Con­ser­va­tive, reck­less sides of Wells Fargo

San Francisco Chronicle - - BUSI­NESS REPORT - THOMAS LEE

Wells Fargo’s ad­mis­sion that its em­ploy­ees cre­ated up to 3.5 mil­lion fraud­u­lent ac­counts sug­gests a reck­less, out-of-con­trol cul­ture.

But the San Francisco banking gi­ant seems to have a split per­son­al­ity of sorts. De­spite the free-forall be­hav­ior of its com­mu­nity banking di­vi­sion, the com­pany’s com­mer­cial busi­ness boasts a rep­u­ta­tion as one of the coun­try’s most con­ser­va­tive lenders to busi­nesses.

While branch em­ploy­ees ag­gres­sively pres­sured con­sumers to sign up for new sav­ings, check­ing and credit card ac­counts, whether they needed the prod­ucts or not, com­mer­cial bankers adopted a rel­a­tively stingy ap­proach to lend­ing

money to com­pa­nies. That strat­egy al­lowed Wells Fargo to avoid the same kind of bad com­mer­cial loans that wiped out many banks dur­ing the fi­nan­cial cri­sis a decade ago, the worst eco­nomic cri­sis in the United States since the Great De­pres­sion.

From 2009 to 2016, about 2.94 per­cent of the to­tal num­ber of loans in the United States de­faulted on av­er­age each year, ac­cord­ing to data from the In­ter­na­tional Mon­e­tary Fund. By com­par­i­son, 2.62 per­cent of Wells Fargo loans went bad in that pe­riod, in­clud­ing just 1.17 per­cent last year. It is un­clear what pro­por­tion of those loans were made to busi­nesses, and what pro­por­tion were made to in­di­vid­u­als.

Asked for com­ment, a spokesman for Wells Fargo re­ferred me to com­ments made Tues­day by CEO Ti­mothy Sloan.

“You don’t want to be­lieve that it’s go­ing to con­tinue for­ever, but geez, while it lasts, it’s ab­so­lutely ter­rific,” Sloan told an­a­lysts dur­ing the Bar­clays Global Fi­nan­cial Ser­vices Con­fer­ence. “And I think it re­flects not only a slow but steady growth in the econ­omy, but also some good credit de­ci­sions that have been made by my col­leagues over the last few years.”

Had Wells Fargo ap­plied the same due dili­gence to con­sumer ac­counts as it did to com­mer­cial banking, the com­pany might have avoided its cur­rent trou­bles. And now that pub­lic and reg­u­la­tory pres­sure has forced Wells Fargo to dial back its ag­gres­sive con­sumer sales tac­tics, the com­pany may find it hard to ap­pease in­vestors used to the bank’s stel­lar fi­nan­cial per­for­mances of re­cent years, said Richard Bove, a banking an­a­lyst with Ver­ti­cal Group.

“Wells Fargo can’t gen­er­ate the earn­ings they posted in the past,” Bove said.

In­vestors look for at least two things in banks: ro­bust sales growth, and strong credit qual­ity or low num­bers of bad loans. Wells Fargo seemed to hit both notes, prob­a­bly a rea­son why famed bil­lion­aire War­ren Buf­fett owns nearly 10 per­cent of the com­pany.

Nor­mally, a bank makes money at­tract­ing de­posits from con­sumers through sav­ings and check­ing ac­counts and then lend­ing those funds to busi­nesses at higher in­ter­est rates. In­deed, Wells Fargo was so suc­cess­ful at win­ning large num­bers of de­posits that the com­pany was able to fund its loans at rates 40 per­cent cheaper than com­peti­tors in North Amer­ica, ac­cord­ing to Morn­ingstar.

A bank might be tempted to lend out a lot of money be­cause it takes in a lot of de­posits. But Wells Fargo has never been an ag­gres­sive lender. The bank care­fully scru­ti­nizes the loans it makes, re­sult­ing in fewer de­faults than other banks.

What makes Wells Fargo’s per­for­mance even more im­pres­sive is that the bank had in­her­ited lots of bad com­mer­cial loans from Wa­chovia when it ac­quired the com­pany nine years ago at the height of the fi­nan­cial cri­sis. But Wells Fargo’s loan port­fo­lio con­tin­ues to en­joy su­pe­rior credit qual­ity.

How do we rec­on­cile th­ese reck­less/con­ser­va­tive sides of Wells Fargo?

For one thing, fed­eral reg­u­la­tors were not ex­actly keep­ing a close watch over Wells Fargo’s con­sumer busi­ness. Over the past two decades, the Of­fice of the Comptroller of the Cur­rency, which is charged with pro­tect­ing con­sumers, is­sued just 448 en­force­ment ac­tions against Wells Fargo, even as the bank’s to­tal as­sets have soared from nearly $200 bil­lion in 1998, the year be­fore its merger with Nor­west, to $1.85 tril­lion to­day.

The sheer size and de­cen­tral­ized struc­ture of the bank al­lows dif­fer­ent di­vi­sions to es­sen­tially act like sep­a­rate com­pa­nies, even though they all re­port to the same CEO and board of di­rec­tors, said Clif­ford Rossi, a for­mer chief risk of­fi­cer at Cit­i­group’s con­sumer lend­ing unit who now teaches fi­nance at the Univer­sity of Mary­land.

“Wells Fargo’s sales cul­ture over­heated in re­cent years.”

Jim Sine­gal, Morn­ingstar Inc. an­a­lyst

“You will find large com­pa­nies will ex­hibit pock­ets of sub­cul­tures,” Rossi said. “Each of th­ese busi­ness lines can be big­ger than some of the coun­try’s top 50 largest com­pa­nies on their own.”

That means com­mu­nity and com­mer­cial op­er­a­tions can boast com­pletely dif­fer­ent strate­gies and meth­ods of com­pen­sat­ing em­ploy­ees, Rossi said. In Wells Fargo’s case, branch em­ploy­ees would re­ceive more pay if they hit ag­gres­sive sales goals, prompt­ing them to open fraud­u­lent ac­counts.

“Wells Fargo’s sales cul­ture over­heated in re­cent years,” said Jim Sine­gal, an an­a­lyst with Morn­ingstar Inc. “Rather than at­tempt­ing to im­prove its cus­tomers’ fi­nan­cial lives, man­age­ment chose to in­crease rev­enue at all costs, in­tro­duc­ing ill-con­ceived in­cen­tive pro­grams for front-line em­ploy­ees. This de­ci­sion led to wide­spread fraud and risked re­la­tion­ships and rep­u­ta­tion built over decades.”

On the flip side, its low num­ber of bad com­mer­cial loans sug­gests the com­pany paid whole­sale banking em­ploy­ees based on qual­ity over vol­ume.

In any case, CEO Sloan and the board of di­rec­tors will need to get greater con­trol over the com­pany by adopt­ing a more con­sis­tent cul­ture across all of its di­vi­sions, whether serv­ing con­sumers or busi­nesses.

Scott Straz­zante / The Chron­i­cle

Wells Fargo CEO Tim Sloan says the com­pany’s growth re­flects some good credit de­ci­sions made by col­leagues.

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