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Wells Fargo was seen for years as the “good bank,” compared with other big U.S. banks. Its focus on strong, basic businesses such as providing mortgages, lending to companies, and helping people bank and buy cars, appealed to investors even if its numbers at times seemed murky. (See “How Wells Fargo Dresses Up Its Earnings,” July 30, 2016.)
The homey veneer was stripped away in September 2016, when the bank admitted that its employees had created millions of unauthorized accounts and credit card applications (eventually totaling 3.5 million). The scandal soon grew to include business banking and kept metastasizing from there, as more and more sham accounts were revealed in increasing numbers of products.
Now the Federal Reserve has ordered Wells Fargo (ticker: WFC) to keep its total assets frozen at a 2017 level of just under $2 trillion until the bank makes “sufficient improvements.” (The bank says it will replace four of its 16 directors this year, too.)
The regulator’s push for change raises a critical question for investors. This is a bank, after all, that once boasted an industry-best 6.1 products per customer, while its competitors averaged 2.7. What can Wells Fargo be, if not an aggressive, cross-selling machine?
“The bottom line is that the cease-and- desist order will mean that Wells will have a harder time maintaining market share and will have to compete more on price or credit terms versus peers,” says Brian Kleinhanzl, an analyst with Keefe Bruyette & Woods.
100
Feb. 2, 2016 = 100
50
2017
2018
250
Bank of America
Citigroup
Wells Fargo
200
150
100
Feb. 2, 2016 = 100
50
2017
2018
250
Bank of America
Citigroup
Wells Fargo
200
150
100
Feb. 2, 2016 = 100
50
2018
2017
The bank, he says, will also have a harder time cutting costs because of expenses related to wriggling out of the Fed’s harness.
Wells Fargo says it has been making changes. That cross-selling metric was axed last year. The bank, Chief Financial Officer John Shrewsberry tells Barron’s, has been focusing on being customers’ primary financial institution and selling products that people “really want, use, and need.” The bank spent $3.9 billion on risk management last year, but still expects to meet its cost-cutting goals.
On a call with investors the day the consent decree was announced, CEO Timothy Sloan stressed that “we are open for business.” He said that the bank could trim its balance sheet and grow despite the Federal Reserve cap.
To pull that off, Shrewsberry says that the bank will quickly shave between $50 billion and $75 billion from its balance sheet, and eventually could trim as much as $200 billion by returning deposits from institutions and other banks and exiting liquid, short-term investments. That, he says, creates “a big cushion for expected, everyday lending and deposit-taking from all of our other customers.”
Part of the challenge for the bank is that the fake-accounts scandal is Wells Fargo’s alone and comes years after the financial crisis.
“We’re the last bank, not the first bank, in the past 10 years to have gone through some sort of a breakdown that led to reputational damage that had to be worked through,” Shrewsberry says. “It’s not a benefit to go last, but it’s not unique.”
Investors aren’t yet betting on a comeback. Wells Fargo shares have fallen more sharply than other financials. Since the sanctions, the stock has dropped 12%, trading on Friday at $56. For the past 12 months, the stock is flat, trailing the 17% gain in the S&P financials index.
Wells Fargo now trades at 1.8 times tangible book value, the same level as Bank of America (BAC), but below JPMorgan Chase (JPM), at 2.1 times.
“It’s definitely a strong investor reaction,” Shrewsberry says. He thinks the drop in the stock “expresses more than the calculated amount of net income that we would project it would cost to comfortably comply with the terms of the consent order.”
Others agree.
“This is a setback; it ought to prove manageable,” Credit Suisse analysts wrote. They estimated “the incremental cost of balance-sheet management to satisfy the asset cap” at six to eight cents a share. Credit Suisse’s target price of $65 is unchanged.
Deutsche Bank analyst Matt O’Connor also believes that the asset cap will be only a “modest earnings drag” over the next two years.
But can Wells Fargo put the scandals well behind it? S&P Global Ratings cut its rating on Wells to A- from A last week, noting that the regulatory risk “is more severe than we previously expected and the process for improving its governance and operational risk policies may take longer than we previously expected.”
And changing the bank’s culture might be a difficult task, given its long history of pushing sales volume and cross-selling. Wells Fargo’s former CEO, John Stumpf, promoted “eight is great” as an internal mantra: Every bank customer should have a total of eight Wells Fargo accounts, cards, and loans. It was a high bar for the bank’s branch salespeople.
That slogan, as Bethany McLean noted last year in Vanity Fair, came from his predecessor, Dick Kovacevich, who created it when he ran Norwest, which Wells acquired in 1998. Sloan, the current CEO, has been at Wells for 31 years.
“You’re looking at an incredibly pervasive, longstanding, widespread failure from the top to the bottom of the third-biggest bank in the U.S.,” says Dennis Kelleher, the CEO of Better Markets, which advocates for stricter financial regulation.
UNLIKE THE RISKY structured-finance products that got Wall Street in trouble during the financial crisis, Wells’ unauthorized accounts were never a big profit center. Some customers ended up paying fees they never should have been charged, but opening accounts clients didn’t know they had, using money already deposited with the bank, was never a strategy for revenue growth.
Still, the regulatory bar on assets is unprecedented. It was the last action by Janet Yellen’s Fed. No one should expect Wells to be delivered from its task of reinvention.
Jerome Powell, the Donald Trump–picked successor to Yellen, was the point person in the negotiations, voted in favor of the punishment, and last summer gave a speech about the Fed’s expectations for behavior from bank boards.
So while the Trump administration has been generally making life easier for the big banks, with the new tax law and a lighter regulatory hand, the action against Wells is a sign that the current regulatory regime is still capable of dropping the hammer. “The administration, and even some Democrats, want to review and tweak some of the Dodd-Frank regulatory framework,” says Brian Gardner, KBW’s head of Washington research. “But the main parts of Dodd-Frank, particularly for the big banks like Wells Fargo, are going to stay in place.”
Follow @BenDWalsh
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