Over the past year, Wells Fargo (WFC 1.24%) has found itself in an unenviable position. After making it through the financial crisis largely unscathed, it has since run into a number of problems directly related to its sales culture. These problems aren't cheap to resolve, as they've served as a catalyst for legal and regulatory actions.
This begs an important question for current and prospective investors in Wells Fargo: Just how much are legal problems likely to cost the bank? Will those costs be material? Or given Wells Fargo's otherwise resplendent bottom line, will any legal settlements and costs that it incurs be insignificant?
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It's impossible to say for sure just how much liability Wells Fargo will ultimately face after employees and third-party vendors working on behalf of the bank got caught surreptitiously opening accounts for customers or charging them for auto insurance that they didn't need. Yet, it's getting clearer with each regulatory filing submitted by Wells Fargo that the costs are adding up.
In the second quarter of this year, expenses associated with outside professional and contract services increased 31% compared to the same period a year ago. The bank noted in its latest 10-Q:
The increase in both periods reflected higher project and technology spending on regulatory and compliance related initiatives, as well as higher legal expense related to sales practices matters.
In the whole scheme of things, the increase was far from debilitating, adding up to $326 million. That's a lot of money, to be sure. But keep in mind that Wells Fargo tends to earn more than $5 billion a quarter in net income.
Wells Fargo also took the opportunity in its 10-Q to update investors on possible future legal expenses. Whenever a potential liability arises, banks set aside money to cover it -- these are known as accruals. But this is done only once those future losses become probable and the costs can be reasonably estimated.
This is tricky business, as it's impossible to predict how a specific legal action will play out in the future. This is why banks tend to disclose how much future liability they may incur beyond their current accruals.
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It's here where investors can get a sense for how much Wells Fargo's bottom line could suffer from ongoing legal problems. According to the bank, "the high end of the range of reasonably possible potential losses in excess of the Company's accrual for probable and estimable losses was approximately $3.3 billion as of June 30, 2017."
To be clear, this is just an estimate, a point that Wells Fargo went on to stress:
The outcomes of legal actions are unpredictable and subject to significant uncertainties, and it is inherently difficult to determine whether any loss is probable or even possible. It is also inherently difficult to estimate the amount of any loss and there may be matters for which a loss is probable or reasonably possible but not currently estimable. Accordingly, actual losses may be in excess of the established accrual or the range of reasonably possible loss.
At the end of the day, in turn, the best answer to the question of how much Wells Fargo's legal problems will cost to resolve is an additional $3.3 billion above and beyond what the bank has already set aside to cover them. That's a lot of money, but it's certainly something a bank as big as Wells Fargo can absorb.
