With Wells Fargo's (WFC 0.50%) stock up about 32% this year and its first-quarter earnings report coming Wednesday morning, it's a good time to revisit the asset cap the bank is operating under, which is easily the biggest obstacle standing in its way.

Following Wells Fargo's phony-accounts scandal, the Federal Reserve in 2018 implemented a consent order that prevents Wells Fargo from growing its balance sheet above $1.95 trillion in assets. The order is easily one of the costliest punishments ever put on a bank. But after more than three years, the bank seems to be making some progress on the order, and an end to the asset cap could be within reach. Let's take a look at where Wells Fargo stands going into its earnings report and how close it could be to exiting the asset cap.

A quick review

This whole situation really began in 2016 when the Consumer Financial Protection Bureau revealed that Wells Fargo had been opening millions of deposit and credit card accounts on behalf of its customers without their authorization. Needless to say, regulators were not happy. Wells Fargo was subject to numerous lawsuits and eventually agreed to pay a $3 billion fine as well. The Federal Reserve also prohibited the bank from exceeding $1.95 trillion in assets until it could fix its regulatory infrastructure and internal controls that led to the phony-accounts scandal.

In August 2020, Bloomberg concluded that the cap had cost Wells Fargo at least $4 billion in lost profits. Additionally, the cap proved very costly to the bank's stock during the coronavirus pandemic. When the Fed lowered the overnight bank lending rate to practically zero early last year, the bank saw its net interest income from loans take a significant hit. It couldn't increase loan volume -- not that there was a ton in 2020 -- to offset the drop in rates because it was right up against the cap.

Exterior of a Wells Fargo branch on a city street

Image source: Wells Fargo.

Since that time, the bank has made progress. It hired industry veteran Charlie Scharf as CEO in 2019, and he got to work on improving the bank's regulatory infrastructure. First, Scharf more or less cleaned house, bringing in a new team to run the bank. Roughly half of the bank's top 150 leaders are new to their roles from the start of 2020, including more than 40 who are brand new to the organization. The bank's operating committee, the most senior group responsible for running the company, has seen nine of its 18 members hired externally. Four of the remaining members were hired within the last two years, and four are in different roles.

The bank has also completely overhauled its internal risk controls. Now, the operating committee reviews important issues using a much more holistic approach, and more business segments report directly to Scharf, who also hired a new chief risk officer for each business line at the bank. Wells Fargo also changed its internal and external reporting methods, rolled out a new customer feedback program, began a new sales practices management and oversight program, and launched an office of consumer practices.

How close is the bank to exiting?

In February, Bloomberg reported that the Fed had approved Wells Fargo's risk management and governance overhaul plan, which marks the most progress the bank has made on the asset cap since it went into place in 2018.

However, that approval, while a major step, is only one of several steps the bank needs to complete in order to get the cap fully removed. The bank still must submit other plans to the Fed that show how the bank's board of directors plans to carry out its overhaul plan and run the bank under the new governance structure. Then Wells Fargo has to actually implement these plans and undergo two independent reviews conducted by experts approved by the Federal Reserve. After all of that, the entire Federal Reserve Board of Governors must agree to remove the cap.

Bloomberg reported in December, citing anonymous top Wells Fargo executives and Fed officials, that the cap won't be removed until later this year at the earliest, and could run into 2022 and beyond. Some investors may be frustrated that they have to wait longer. But it's important to note that while Wells Fargo's asset cap is certainly unique, it is not uncommon for bank regulatory orders to last for three or four years.

Additionally, investors now have a timeline of when the asset cap could be removed, and most of the pain from the scandal is likely behind Wells Fargo at this point. While some of this good news may already be priced into the stock, the bank should still have significant upside when the asset cap is removed and it can once again grow its very valuable U.S. lending franchise.