Wells Fargo & Co. took Monday — as expected — a substantial blow from investors reacting to the latest federal regulatory restriction on the bank’s practices.
The share price closing down 9.2 percent, or by $5.91, to $58.16 in response to the bank saying the restrictions could lower 2018 profit by $300 million to $400 million.
To put that into context, Wells Fargo had $22.2 billion in profit in fiscal 2017.
The Federal Reserve, in the last action by Chairwoman Janet Yellen before the end of her term Friday, said Wells Fargo would not be allowed to grow its total assets beyond the $1.93 trillion it had on Dec. 31.
“In recent years, Wells Fargo pursued a business strategy that prioritized its overall growth without ensuring appropriate management of all key risks,” according to the Fed.
On Sept. 1, the bank confirmed there were at least 3.53 million checking and credit-card accounts affected by its fraudulent scandal, up from the 2.1 million announced in September 2016 when the activities were acknowledged.
Although the bulk of those accounts were created in Arizona and California, the bank has said it cannot rule out that 38,722 were established in North Carolina and 23,327 in South Carolina.
In August, Wells Fargo confirmed it could experience overall losses reaching $3.3 billion in its attempt to resolve its scandals.
The Fed restrictions could require Wells Fargo to divest some businesses in order not to grow past the total asset restrictions.
“We cannot tolerate pervasive and persistent misconduct at any bank, and the consumers harmed by Wells Fargo expect that robust and comprehensive reforms will be put in place to make certain that the abuses do not occur again,” Yellen said
“The enforcement action ... will ensure that Wells Fargo will not expand until it is able to do so safely and with the protections needed to manage all of its risks and protect its customers.” Each current board member was required to sign the cease and desist order.
Allen Tischler, an analyst with Moody’s Investors Services, said the restrictions are “credit negative” for the bank.
“We expect profitability to be satisfactory, assisted by a lower tax rate and prospects of higher interest rates,” Tischler said.
“However, the Fed’s strong remediation actions leave little doubt that further improvement is required, a point that its competitors will highlight in their attempts to take away market share from Wells Fargo.”
The Fed required Wells Fargo to remove three current board members by April and another member by the end of the year. The bank has not identified which members would be replaced.
The board requirements comes on top of the bank naming three new independent members on Nov. 29, who replaced three members, including then-Chairman Stephen Sanger, on Jan. 1. Betty Duke took over as chairwoman on Jan. 1. Altogether in 2017, the bank added six new independent board members while five retired.
Erich Reimer, a Seeking Alpha contributor, called the Fed’s move “unprecedented” in its oversight history, with “the growth restriction likely moderately restricting the bank’s profits for the immediate future.”
However, Reimer said that “after years of dealing with the fallout and seemingly unending turmoil from the fake accounts scandal, Wells Fargo may now finally have the concluding note it needs to have a fresh start and begin on the path to long-term growth once again.”
Wells Fargo said “it is confident it will satisfy the requirements of the consent order” and that it will provide “plans to the Federal Reserve within 60 days that detail what already has been done, and is planned, to further enhance the board’s governance oversight, and the company’s compliance and operational risk management.”
“We take this order seriously and are focused on addressing all of the Federal Reserve’s concerns,” said Timothy Sloan, who replaced John Stumpf as chief executive in October 2016.
“It is important to note that the consent order is not related to any new matters, but to prior issues where we have already made significant progress.”
Wells Fargo projects having a third-party review of its plan completed by Sept. 30, after which it expressed optimism that the asset restrictions could be lifted.
Even though Trump administration appointee Jerome Powell replaced Yellen as Fed chairman Monday, it appears unlikely that he will attempt to reverse Yellen’s actions. President Donald Trump said on Dec. 5 he does not support easing up on sanctions and penalties against Wells Fargo related to the scandal.
Matthew Frankel, with The Motley Fool, said the Fed’s move “may have taken away the only reason left to buy the stock.”
“In many ways, Wells Fargo looked like a rather appealing bank investment until recently. Shares had dramatically underperformed peers, and the bank still had tremendous asset quality and was generating strong returns on equity.
“By restricting Wells Fargo’s ability to grow, the Fed has effectively taken away this catalyst for growth,” Frankel said. “Sure, Wells Fargo will still benefit from lower tax rates and higher margins, but it won’t be able to parlay these into growth.”
Brian Kleinhanzl, analyst with Keefe, Bruyette & Woods, said the “major takeaway is that we believe Wells Fargo will have to be defensive until the cease and desist order is lifted, and that is negative relative to our previous earnings forecast.”
Also downgrading Wells Fargo were Citigroup, JPMorgan and Morgan Stanley analysts.
In downgrading Wells Fargo to “market perform” from “outperform,” Kleinhanzl said “we do not want to be reactionary to one piece of bad news, but the resulting drop in our (fiscal 2018) earnings-per-share estimates from $4.90 to $4.70), once we factor in the potential impacts of the order, should leave us well below consensus.”
“We would expect consensus to move lower, which should be a headwind for shares of Wells Fargo.”
“The bottom line is that the order will mean Wells will have a harder time maintaining market share and will have to compete more on price or credit terms vs. peers, in our view.”