Please ensure Javascript is enabled for purposes of website accessibility

Wells Fargo's Hard Slap From the Fed Is Going to Hurt

By Eric Volkman - Updated Feb 9, 2018 at 3:50PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

In a bold and unprecedented move, the misbehaving bank will be prohibited from growing its assets.

Wells Fargo (WFC 1.92%) was stunned by a blow dealt by the Federal Reserve at the beginning of February. In an unprecedented move, the Fed has prohibited the bank from growing its assets from the level they reached at the end of 2017, among other penalties.

This is a crushing sanction from the regulator, and it's going to send Wells Fargo reeling.

exterior of Wells Fargo branch in city

Image source: Wells Fargo.

Dogged by scandal

This is not, of course, a surprise. Wells Fargo's reputation has been in the doghouse since late 2016, when it was discovered that the bank opened millions of new accounts for existing customers. That wouldn't be a problem, except those clients apparently neither requested nor authorized them. Before long, it came to light that this "fake accounts scandal" was more widespread than first reported. All told, the bank admitted that around 3.5 million bogus accounts were created.

Wells Fargo soon dropped the ball again, and more than once. It was also accused of malfeasance with auto insurance products and, worse, mortgages -- a crucial segment for the company.

All of this seems to have eroded customer trust, as growth in most of the bank's key line items has been sluggish. In the company's Q4, its top line grew by only 2% on a year-over-year basis. The preceding three quarters featured either decreases or flat-line growth.

Q4 per-share net profit rose only slightly, while loans and deposits declined by 1% and 2%, respectively. The company's efficiency ratio, once the envy of Big Banking, shot up 10 percentage points to 76%.

Contrast that with the Q4 performance of, say, fellow giant lender JPMorgan Chase (JPM 1.28%). The bank increased both its "managed" (i.e., adjusted) net revenue and its deposits by 5%, and its loans by 4% in its Q4, even if adjusted net profit slipped 1% during the period. Its efficiency ratio was 60%.

A still-thriving economy, among other factors, has been making life good for American banks of late; JPMorgan Chase's encouraging Q4 performance wasn't unusual for the sector. But Wells Fargo has been a laggard, and not only in terms of fundamentals. Here's how its stock did in 2017:

WFC Chart

WFC data by YCharts

On the mat

Wells Fargo needs to improve, and now. Unfortunately, it's been punched to the ground by the Fed, and it probably won't get up anytime soon.

More than many kinds of enterprises, banks depend on their asset bases (loans are classified as assets, after all) to make money. It'll be one heck of a challenge for Wells Fargo to squeeze out growth in net profit under such conditions -- and for an indeterminate amount of time, as per the Fed's order. Good luck with that.

I feel the scandals are the result of a corporate culture that turned bad at some point (perhaps when the bank started pushing customers to sign up for additional services). That's worrying, because it can be tough to turn around a big organization that goes to the Dark Side.

Also, a penalty of this scope will further diminish the bank's reputation, and that means customer abandonment. Every scandal and sanction increasingly paints Wells Fargo as The Bad Bank.

The likes of JPMorgan Chase and Citigroup (C 1.91%) have done some questionable things in the past, and they've been punished, but never as badly as this. With cleaner reputations, they should be able to scoop up some Wells Fargo defectors. 

As we came to the end of 2017, in the wake of those scandals I wrote that I didn't think Wells Fargo would have a solid and productive 2018. That's looking like quite the underestimation now.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Wells Fargo & Company Stock Quote
Wells Fargo & Company
WFC
$39.92 (1.92%) $0.75
Citigroup Inc. Stock Quote
Citigroup Inc.
C
$46.87 (1.91%) $0.88
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
JPM
$114.05 (1.28%) $1.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/04/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.