Stock Analysis on Wells Fargo : Opportunity or Crisis
What Happened at Wells Fargo?
In early September, an investigation in Wells Fargo found that employees had created over 2 million false accounts for customers without their permission. This scandal received much attention from the US government, which has since held Senate sessions to grill the management of Wells Fargo. Especially the CEO, John Stumpf, more about him later.
This scandal was apparently a result of Wells Fargo’s sales strategy called Cross-Selling. In essence, it is selling multiple products to customers. For example, if you have a savings account with Wells Fargo, they will also want to sign you up for credit cards, housing loan and other financial products. This is to “build relationship” with the customers as the customers will be less willing to switch to another bank when most of his financial dealings are with a particular bank.
In 2015, Wells Fargo claimed that its retail customers held an average of 6 products per household. This is a remarkable figure when most other banks are only averaging less than 4. However, this is likely due to the aggressive sales target set by Wells Fargo management on its sales representatives. In the news articles following the scandal, some employees mentioned that they felt pressurised by the sales target to “sign up products for their existing customers”
Stumpf being grilled by the Senate hearing
Source: cnbc.com
Long story short, Wells Fargo is fined US$185m for this scandal and it is still undergoing further investigation. Following are some of the outcome thus far:
- Wells Fargo fired 5,300 employees who were involved in the scandal.
- Wells Fargo CEO, John Stumpf has forgone his $41m compensation for this year.
- The Head of Community Banking, Carrie Tolsedt, has resigned and forgone her $20m compensation (Note: she was due to retire by end 2016 anyway)
- Wells Fargo has since reviewed the aggressive sales target for its sales representative and openly condemned the act of signing up for products without customers’ permission.
- Wells Fargo has refunded about US$2.6m of fees to the affected customers.
- In another investigation, Wells Fargo was also fined US$24m for misappropriating accounts of US Veterans.
- More seri0usly, the state of Illinois and Chicago has imposed banking sanctions on Wells Fargo. This means Wells Fargo cannot operate in those areas, hence will affect their earnings.
Since the beginning of this scandal, Wells Fargo shares has gone down from $50.80 to $44.28 (-13%).
What is Wells Fargo?
Wells Fargo is one of the Big Four banks in USA, together with JP Morgan, Citibank and Bank of America. Most importantly, it is the only one among them that survived the 2008 Global Financial Crisis unscathed. It was reported that the main reason Wells Fargo was able to escape unscathed from the crisis, was its focus on retails banking. In fact, in 2012, the Forbes even called it “the bank that works”, commending Wells Fargo for its good and responsible banking practices.
Therefore, it was viewed by many as the “ethical bank”. It was also made famous by Warren Buffett who is one of its largest shareholders. In fact, Buffett has applied to own more than 10% of Wells Fargo in Mar 2016.
Hence, when such a scandal was reported, it was a shock to many. But to those who are in the banking sector, cross selling is not uncommon. Unfortunately, Wells Fargo is being used to set an example to all.
Risk Going Forward
People strike back at Wells Fargo
While Wells Fargo has been fined about US$200m in total, the implication of the scandal is unlikely to end here as the US Senate is putting on more pressure on the bank management, even calling the CEO to resign.
With Illinios and Chicago imposing banking sanctions on Wells Fargo, the worse case scenario will be when other states chooses to follow suit. The impact will be immense as it will equal to putting Wells Fargo out of business.
However, in my personal opinion, it is unlikely that the US Government will fully shut down Wells Fargo. It is one of the largest bank in the US and shutting down means the economy will be affected greatly. But it remains to be seen.
Valuation
From the June quarterly report, it was indicated that about US$770m came from the Bank’s Service Charges, while to Net Income was about US$5,100m. If we were to deduct all these earnings from the Net Income, the new quarterly Net Income will be US$4,330m. Hence, the new annual Net Income will be US$17,320m
This will give rise to an adjusted Earnings Per Share of US$3.43. The current PE for Well Fargo is ~11. Hence the estimated stock price is ~$37.73. The current stock price as of 1 Oct 2016 is $44.28.
Another point to note is the average PE of other banks. If we use the Big Four Banks, the average PE is ~10 to 11. This also shows that Well Fargo was previously trading at a premium above the industry average PE, and now it is trading at the average.
Perhaps a good entry will be below PE of 10?
Do your own due diligence!
See you next week!
Investing Always,
Pete
