Fargo (WFC) Is Making Shareholders Rich" is the title of an article I wrote on July 15.

Wells Fargo originally prevailed in federal court against against lawsuits claiming the bank acted in bad faith in a federal district court. But the Ninth Circuit Court of Appeals has reversed the decision, ruling that the case can move forward.

Does this litigation setback change my opinion on Wells Fargo? No.

As a result of falling home prices and a growing number of homeowners faced with mortgage payments they could no longer afford, the federal government created a program called the Home Affordable Modification Program (HAMP) as part of the Emergency Economic Stabilization Act of 2008 and American Recovery and Reinvestment Act of 2009.

The desired goal of HAMP was to give banks incentives to lower the payments of borrowers so that the borrowers could continue making payments and avoid foreclosure.

The plaintiffs allege that Wells Fargo acted in bad faith by giving homeowners hope that they would receive approval for a loan modification in order to entice the homeowners to make additional payments that they otherwise wouldn't have made.

The issue is whether the borrowers qualified for the permanent program after the trial period. In a nutshell, the plaintiffs claim they qualified or were told they did, and the bank states they weren't.

It's hard to handicap such cases when you have incomplete information, but it's reasonable to assume litigation costs alone will have a short-term impact on Wells Fargo. The appeals court ruled the plaintiffs may move forward as a class-action suit.

A class action makes it much easier for additional plaintiffs to join. Class actions allow people who don't necessarily have enough at stake to sue on their own, to join as part of the class action and seek compensation. I think this case is fully baked into the cake and doesn't move me from my $48 price target.

In another case, Blue Cross Blue Shield of Minnesota v. Wells Fargo Bank, Wells Fargo prevailed in a federal jury trial. With housing prices rising again, the number of lawsuits should slow down, but these cases will take years to work through.

Refinancing activity is expected to slow down, although original mortgages will likely more than offset lower refinancing revenue. Higher interest rates also mean larger spreads between the average cost of capital rate and the lending rate the bank can charge.

Wells Fargo financial strength is among the strongest in the space. It's one of the very few large banks that didn't need a bailout when the housing market crashed. The attractive 2.7% dividend isn't in jeopardy, and investors should view retracements as buying dips.

If the volatility lately is a little more than you're comfortable with, you can look to options to mitigate the ups and down to your portfolio while simultaneously reducing your risk. Looking at the options chain, I see October $45 strike calls trading for about 75 cents.

By selling covered calls, you continue to receive your dividend payments while also receiving option premium. The call options will move higher and lower with the shares, although not as much, thereby reducing your portfolio's volatility.

At the time of publication, Weinstein had no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Robert Weinstein is an active trader focusing on the psychological importance of risk mitigation, emotion and financial behavior of market participants. Robert co-founded the investing blog StockSaints, where he writes a journal about his trading activity and experiences.

In addition to TheStreet, Robert also contributes to Real Money Pro, providing real-time trading ideas for stocks, options and futures.

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