Ouch! As far as regulatory punishment goes, Wells Fargo & Co (NYSE:WFC) — along with WFC stock owners — were feeling some pain on Monday. Wells Fargo stock fell on the order of 8% in response to Friday’s news that the Federal Reserve was capping its growth until further notice.
Yes, this all stems back from the 2016 revelation that the mega-bank had been opening unauthorized bank and credit card accounts for existing customers, mostly as a means for its bankers to meet sales quotas. All told, an estimated 3.5 million sham accounts have been opened, often costing their owners unexpected fees.
It was, almost needless to say, a horrifying act of consumer abuse not to mention downright embarrassing. Wells Fargo paid the price too, dishing out $100 million in penalties to the Consumer Protection Financial Bureau. More than that, consumers have largely steered clear of the bank in the meantime, wary of other questionable actions Wells Fargo may take in the future. By and large though, it was starting to look like the matter was a fading memory.
The Fed just made sure the market (investors more so than consumer this time around) won’t fully forget it anytime soon.
Capped Until Further Notice
It’s not an entirely unprecedented maneuver, though it’s not exactly common either. In short, for its lack of oversight that gave rise to the unauthorized opening of so many accounts, the Fed will not permit the bank to grow its asset base beyond the $1.95 trillion worth of assets it had as of the end of 2017. The sanction will be lifted when, as outgoing Fed Chair Janet Yellen explained, the bank is “able to do so safely and with the protections needed to manage all of its risks and protect its customers.”
That appears to be a relatively open-ended, subjective decision incoming Federal Reserve chief Jerome Powell will have to make in the foreseeable future.
It’s certainly a new wrinkle, though not just one that owners of Wells Fargo stock will have to deal with. Rival banks like Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) also saw their stocks slump on Monday, partially because of the market’s bearish tide, but partly because the sanctions applied to Wells Fargo are an indirect message to all banks that the regulator is serious about protecting consumers. As Capital Alpha analyst Ian Katz opined:
“The Fed just put the Fear of God into bank boardrooms across the country. And that’s exactly what it wants to do. Since the financial crisis, bank boards have gradually become more serious and less rubber-stampy. But the Wells scandals indicate that some boards still aren’t vigilant enough.”
Not the End of the World, But…
To be clear, the Fed’s latest levy against Wells Fargo won’t prevent the bank from becoming more profitable or returning more capital to shareholders. Indeed, with interest rates on the rise for 2018, better margins even using the stagnant asset base are in the cards.
There’s also the not-so-minor possibility that the unusual measure is intended to be more for show — to make a point — than actually punish Wells Fargo. The matter is well over a year old now, and most everyone was moving on. The measure from the Federal Reserve was mostly unprompted, and somewhat unexpected, in addition to being unusual. That’s why the lid on its asset base isn’t likely to be kept in place for very long; the point has been made and the message has been received by all.
Nevertheless, in a statement made following the unveiling of the Fed’s order, Wells Fargo CEO Timothy Sloan had to concede that this cap would likely reduce 2018’s expected income between $300 million and $400 million. That’s between 1.4% and $1.8% of the amount it earned in 2017.
Perhaps more problematic is that the penalty is yet-another embarrassment that leaves consumers and investors wondering if the company can ever by fully trusted again.
Bottom Line for Wells Fargo Stock
There’s been more than a small amount of chatter that Monday’s steep setback is actually a good opportunity to step into Wells Fargo stock at a discount. Bank of America Merrill Lynch analyst Erika Najarian is one of those bulls, explaining after the selloff:
“If there is any silver lining for shareholders, it is that the order forces WFC to optimize its balance sheet. We show how WFC can stay under the asset cap and still grow loans and spread revenue, by running off low-value, high cost deposits and shifting excess cash and other low-yielding cash flow into Ginnie Mae securities — without compromising liquidity needs.”
Najarian and all the other new bulls may well make a valid point as well. Just for the record though, it’s still a fairly speculative trade, simply because nobody really knows how the banks customers are apt to respond to this lengthening string of headaches that could ultimately crimp customer services.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.