Wells Fargo’s CEO may not be able to talk himself out of this one
Nicole Sinclair
Wells Fargo (WFC) has fallen 8% since its announcement on September 8 that it was hit with a $185 million sanction from regulators and after later reports that it may face a criminal investigation.
On Tuesday, Wells’ Chairman and CEO John Stumpf will face questions from the Senate Banking Committee over the creation of sham bank accounts that led to the firing of 5,300 employees.
After commissioning a review of 93 million accounts opened since 2011, Wells Fargo identified 2 million accounts where customer authorization couldn’t be determined. This led to the ultimate discovery of $2.6 million in fees accrued for 115,000 unauthorized accounts.
The scope of the scandal may seem small relative to the size of Wells Fargo’s overall business. But the 5,300 individuals who were terminated—10% of them managers—could reflect deeper organizational issues … and more pain for the company.
Tuesday’s hearings promise to shed new light on just why the stock has plummeted and why it could have more room to drop.
Culture under fire
The big questions for Stumpf: Did he know about the creation of phony accounts? Does this scandal reflect a deep-rooted cultural problem, where the bank created incentives for fraud by giving branches high sales targets? Or was this an issue of individual deviances?
The problem is: None of it may matter.
See, Stumpf is caught in what can be characterized as a “Nixon problem.” If he knew about the opening of the accounts or even an aggressive culture that encouraged predatory sales tactics, he was complicit. But if he didn’t know, the abuse of customer trust marks a failure of supervision, leadership and control.
“Failure to supervise is a very serious issue, but it suggests a failure at some point in the chain of command,” Oppenheimer’s Chris Kotowski said.
The story began with a December 2013 LA Times article citing the company’s “pressure cooker” sales culture based on internal bank documents and court records along with a few dozen interviews with those involved in the company. The reporting brought on an investigation by LA City Attorney Mike Feuer, which led to a formal complaint in May 2015 and then a settlement last week.
Reports, including one from The Wall Street Journal this weekend, reflect a culture where managers put high demands on employees, including hourly targets and tactics such as searching for customers at retirement homes and bus stops.
The ‘regional bank’
The current scandal contrasts with Wells’ identity as a bulge-bracket “regional bank” that distanced itself from traditional investment banks during the financial-crisis era scandals.
Even its logo, the stagecoach, is a symbol of the company’s heritage of service and stability.
And Berkshire Hathaway’s (BRK-A, BRK-B) 10% stake in the bank reflects a level of confidence from the “Oracle of Omaha” Warren Buffett, who started a position in 1989 after being impressed with the bank’s culture.
Stumpf, meanwhile, fits the template of a “Buffett CEO.” Stumpf’s father was a dairy farmer in Minnesota, where his 11 children, including Stumpf, were expected to help. After high school, Stumpf became a breadmaker before deciding to enroll in St. Cloud University, with a focus on finance. Stumpf told Forbes he learned how to lend money by cleaning up the messes of others who had made loans before. Stumpf, who joined Minnesota-based Norwest in 1982, began to work up the chain, particularly after the acquisition of the bank by Wells Fargo in 1998.
Taking the helm as CEO in 2007, Stumpf was quickly thrust into the financial crisis and oversaw the successful acquisition of Wachovia for $15 billion, which allowed Wells to double its branch count and add more eastern US exposure. Its offer for Wachovia beat out Citigroup’s (C), without help from the US government. It also avoided integration issues that Bank of America (BAC) faced after acquiring the subprime mortgage lender Countrywide, which Wells decided not to buy in 2008.
While hit hard by the financial crisis, Wells was thought of as having a more limited capital-markets business and more of a focus on retail banking and cross-selling multiple products.
The underlying culture of that cross-selling business is what’s now being called into question.
Cross-selling culture
The current scandal puts into question the bank’s underlying sales culture and specifically its efforts to encourage customers to sign up for multiple products, known as “cross-selling.” For example, a customer with a mortgage may be encouraged to open a checking account, savings account and credit card.
Sales targets were aggressive, ambitious and somewhat arbitrary. For example, Wells Fargo had developed a cross-selling goal of eight accounts per customer, which became known internally as the “Gr-eight” initiative, Emily Glazer noted in the Wall Street Journal. In its 2010 annual report, Stumpf explained why the bank had a cross-selling goal of eight.
“The answer is, it rhymed with ‘great,’” he wrote. “Perhaps our new cheer should be: ‘Let’s go again, for ten!’” He laid out even more upside: “Even when we get to eight, we’re only halfway home. The average banking household has about 16,” he wrote.
A question of responsibility
Stumpf’s appearance before the Senate Banking Committee continues an “important political pastime,” according to Oppenheimer’s Chris Kotowski. “It promises to be a made-to-order chance to berate a large bank CEO just seven weeks before elections.”
In an interview on CNBC’s Mad Money, Stumpf has said he took blame for the mistakes: “We take accountability for not getting it right 100% of the time.” And in his prepared testimony for the Senate committee, Stumpf is expected to take on an apologetic tone, while reiterating the lack of an underlying scheme orchestrated by company management.
Stumpf, along with CFO John Shrewsberry, has characterized the creation of the unauthorized accounts as reflective of underperforming employees as opposed to an issue of corporate culture. And while Stumpf has said in recent interviews that any misconduct is unacceptable, he emphasized the 5,300 employees over five years represent about 1,000 employees a year not doing the right thing. That’s 1% of the 100,000 team members at any one time at branch and retail bank networks, he noted.
While the company has upped investment in compliance, issued an apology, and paid back fees for the unauthorized accounts, the scandal comes at a time of heightened antagonism toward banks, even eight years after the financial crisis. Some investors have called for Stump’s resignation, along with claw-backs from the former head of community banking, Carrie Tolstedt.
There are also questions about whether this is more widespread across the sector. According to the Washington Post, consumers have filed more than 31,000 complaints since 2011 about account management and unauthorized credit cards, according to complaints filed with the Consumer Financial Protection Bureau (CFPB).
Given this backdrop, analysts say it could be months of investigations that will likely affect the overall perception of the company and the stock even if the impact to the bank’s bottom line is minimal.
Meanwhile, underlying cultural changes could impact the company, as well.
Strategy changes
On September 13, Wells announced it would eliminate “all product sales goals” in its retail banking segment, which could have some business operational impact, according to analysts. This could have a particular effect on retail banking, which accounted for 57% of revenue in 2015.
“The financial tailwind from the sales mishaps was immaterial to the company’s fee revenue, but the elimination of product sales goals could materially change how the company’s Retail Banking segment operates and the fee revenue it generates,” said Piper Jaffray’s Kevin Barker. “In the near-term, we do not expect a dramatic impact to fee revenue but over a longer period of time, it is possible fee income from the retail banking segment could stagnate.”
Barker added that revenue growth could slow as Wells shifts to new metrics and cross-selling is pushed less aggressively.
Source: UBS Research
Meanwhile, from a public-relations standpoint, Wells’ differentiated and value-oriented sales culture being called into question could damage its reputation as a Main Street-focused bank, analysts added.
Plus, added Barker, there is a risk of incremental compliance expenses given the high-profile nature of this stumble. Wells spent $50 million so far on implementing new processes with structurally higher costs over the next few years possible.
Source: UBS Research
While it remains uncertain how large the earnings headwind will end up, there is no question that landing in the cross-hairs of politics is not positive for any company, including Wells. The Senate Committee is just the start of many tests it faces in the months ahead in an already-difficult environment for banks.
