Legal Troubles Making It Difficult For Wells Fargo To Regain Customer Confidence

Wells Fargo’s (NYSE:WFC) efforts to win back customer trust in the wake of its fake account opening scandal saw yet another hurdle recently, as Senator Elizabeth Warren implored the Federal Reserve to dismiss all 12 of the bank’s board members. The Senator pointed out that Wells Fargo’s board failed to monitor the bank’s risk management practices, and that the Fed has the legal authority to remove the board members in such situations. Notably, the demand comes on the heels of a class action lawsuit filed by several customers against Wells Fargo for making unauthorized changes to their mortgages.

The recently filed lawsuit alleges that the banking giant increased the duration of mortgages taken by customers undergoing personal bankruptcy proceedings by reducing the monthly payments. This benefits the bank in the long run due to the jump in interest payments over the longer loan period. The bank allegedly did not seek the necessary approval needed to make the modifications from the customers and the court.

The lawsuit puts a spotlight on Wells Fargo’s internal control policies once again, and is the latest development in a chain of issues affecting Wells Fargo that have hurt customer and investor sentiment towards the banking giant. While we maintain our $57 price estimate for Wells Fargo’s stock, we acknowledge the downside risk presented by the growing legal and regulatory headwinds the bank faces.

See our complete analysis of Wells Fargo here

Until last September, Wells Fargo (NYSE:WFC) stood out in the U.S. banking sector as one of the few banks that emerged stronger from the economic downturn of 2008 – capitalizing on its risk averse, community-focused business model to grow large enough to rival its substantially diversified peers JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C). But the bank’s strong growth story – driven primarily by efficient cross-selling of financial products – had been fueled in part by fraudulent selling practices by some of its employees since 2011. This misgiving resulted in Wells Fargo paying $185 million in fines to regulators, with potentially millions more at risk due to several large class-action lawsuit filed by customers. The bank’s top management also took considerable heat from investors and the U.S. Senate over the malpractices, and then-CEO John Stumpf was forced to resign shortly after the scandal came to light.

But the biggest fallout of the scandal for Wells Fargo was a sharp reduction in retail banking activity at the bank over subsequent quarters. The bank’s loan portfolio and deposit base have grown at a noticeably slower rate than its peers over the last two quarters, as the reputational hit resulted in existing and potential customers switching away from Wells Fargo’s services. While the bank claimed to have made sizable progress in addressing the core issue of weak internal controls, the recent lawsuit about unauthorized mortgage changes highlights the need for more efforts on this front.

This would explain why Senator Warren presented the rather radical suggestion of dismissing the bank’s entire board. Making all 12 members responsible for the bank’s failure to maintain sufficiently strong risk management standards would ensure that the board is more cognizant of such issues in the future. That said, the Fed will need to initiate an enforcement action and prove that the board members’ actions were “unsafe or unsound” to be able to get them removed.

We believe that the continued regulatory pressure on Wells Fargo will remain a deterrent to growth in the bank’s retail banking division at least in the short run. You can see how slowing growth in mortgage loans affects our estimate for Wells Fargo’s shares by making changes to the chart below.

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