It's been an eventful week in the financial markets. Wells Fargo's (WFC 1.04%) scandals are in the headlines (again), the two largest investment banks reported excellent earnings, and there's another data breach consumers should know about.

In this episode of Industry Focus: Financials, host Michael Douglass and contributor Matt Frankel bring you up to speed on all of these.

A full transcript follows the video.

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This video was recorded on April 23, 2018.

Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, April 23rd, and we have a round-up of financials news: yet another Wells Fargo fine, Morgan Stanley (MS) and Goldman Sachs (GS 0.06%) earnings, and a data breach at SunTrust (STI). I'm your host, Michael Douglass, and I'm joined by Matt Frankel. Matt, welcome back! Let's hop right in, because really, quite a bit of interesting news for us to talk about today. First off, Wells Fargo was fined $1 billion from the Consumer Financial Protection Bureau.

Matt Frankel: Right. The big deal is not so much that it's $1 billion. That's really not that much to a bank like Wells Fargo. We saw much, much bigger fines a few years ago in the aftermath of the financial crisis. This is significant for a few reasons. One, it's the largest penalty ever levied by the CFPB. And, it's the latest chapter in Wells Fargo's drama. It's not just this one $1 billion fine. We'll go through in a minute, but, this is the seventh or eighth major news headline they've had in the past year or two.

Douglass: Yeah. With that in mind, let's go ahead and break down exactly what happened with this penalty and then, as you noted, we'll expand back further. So, they had wrongly charged insurance on some drivers, and they charged mortgage customers excessive fees. And this affected over half a million customers, about 600,000 customers. And just the refunds on those fees will cost the bank about $300 million, in addition to the billion dollars that they've already paid out.

Frankel: Right. I'll just give you a little bit of background on both of those. The mortgage incident they admitted to right away. What was happening was, they would agree to lock in customers' rates for a certain amount of time based on them getting their paperwork in by a certain deadline, and if they didn't, they were subject to a fine. Well, Wells Fargo themselves were responsible for this paperwork being late in a lot of cases, and were still charging these customers hefty fines, which, obviously, that's just bad business.

Douglass: Right. 

Frankel: [laughs] And in the car insurance case, that was the bigger of the two. The car insurance was about 500,000 out of the 600,000 people. This is a standard industry practice -- banks can force you to get in an auto insurance policy of their choosing if your current coverage lapses. The bank is loaning you money on the car, so it protects them to have insurance. But Wells Fargo was doing this for people who had insurance. 

I was actually one of the ones who got a note in the mail -- I don't know if I ever told you this, Michael -- saying that my insurance had lapsed, and they were about to start this new policy on me if I didn't do anything about it. Fortunately, I realized their error and pointed it out, but a lot of people didn't. And their insurance policies, from what I read, were very expensive relative to what people were paying on their current insurance.

Douglass: Yeah. So, just, all around, as you put it, bad business. Let's go ahead and step back. Listen, every company makes mistakes. No company is perfect. But Wells Fargo has been making quite a few of them, it seems. Heading all the way back to September 2016, the fake accounts scandal, which many of you have heard about, if not on Industry Focus then on literally every major news program in America, was revealed. Initial estimates said about two million accounts were affected by fake accounts that were opened in people's names without their knowledge by bank employees who were trying to hit quotas. 5,300 employees were fired. The CEO, John Stumpf, retires in October. Of course, it just continues from there.

Frankel: Yeah. That's a pretty big number, two million people. So, chances are pretty high that some of our listeners were affected by this. 

Douglass: Right.

Frankel: So, if that was bad enough, then from then until now -- December of 2016, the bank was punished for failing to comply with certain Dodd-Frank regulations. June of the next year, that's when this mortgage mess happened, where they were charging people for late paperwork that wasn't really late on their fault. The next month, in July of 2017, that auto insurance mishap was revealed. Then, the next month, in August, that number of fake accounts went from two million to there and a half million, because they widened the timeframe they were looking at and found a whole lot more. 

[laughs] And I wish I were done, but I'm not. In October of that same year, the mortgage fines were revealed. Then, in February of this year, the Federal Reserve actually did something that they've never done before -- they issued a penalty that prevents Wells Fargo from growing beyond its size at the end of 2017 until they can show improvement, as the Fed put it. And it's really unclear what that means. So, right now, not only is Wells Fargo reeling from all these scandals and probably losing some customers, they're really limited to what they can do to build their business back up.

Douglass: Right. And I think that, even more broadly than that, we've also seen Wells Fargo have tremendous execution difficulties. When we're talking about big bank earnings, it's become this broken record the last couple of quarters where we'll say, "Yeah, Citigroup, JPMorgan, Bank of America, they're all doing great. Here's what's going on. OK, let's turn to Wells Fargo now," which has generally been a very different story. Slower growth for a number of reasons, but also just, in general, a struggle on execution. 

And it's interesting, because as investors, thinking long-term here, the way we have to think about this is, or, at least the way I've thought about it is, this bank that has historically been a tremendous bank, the big bank that was always held up as the good one, it turns out, has really fallen on hard times. Is this a buying opportunity? And for me, at least, the answer is no, because I have no clear sense that Wells Fargo will be able to execute at anywhere near its former glory while also cleaning up its practices. And, frankly, it needs to clean up its practices. That's not optional. And in tandem with that, it's not clear to me that they're going to be able to really effectively prosper, and ultimately that's what I'm looking for in a stock.

Frankel: Not any time soon, anyway. In full disclosure, right after the fake accounts scandal came out, I wrote a few articles in support of investing in Wells Fargo on the dip. That was before all of this other stuff came to light. The thing that really stands out to me from an investor's standpoint is the Federal Reserve's action. Like I said, not only are they reeling from all these scandals, but your whole investing thesis is, you want to invest in stocks that are going to grow over time. And this takes away that ability. So, from an investor's standpoint, I wouldn't even consider, no matter how low the stock goes or no matter how bad things look, I wouldn't consider investing in Wells Fargo until the Federal Reserve's penalty is completely lifted.

Douglass: Yeah. To be honest, that's where I am, too, so I think that's fair. Interestingly, by the way -- this is something that you notice in the market, and listeners who have written in have heard me talk about, when you try to predict the market in the short-term, you're trying to impose rationality on something that's fundamentally irrational. One of the things we've seen is, the market tends to hate uncertainty. So, even a certain bad outcome, in a lot of ways, seems to be preferable to an uncertain outcome where it's not clear what's going to happen. So, the penalty from the CFPB, the billion dollars, that was exactly what was expected, so the stock was actually up on the news. Which, again, when you hear about $1 billion a company is going to have to pay out, which is going to lower earnings by $0.16 a share in 1Q 2018, usually you don't really see that as a piece of good news. But, because it removed this overhang of uncertainty, that's why the stock was up.

Frankel: Yeah, definitely. Like you said, it was very expected. Wells Fargo put some intentionally very vague language in their earnings report, saying they would have to restate earnings once this was finalized. Turns out, it was finalized just a few days later, but the way they worded it sounded like the penalty could potentially be a lot more. So, when it came out that the actual penalty that everyone agreed to and it's settled and done was only $1 billion -- only -- [laughs] -- then, investors breathed a little sigh of relief there.

Douglass: Yeah. What's $1 billion between friends, right?

Frankel: [laughs] Especially Wells Fargo.

Douglass: Indeed. Alright, let's go ahead and turn to our second story. Rounding out the remainder of big bank earnings, Morgan Stanley and Goldman Sachs, the investment banks. Frankly, both had pretty strong results.

Frankel: Yeah. In last week's episode, we said how the Big Four banks all beat on earnings and revenue, the first time in a while I've seen all of them. Now it's a six-for-six, because Goldman and Morgan Stanley also both beat on the top and bottom lines, and by a pretty significant margin. The big headline that we saw was trading revenue. If you read anything about their earnings, you probably heard about trading revenue, because it's just been so terrible the past few quarters. And now, especially in these two cases, it's gone up a whole lot.

Douglass: And what's interesting about that to me -- and, of course, first off, that it's a major headline, not surprising. These are investment banks. Trading revenue is a big portion of things for them, so of course it's going to get brought up, just like the iPhone is going to get brought up whenever you're talking about Apple. OK, it's not quite as big for them as the iPhone is for Apple, but you get the idea. But, what was interesting to me is, their fixed income and the commodities and currency revenue was up really quite a lot. Morgan Stanley's was up 12%. Goldman Sachs' was up 23%. It's interesting, because when you look at the other large banks, they didn't perform nearly as well on the fixed income side of their trading revenue.

Frankel: No, not at all, they were actually pretty flat in most cases.

Douglass: That's one of the interesting things that you always want to look at when you're looking at the big banks -- why are a couple of them doing much better than the others in a particular area?

Frankel: Goldman and Morgan Stanley both had terrible performance, even relative to the other banks with trading desks, for the past year or so. I think Goldman's last quarter was down 50% while everyone else's was down in the 20-30% range. So, it could just mean more of a rebound from terrible numbers. Goldman and Morgan Stanley both said that it was commodities and foreign currency trading that really fueled their results, so, it could have something to do with those two being more levered to that. 

It could also be that, as Michael said, Goldman and Morgan Stanley are investment banks, so they depend a whole lot more on trading revenue than, say, a Bank of America does, so are willing to drive more of their resources in that direction to try to right the ship. So, there are a few different things it could be, but the gain in Goldman and Morgan's trading revenue is definitely much more impressive than the rest of the pack.

Douglass: Yeah. So, certainly an important thing to watch going forward, again, probably in part because of a weak comp. But, we'll see how that plays out over the next few quarters, especially as volatility has been up. Anyone invested in the stock market right now has probably noticed that.

Let's talk about the rest of their businesses as well. Both, really across the board, doing quite well. Asset management, wealth management portfolios looking strong. You've got good, strong inflows, so it's not just a matter of being up 20% because stocks were up 20%. It's more like, up 20% while stocks were up a lower percentage because adding new clients and getting clients to commit more resources to their current accounts.

Frankel: Yeah, definitely. Tax reform was also a big, big driver of the good performance. Goldman's effective tax rate was down to about 17%. Morgan Stanley was right around 21%. Generally, banks run in the upper 20s to 30% range. So, as a result, both of them had much higher profitability than they normally do. They both had returns on equity of close to 15%. Goldman's was actually a little bit over. And tax reform or no tax reform, if a bank is generating a 15% return on equity, they're doing something right. That's a pretty impressive number.

Douglass: Yes, absolutely. Just, across the board, things looking impressive. One of the other things that you'll often see with the banks is, they'll juice profitability by cutting expenses. You can think about expense cutting in two ways, and it really does depend on exactly what expenses they're cutting, which they're never very clear about. But, expense cutting can either be, "OK, cool, we're cutting out bloat," or it's, "We're trimming muscle and heading down toward the bone because we're trying to hit," perhaps, an arbitrary number. So, cuts can be a good thing or a bad thing, depending on those nuances. 

But, in both cases, a lot of reinvestment in the business. So, a lot of potentially good news there, particularly, I would say, in Goldman with their Marcus platform. Longtime listeners, or, well, listeners who have been listening for more than a couple of months, have heard us talk about Marcus before, but it's basically Goldman's consumer lending platform. So, just the sort of thing that's marketed online and they'll source loans through it. And they're up to $3 billion in loans originated now, which is just enormous growth. So, a lot of good news for Goldman there.

Frankel: I've followed Marcus a lot, especially in the beginning. They have a real leg up on their competition, because they're devoting a whole lot of resources to it, and Goldman has a lot more resources to throw at it than, say, a Lending Club or one of those. And they're not really worried about making money on it yet. They offer a savings account through the Marcus platform that pays higher interest. I just saw this morning 1.6%, which is pretty much unmatched anywhere else, so they're stealing some market share with that. And they got to the $1 billion mark quicker than anyone else, and I'd be willing to bet that the $3 billion origination mark is also quicker than anyone else got there.

They also just acquired Clarity Money, an app designed to help people manage their money. That should help fuel their growth even more. Goldman looks more and more serious about getting into consumer banking, is the takeaway I get from this Marcus news.

Douglass: It's interesting, because, when we talked about disruptors to the big banks -- and thanks, by the way, to the folks who wrote in to get that transcript and head back to that episode. We're certainly happy to provide that for anyone who is looking for more background and a thoughtful commentary on what's going on in banking writ large. But, the fact is, I think one of the best opportunities for these big banks to really be competitive long-term is to create the one-stop-shop, an easy, as-frictionless-as-possible experience that's primarily online, where people can put all of their stuff, all their different accounts, all the different ways that they are making money and are trying to save money, preferably juiced with some good ideas from the bank, into one app, one place, one shop to rule them all, if you will. 

And it looks increasingly like Goldman is trying to get into that game, because that's really what Clarity Money does. I think the problem that a lot of folks have seen when they've worked with a Mint or a Clarity or some of these apps online is that they get most of the way there, but there are just some things that don't quite compute well. So, this is a really good opportunity for Goldman, if they can be patient, keep it free for a long time, and really build the perfect product. 

Of course, that requires a long-term mindset, which, frankly, publicly traded companies often struggle with. And this, to my mind, is a real test of whether management can execute something well here, because if they can, then Goldman is really very well-positioned to compete online for a long time hence.

Frankel: Yeah. If I were one of the smaller peer-to-peer lenders, I would be very worried about where Goldman's taking this. 

Douglass: Yes, absolutely. Let's turn to our third bit of news, which was a data breach at SunTrust. Which, OK, another data breach. [laughs] It seems like there's a new one announced every other day. 

Frankel: Right. This one is kind of a different story, though.

Douglass: Yes. 

Frankel: The significance is just that you keep hearing the phrase "data breach," and it reinforces the need to protect your information and be careful.

Douglass: Right.

Frankel: This one, just to give you some background if you haven't read it yet, one SunTrust employee stole client contact lists. Which, I say "a list," this was 1.5 million people, so that's a pretty big list. [laughs] 

Douglass: Right. [laughs] 

Frankel: But, they only stole names, addresses and account balances. They did not get things like Social Security numbers, account numbers. So, this isn't like a Target data breach, where they took credit card numbers and things like that. The most sensitive information did not get compromised. There's really not that much an identity thief can do with just names, addresses and account balances. It's definitely a piece of the puzzle, and information you don't want random thieves to have. [laughs] But, it's kind of a different animal than what we were talking about with the Target data breach, the Equifax data breach, where they pretty much took information on every account that you own. So, it's a different story.

Douglass: And the other piece here is that this was an inside job. At least, as far as we know, this wasn't a hack, this wasn't some sort of outside thing where they breached the firewalls and got into a bunch of stuff. This was one person misusing data. And I have to say, perhaps unsurprisingly, SunTrust has basically done all the right things here, which is, they reported it, quickly -- that's important -- they proactively offered consumer protections, and also not surprisingly, they terminated the employee. So, hopefully this one is really is just an isolated incident for the bank.

Frankel: Yeah. I think banks -- I don't know if this is the case for SunTrust, if they would have done the same things anyways -- but I think banks are really starting to learn what to do and what not to do in the event of a data breach. Equifax is a good example of what not to do. They waited, what was it, three months after they knew about the breach to tell anybody, after some of their executives had sold some stock. There's a current inside trading suit going on right now.

Douglass: [laughs] Yeah, a lot of not great stuff there.

Frankel: So, that's definitely something you don't want to do. [laughs] And SunTrust is doing a really good job of keeping people informed. They went ahead and told everybody before anything leaked out. They did a good job. I applaud them, especially since, like I said, this was not a large-scale Social Security number and credit card number breach.

Douglass: Right. Have to throw out there as well, this is a really important piece of the puzzle for banks, handling this kind of thing correctly. The fact is, no security is perfect. That is, unfortunately, the way things are. So, there are going to be things that happen, and I think that's pretty much unavoidable. I mean, I was involved in the OPM breach with the federal government. It's just not possible to get things perfect. But, banks rely so much on trust, particularly trust with money. That's what's the wealth management stuff is all about. That's why people accept those low yields on their savings accounts and things like that, because they can trust the money will be there. So, for banks, it's critical that they maintain customer trust. And handling tough situations the right way is really the best way to preserve that trust, because you can burn up a lot of good will very quickly.

Frankel: Yeah, definitely. It's important for people to remember also that fields like cybersecurity are still in the pretty early stages. So, as this evolves and thieves are getting more and more sophisticated every day, there are going to be breaches. It's important to take a step back, figure out exactly what happened, and most importantly, take steps to protect yourself. We've written extensively about credit freezes, putting a fraud alert on your credit. I have a fraud alert on my own credit report, just to prevent something like this from becoming an issue. So, it's really important to be proactive and protect yourself from these kinds of breaches. The news like the SunTrust breach just serves as a good reminder of that.

Douglass: Yes. And with that in mind, folks, if you have questions about the different sorts of consumer protections you can take for yourself, shoot us an email, [email protected], and I will be happy to compile some of Matt's and some of our other writers' best content on it and send it over to you. We have some good write ups on what those next steps look like so that you can make sure that you're protecting your information in a way that most makes sense to you. Again, that's [email protected].

Alright, folks, that's it for this week's Financials show. If you have questions or comments, you can always reach us at [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so, don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Michael Douglass. Thanks for listening and Fool on!