Should Investors Be Concerned About Wells Fargo's Latest Regulatory Headache?

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Wells Fargo (NYSE:WFC) cruised through much of the first eight months of 2021. The bank showed progress on regulatory issues related to its phony-accounts scandal, and it also put a solid plan in place to improve profitability. A good set of results in the second quarter sent the stock up to $51 per share in August, a nearly 70% gain this year.

Recently, however, Bloomberg reported that regulators are weighing further action in regard to matters associated with the phony-accounts scandal. The news caught the market off guard, sending Wells Fargo’s stock down more than 10% in a two-day period, which is a big move for a large bank. Should investors be concerned about the recent report? Let’s investigate.

What happened

The Bloomberg report is the latest in what has now been a years-long headache for Wells Fargo. In 2016, it came to light that employees at the bank had opened millions of depository and credit card accounts without customers’ authorization, in addition to charging customers for other products without their consent. What followed were numerous consent orders from regulators, billions of dollars in fines, and an order from the Federal Reserve that prevented Wells Fargo from growing its balance sheet until it improved its regulatory infrastructure.

Progress was slow, but in 2019 Wells Fargo hired Wall Street veteran Charlie Scharf as CEO. He seemed to move quickly despite having to deal with the coronavirus pandemic. On the regulatory front, Scharf more or less cleaned house, instituting a new management team and replacing many top leaders at 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. Additionally, Scharf has created new regulatory infrastructure at the bank and hired new compliance chiefs for each of its divisions.

The bank saw some real victories. In January, it announced that the Office of the Comptroller of the Currency (OCC) had ended a 2015 consent order related to anti-money-laundering issues at the bank. Then in February, Bloomberg reported that the Federal Reserve had approved the bank’s proposal for overhauling its risk-management and governance structure. The approval was seen as a key step toward getting the asset cap limiting the bank’s growth removed, which is considered the main roadblock inhibiting the stock.

But the latest Bloomberg report clearly disturbed investors. It said the OCC andConsumer Financial Protection Bureau (CFPB)may bring further regulatory action against the bank because the agencies are not happy with Wells Fargo’s progress on compensating victims of the phony-accounts scandal, or efforts to enhance its regulatory infrastructure.

Building with Wells Fargo logo on the outside.

Image source: Wells Fargo.

What to make of the report

In terms of compensating the victims, while one never knows what’s really going on behind the scenes, this surprised me because it seems like the bank has made a clear effort to do this.

In 2017, Wells Fargo reached a settlement with all state attorneys general and Washington, D.C., to address the scandal, and it started providing remediation to customers. There is a page on the company’s website with detailed information on how to go about remediation. In June 2018, a judge approved a $142 million settlement for all people who claimed the bank opened a consumer or small business checking or savings account, unsecured credit card, or line of credit without their consent between May 1, 2002, and April 20, 2017.

As for the regulatory infrastructure issues raised in the Bloomberg report, perhaps investors should have not have been so surprised, as Scharf has alluded on the bank’s recent earnings call that this work is still not that close to being completed:

Regarding our work on consent orders and other regulatory requirements, the work remaining is significant, and as such, this remains a multi-year journey for us. While what’s required for each is clear, there are numerous complexities with managing this amount of work concurrently, and it will take time to consistently accomplish all at the level we and our regulators expect. As such, we may have setbacks and progress will not be a straight line. However, I remain confident in our ability to complete the work.

Banks have many regulators, and Wells Fargo took heat from all sides following the phony-accounts scandal. One thing to keep in mind is that Wells Fargo is currently operating under 10 different consent orders from different regulators pertaining to many different issues, so a setback on certain aspects of one or two consent orders doesn’t necessarily mean everything is in jeopardy. For instance, a setback from the OCC and CFPB doesn’t necessarily mean that the Fed would alter its current asset cap order or make it stricter, and the asset cap is by far the biggest constraint on the stock.

Should investors be worried?

Any kind of new regulatory development related to the scandal is always going to be a cause for concern among investors. But remember, there are several consent orders from multiple regulators on a number of different issues. The No. 1 regulatory issue holding the bank back is the asset cap, which inhibits growth in Wells Fargo’s strong lending franchise.

The report from Bloomberg does not necessarily mean that the bank is facing a setback on the asset cap, or that Wells Fargo hasn’t made significant progress on the asset cap. This leaves me cautiously optimistic that fears regarding the Bloomberg report may be overblown.

This article represents the opinion of the writer, who may disagree with the official recommendation position of a Motley Fool premium advisory service. Were motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.