Wells Fargo’s International Ambitions Will Have To Wait
Earlier this week, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) singled out Wells Fargo (NYSE:WFC) as the only major U.S. bank yet to come up with a satisfactory resolution plan for its business in the event of a bank failure. [1] Wells Fargo was one of five systemically important U.S. banks that had to resubmit their 2015 resolution plans in October after their original plans were rejected by regulators in April. But the updated plan was also not adequate, with the bank falling short on two criteria. Consequently, the regulators have prohibited Wells Fargo from growing internationally and from acquiring any non-bank firm until it fixes these issues. [2] In case Wells Fargo is unable to address these issues satisfactorily by next March, the bank could attract stricter action – including a forced sale of its investment banking assets.
This development is the latest in a chain of issues affecting Wells Fargo that have hurt investor sentiments, beginning with the bank’s account opening scandal revealed in September (see Wells Fargo’s Sales Scandal Is A Bad Look, But Bank Is Well-Positioned Going Forward). While the bank continues to deal with the legal and regulatory fallout of the scandal, the Financial Stability Board (FSB) also upgraded Wells Fargo’s risk level in the global banking industry recently – resulting in an increase in the minimum level of capital the bank now has to hold.
While we maintain our $59 price estimate for Wells Fargo’s stock, we acknowledge the downside risk presented by additional restrictions imposed by regulators on the bank’s operations in case it is not able to satisfactorily address the deficiencies in its resolution plan.
See our complete analysis of Wells Fargo here
As a part of the laws implemented under the Dodd-Frank act in the wake of the economic downturn of 2008, all major U.S. banks are required to submit detailed resolution plans (commonly known as “living wills”) to U.S. financial regulators which detail the steps that will be taken by the bank to liquidate itself efficiently in the event of a bank failure. While all bank holding companies with more than $50 billion in assets have to submit these plans by July 1 each year, the eight largest U.S. banks are tracked in this regard more closely due to their importance in the larger U.S. banking system. These banks are Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo.
This April, the Fed and the FDIC accepted the 2015 resolution plans of just three of these eight banks – Citigroup, Goldman Sachs and Morgan Stanley. The other 5 banks worked on the deficiencies pointed out by the regulators and resubmitted their plans in October. All of them besides Wells Fargo successfully ironed out the problems in their older submissions and received approval for their updated plans recently. As for Wells Fargo, the regulators determined that the bank still needed to fix two of three problem areas red flagged earlier – under the “legal entity rationalization” and “shared services” categories. [1] The banking giant now has until March 1, 2017, to fix the remaining issues and to resubmit the resolution plan.
The biggest impact of Wells Fargo’s failure to fix its resolution plan within the stipulated timeframe is the restrictions that are now in effect on the bank. The bank cannot establish any subsidiaries outside the U.S. and it cannot acquire any non-bank firm until it fixes the issues – restrictions which could potentially hurt Wells Fargo’s long-term growth if not addressed soon. We believe that the restrictions on foreign expansion in particular is a problem given the bank’s focus on growing internationally over recent years.
Having been almost exclusively focused on U.S. operations historically, Wells Fargo first detailed plans to extend corporate banking services to 20 other countries in early 2012. [3] Prominent locations targeted by the bank were the U.K., Germany, the Netherlands, France, China, Hong Kong, Australia, Japan, India, South Korea and Singapore. Since then, Wells Fargo has increased its headcount outside the U.S. substantially – opting for the occasional strategic acquisitions to complement its organic growth strategy. This has helped its foreign loan portfolio swell from under $40 billion at the end of 2012 to more than $51 billion now.
If the restrictions imposed by the regulators remain in place for long, then this high-growth (and high-revenue) avenue for the bank will be hit. This, in turn, will negatively impact overall loan growth for the bank going forward. As Wells Fargo’s non-U.S. loan portfolio is almost completely comprised of commercial and industrial loans, we include these loans in our analysis as a part of the bank’s commercial lending portfolio. You can see how slowing growth in these loans affects our estimate for Wells Fargo’s shares by making changes to the chart below.
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- Joint Release/Agencies Announce Determinations on October Resolution Plan Submissions of Five Systemically Important Domestic Banking Institutions, FDIC Website, Dec 13 2016 [↩] [↩]
- Agency Response Letter to Wells Fargo & Company, Federal Reserve Website [↩]
- Wells Fargo plans global expansion drive, Financial Times, Mar 4 2012 [↩]