In December, Wells Fargo (WFC 0.98%) agreed to a $3.7 billion settlement with the federal Consumer Financial Protection Bureau (CFPB) for widespread violations in the way it managed auto and mortgage loans. The settlement included a $1.7 billion civil penalty, the largest ever doled out by the consumer watchdog.
Although the number is certainly enormous and put a big dent in Wells Fargo's fourth-quarter earnings results, I do see it as an important step for the bank in getting past its regulatory troubles. In fact, the bulk of Wells Fargo's regulatory fines may now be in its rearview mirror. Here's why.
Terminating consent orders
Ever since Wells Fargo's phony-accounts scandal came to light in 2016, in which bank employees opened millions of credit-card and bank accounts without consent from its customers, the bank has faced endless regulatory issues. While many of these issues relate to the phony-accounts scandal, regulators over the years have also uncovered numerous infractions that were a result of the bank's insufficient regulatory infrastructure and internal controls. Wells Fargo at one point a few years ago had at least 12 consent orders outstanding.
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Since Charles Scharf became chief financial officer in 2019, he has worked to clean up the mess. But the bank has still been dealing with fines, litigation, customer remediation -- and an asset cap imposed by the Federal Reserve that limits the bank from expanding its balance sheet until it improves regulatory controls. The asset cap has now been in place for about five years and has probably cost billions in profits.
Scharf has said that as the bank sees consent orders terminated, it will be a good indication to the market that Wells's regulatory infrastructure is becoming more satisfactory to regulators. Although the settlement with the CFPB is huge, as part of the agreement, the bureau terminated a 2016 consent order related to Wells Fargo's student-loan servicing, and also set a timeline in which a 2018 consent order eventually will be removed.
By my count, the removal of these two -- and potentially another separate order related to the 2018 order -- could get Wells Fargo down to seven consent orders outstanding.
The bulk of the fines might be behind the bank
When Wells Fargo incurs costs related to regulatory matters such as it did with the CFPB, those fall into a bucket called operating loss expenses, a line item under broader noninterest expenses, which hurts earnings.
But the bank also records another estimate in its regulatory filings called probable and estimable costs -- also referred to as reasonable probable losses (RPL) -- or charges that the bank could incur from customer remediation activities due to regulatory issues.
These are charges the bank has not reserved for yet but could in the future, so it's a good indicator of what could be coming down the pipeline. Following the CFPB settlement and as of Dec. 31, Wells Fargo said its RPL had fallen to $1.4 billion, down from $3.7 billion at the end of September. This is the lowest level of RPL the bank has had since the second quarter of 2016.
Keep in mind that RPLs are only taken when the bank has good reason to believe that charges from some kind of regulatory issue are likely, so this number could spike again. But Wells Chief Financial Officer Mike Santomassimo told analysts on the bank's recent earnings call that the lower RPL "gives you confidence that we're putting some of the big things behind us. But we still have stuff to work through, and there'll be more over time, I'm sure. But we've put a lot of big things behind us."
The biggest limitation on Wells Fargo is still the asset cap because it essentially prevents it from building up its balance sheet, which is a key way banks make more money. But Scharf told investors that the asset cap is just one piece of the consent orders, which could mean that not all of the consent orders must be terminated for the bank to get the cap lifted.
The progress is real
Roughly seven years after the phony-accounts scandal came to light, Wells Fargo still has work to do. The RPL number is still at $1.4 billion, the asset cap is still in place, and there are still many consent orders in place. But the bank is making clear progress with the termination of those orders and by putting big fines behind it.
Wells Fargo also announced that it would resume share repurchases in the current quarter, something it has had on pause for about a year. I had been confused about why it had stopped repurchasing shares, given the bank's strong capital position, but it's quite possible that management had been bracing for regulatory charges like the one it just took for the CFPB. The fact that the bank is resuming repurchases shows that it has a good line of sight into events that might affect its capital levels. The job is not done, but I am becoming more and more confident that Wells Fargo is now in the later stages of the work it must complete to satisfy regulators.
