The revelation that Wells Fargo employees had opened
millions of accounts without the knowledge of their customers has come like
thunder in a bright blue sky.
Here was the most respected
of the big US banks seemingly behaving as the reviled Wall Streeters, after it
had touted its plain vanilla business and earned Warren Buffett’s confidence
and admiration[1]!
Of course, not everybody
cried, as Congressional critics were quick to point out that they had been
right all along: big banks were out to trick their customers rather than serve
them, and their staff would stop at nothing to earn fat bonuses. It also provided a timely boost to the
controversial Consumer Financial Protection Bureau which uncovered the problem.
Still, the bank has given
them ample ammunition:
-
The scope of the
fraud, close to two million accounts and credit cards,
-
That some 5,300
employees and managers were fired, hardly “a few isolated bad apples”,
-
That the leader
of the unit where the shenanigans had taken place chose that time to retire
with US$125 million in stocks, options and retirement benefits, a large chunk
of which had been accumulated during her stewardship of the consumer banking
unit,
-
Finally, that the
bank CEO squarely blamed employees but didn’t name any high ranking executives
among those responsible and was vague as to his own accountability.
At the same time, it should
be noted that the actual financial damage inflicted on the bank customers was
light: some 14,000 accounts incurred an average of US$28 each, and, in total,
US$5 million was refunded which works out to less than US$5 per client[2]. This explains why, by today’s standards, the
fine was a very modest US$185 million.
Nevertheless, I expect that the
final cost to the bank will be much higher.
To begin with, the bad
publicity will bite all the more so that Wells Fargo had such a good
reputation. Negative sentiment will weigh
on the stock price.
The bank will need to spend
hundreds of millions on better internal controls and training. The decision-making will likely be slowed
down as transactions will need to go through lengthier and slower approval
processes. Risk taking will probably
diminish, and with it profits as staff will be wary of making career-ending decisions.
This scandal will likely take
a bigger toll on top management than we have seen to-date. Let’s face it, when thousands of employees
feel so pressured to reach their goals that they resort to fraud, either (1) they
were poorly trained and/or of uncommonly bad character, or (2) the top down pressure
was so intense and widespread that it was no accident. Either way, management is at fault.
Having worked for a large
bank, I for one believe that corporate culture determines how business is
conducted; it is critical in guiding managers’ and employees’ behavior and
decision making. In this instance, and from
anecdotic evidence, I believe that there was a corporate cultural problem. Setting the appropriate culture IS the
responsibility of top management, under the supervision of the board of directors.
A key Wells Fargo strategy
toward growth and profitability has also been called into question: the much
advertised effort to deepen and broaden the relationship with customers by
selling them ever more products. Yet in
recent years, while the goal had been set at 8, they had plateaued just north
of 6. If 6 rather than 8 is the
effective ceiling, how will the bank make up for this setback, especially since
cross-selling will be under closer scrutiny?
Some have compared this crisis
to the JP Morgan “London Whale”. JPM was
punished much more harshly, even though its victims were its own shareholders
rather than its customers. With its
“fortress balance sheet”, JPM recovered relatively quickly although it is
likely that its future profitability suffered because of rising compliance
expenses and lower risk tolerance.
Wells Fargo has in my view a
bigger problem: besides incurring greater compliance expenses and dialing back risk-taking, it faces a greater strategic challenge and it may suffer from
upheaval in its top management ranks.
For all these reasons, I
wouldn’t be surprised if its stock price were to drift down toward book value,
i.e. US$36 vs. US$47 today, reflecting a loss of premium valuation and lower
future earnings.
Although it is no excuse, I
think that the current financial context of quasi-zero interest rates keeps
exerting ever stronger pressure on banks’ net interest margins, and Wells Fargo
is the latest but by no means last victim.
