How Will Wells Fargo Be Affected If The Fed’s Growth Restrictions Remain In Place Over All Of 2019?

by Trefis Team
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Wells Fargo’s efforts to put its sales malpractice issues in the past received a major setback recently, with the Federal Reserve pointing out inadequacies in its plan to resolve internal governance issues. While the U.S. banking giant now expects the growth restrictions to remain in place for around six more months, we believe that the bank may have to contend with the restrictions for much of 2019. Our interactive dashboard captures the impact of the growth restriction on Wells Fargo’s results as well as share value. Notably, if the restriction lasts through the end of 2019, then we estimate the fair value of Wells Fargo’s share price to be around $53 – a figure that is almost 15% lower than our current estimate of $62 for the bank’s shares.

Understanding The Fed’s Enforcement Order, And Wells Fargo’s Progress So Far

The U.S. banking giant has been hard at work trying to set its house in order since September 2016, when it was revealed that its employees fraudulently opened millions of accounts. Since then, internal investigations by the bank unearthed other improper practices by some employees, including making unsuitable mortgage modifications, selling unwanted auto insurance, improperly charging fees for locking in mortgage rates, and adding chargeable add-ons to accounts without the customers’ permission. The extent of malpractices led to an unprecedented enforcement order by the Fed in February prohibiting the bank from growing any larger until it has satisfactorily resolved all its internal governance issues. The Fed’s enforcement action was an attempt to contain the risk to customers from unsound control policies at the bank.

As a part of the order, the Fed expects Wells Fargo to:

  1. Replace three board members
  2. Submit a written plan by April detailing how the bank intends to improve the effectiveness of its board to oversee and govern the bank, and what it aims to do to improve its compliance and operational risk management program
  3. Conduct two independent reviews of the efficacy and sustainability of its submitted plans later
  4. Maintain its average quarterly asset balance at $1.95 trillion until it successfully completes implementing these plans and obtains the Fed’s clearance to grow its balance sheet again.

While Wells Fargo submitted its plan to the Fed in April, the Fed clearly remains unsatisfied with the bank’s efforts to improve compliance and risk management despite months of negotiation around this core requirement. Wells Fargo is working on a revised plan on a priority basis, but the new plan will undergo another round of scrutiny by the Fed, following which it will be reviewed independently by third parties. As a result, the growth restriction (#4 in the list above) is likely to remain in place for at least two more quarters.

What’s In Store For Wells Fargo In 2019?

When the Fed first imposed the growth restriction, Wells Fargo estimated the impact of the order on its profits to be $300-$400 million, though it now estimates a $100 million loss due to the delay. We believe that these figures do not fully reflect the financial impact of the restriction on the bank, as it does not account for the loss in business from the hit in customer confidence. Further, Wells Fargo was able to keep its balance sheet in check over 2018 without significantly affecting its results through steps like selling off short-term investment securities and trading assets, and liquidating non-core deposits. That said, these options are now less available to the bank, and we expect that it may have to sacrifice some growth in its core loans-and-deposits business going forward – which would hurt more the longer the restrictions remain in place.

If Wells Fargo’s growth is curtailed for all of 2019, then we expect its net interest margin to be affected the most, as the bank will have to incur a higher interest expense on its deposit base (due to the Fed’s ongoing rate hike process) even as sub-par loan growth and a relatively slower rate of growth in interest yields weigh on the interest income. What remains to be seen is how quickly Wells Fargo can get the Fed to sign off on its revised plan.

Additional details about the impact of the delay on Wells Fargo is available in our interactive dashboard

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