The Federal Reserve's prohibition on Wells Fargo & Co. expanding its balance sheet could hinder the bank's ability to deliver the revenue growth its investors have been hoping for, analysts say.
"It is a significant and serious penalty here," Scott Siefers, a Sandler O'Neill & Partners analyst, said in an interview. He was not surprised to see Wells' shares tumble in morning trading Feb. 5, the first session after the Fed action was announced. "There is an element of shock and awe to this; you just don't see this kind of thing."
The Fed issued a consent order against Wells that included a ban on the bank growing its $1.952 trillion-in-assets balance sheet until it can prove to regulators that it has further bolstered its governance and risk controls. The move was unprecedented, and analysts said it signaled that Wells' executives will have to further devote themselves to crisis management, potentially distracting them from growing loans and interest income.
Wells has been under heavy scrutiny since September 2016, when regulators fined the bank after learning that its employees opened millions of phony accounts in existing customers' names to meet exceptionally aggressive sales goals. Wells has since taken several steps to change its sales culture and beef up controls, including shaking up its board, revamping how it pays and motivates front-line staffers, and parting ways with its chief executive and replacing him with current President and CEO Timothy Sloan.
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| Wells Fargo President and CEO Timothy Sloan |
In a statement, Sloan said Wells is taking the order "seriously" and is "focused on addressing all of the Federal Reserve's concerns." Yet he also emphasized that the consent order "is not related to any new matters, but to prior issues where we have already made significant progress."
But the Fed's action this month indicates substantial work still lies ahead, Moody's Investors Service analysts said in a report. They added that, while Wells' growth is constrained and its management team is focused on clearing regulatory hurdles, competitors are likely to pounce.
"The Fed's sanctions are credit negative for Wells Fargo and threaten to increase client attrition and undermine its franchise, especially since competitors will likely use Wells Fargo's hobbled status to attract clients," the Moody's analysts said. They noted that Wells executives estimated that the Fed-imposed limits could cut 2018 net income by $300 million to $400 million.
Raymond James analyst David Long said in a report that, in addition to client attrition, he has concerns about Wells' ability to retain employees amid the drawn-out era of uncertainty in which the bank finds itself. Costs could also come under additional pressure as Wells devotes resources to regulatory compliance and, potentially, to new litigation that could emerge if new compliance issues arise.
None of that bodes well for revenue growth. Long noted that, relative to its megabank peers in the U.S., loan and revenue growth expectations for Wells already were low. The added regulatory and competitive pressures are bound to increase challenges to top-line expansion. Wells' 2017 revenue was flat from the previous year, as competitors such as JPMorgan Chase & Co. and Bank of America Corp. grew. Both JPMorgan and BofA are investing in expansion plans this year.
Wells' Sloan said the bank can reduce certain deposits as well as trading assets, among other moves, to manage its size and enable the bank to continue to grow core loans. Loan growth is key for Wells, analysts say, because with interest rates rising, new loans made at higher rates would boost the company's interest income and help it lift its top line.
"We remain in a strong financial position and stand ready to serve the varied financial needs of our customers," Sloan said.
But investors are dubious. Shares of Wells were down about 8% at 1:30 p.m. ET on Feb. 5.
Wells "has done a lot since the scandal broke," Richard Clayton, research director at Wells investor CtW Investment Group, said in an interview. "But clearly they have significant work yet to do to restore trust, and that leaves a lot of uncertainty."

