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Is Wells Fargo Close to Exiting Its Asset Cap?

By Bram Berkowitz – Dec 2, 2020 at 7:00AM

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Analysts now seem to believe that Wells Fargo could exit its costly asset cap some time in the near future.

Wells Fargo (WFC -0.77%) has been trading at a discount all year, as earnings have slumped and the bank trimmed its dividend by 80%. Despite the recent rally in the banking sector, Wells Fargo is still trading below tangible book value and significantly lower than book value. The coronavirus pandemic has obviously played a major role in this, but so has the asset cap imposed by the Federal Reserve as punishment for the bank's phony-accounts scandal.

Nearing the third anniversary of the asset cap, analysts and investors have been perplexed about the novel punishment and how long it can last. But now, there may be reason to believe that Wells Fargo is closer to exiting the asset cap than many initially thought, which would be a significant driver for the company's stock price.

Wells Fargo branch

Image source: Wells Fargo.

Analysts grow bullish

Wells Fargo has been severely punished for its phony-accounts scandal, in which employees at the bank fraudulently opened millions of unauthorized deposit and credit card accounts on behalf of their customers. Among many other punishments, the Federal Reserve in 2018 placed an asset cap on the bank, prohibiting it from exceeding $1.95 trillion in assets. In August, Bloomberg estimated that the asset cap has cost Wells Fargo $4 billion in profits since it went into place, not including all the money the bank has spent on litigation relating to the scandal and then efforts to correct the issues.

Recently, analysts have seemed to be growing more confident that Wells Fargo may be close to the finish line on its asset cap. Analysts from Deutsche Bank speculated in a recent research note that the bank could exit the asset cap within the next six months. "Our best guess is that WFC is further along in dealing with its regulatory issues and may be able to exit its asset cap," wrote Matt O'Connor, a research analyst at Deutsche Bank. Raymond James analyst David Long followed suit, doing a 180-degree turn on the bank. Since December, Long had rated the bank as underperform, but recently changed his outlook on the stock to outperform, saying in his research note that worst is likely in the past.

Analysts are extremely knowledgeable on their specific industries. While they are not always right, if multiple analysts are growing bullish on the bank and suggesting that its regulatory issues may be close to ending, it's certainly something to take note of. It could also support what Wells Fargo CEO Charlie Scharf may have been hinting at on the company's third-quarter earnings call. Despite being tight-lipped on the asset cap, Scharf said, "The amount of time and resources that the senior team is spending on this is extraordinary. You'd be shocked at the amount of time because we know we need to do what's required."

Significant changes

As a result of the phony-accounts scandal, Wells Fargo is operating under 14 consent orders from various regulators, including the U.S. Office of the Comptroller of the Currency (OCC), the Federal Reserve, the Consumer Financial Protection Bureau, and the Securities and Exchange Commission. Overall, the bank needs to fix its risk management and governance controls to make sure that such a scandal never happens again, and to ensure it has the proper oversight in place to make sure that it doesn't.

In recent years, Wells Fargo has cleaned house and gotten rid of senior management linked to the scandal. When Scharf was named CEO in 2019, he became the bank's third CEO in three years. Of the 15 members on the board of directors at Wells Fargo in 2016, only three remain. And with the retirement of CFO John Shrewsberry, much of the old Wells Fargo C-suite is gone, as Scharf has brought in a new team of executives mostly from his past employers such as JPMorgan Chase and Bank of New York Mellon.

Scharf has also moved to set up a new regulatory infrastructure. The bank hired a new chief compliance officer and five new chief risk officers to specifically oversee risk in each one of the bank's business segments. "Our new model will strengthen our centralized, independent risk management program, provide greater consistency in how we manage risk across our businesses, and better position us for the future," said Wells Fargo Chief Risk Officer Mandy Norton following the new hires.

How much more punishment?

The fake accounts scandal is certainly one of the most serious banking violations ever to occur, and it shouldn't be taken lightly. Wells Fargo lost the trust of many of it customers, and really damaged the reputation of the entire banking industry. But it does seem like regulators have significantly punished the bank at this point. The bank has paid $7 billion in fines and penalties when you consider the $4 billion it has paid in litigation relating to the scandal since 2016 and the $3 billion fine from regulators earlier this year.

The asset cap has likely cost the bank more than $4 billion, which doesn't include all the money Wells Fargo has spent to improve its regulatory infrastructure. And the bank has pretty much implemented an entirely new management team. Regulators have banned former CEO John Stumpf from the banking industry and charged him and seven other former executives with more than $58 million in combined civil penalties for their roles in the scandal.

The bank's rebound may be speculation, but I think when you look at the change in sentiment from analysts, the amount of punishment and fines on the bank, and the regulatory and management changes, there is a good chance that Wells Fargo is closer to exiting its asset cap than people may have realized.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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