Wells Fargo: Unlike The Rest?

Includes: WFC
by: John M. Mason


Wells Fargo has just gone though an embarrassing experience in the public.and Congressional.exposure of some of its shortcomings.

Wells Fargo was thought to be different from other big banks, less prone to innovate into exotic financial instruments, more conservative, performed better through the Great Recession and subsequent recovery.

Management of Wells Fargo was certainly at fault for allowing such things to happen, but they were subject to the same pressures to grow and perform as other big banks.

Coming through the Great Recession and the following economic recovery, Wells Fargo & Company (NYSE: WFC) performed as well as anyone.

One reason given that the bank did so well, it was argued, was that it had not gone wild over the financial innovation that entrapped so many of the other large banks and drove them into excesses of financial engineering.

Wells Fargo was the most conservative of the larger bans and, coming out of the Great Recession, performed better than its competitors.

In fact, Wells Fargo was expected to be the first of the major banks to return to earning a 15 percent return on shareholder's equity, the benchmark for high performers before the onset of the financial crisis.

In 2006 and 2007, Wells Fargo posted numbers for its ROE of 18.5 percent and 16.9 percent. It was right in the race for high performance.

It ROE dropped off during the Great Recession, but then rebounded better than others and posted an 11.3 percent return in 2011. By 2013, the return was up to 12.9 percent and it looked as if the bank was sure to get up to the 15 percent level in the very near future.

That is when things started to go "not so well" for the big bank.

Returns leveled off as troubles mounted and now Wells Fargo faces the possibility that its ROE in 2016 and 2017 might be around the 10.0 range.

Not bad, but certainly better things were expected.

Of the large banks, Wells Fargo has certainly stayed more like banks used to be than any of the others. It has built a major business out of the mortgage business and has continued to emphasize consumer and customer relationships as the builder of business. It tends to be quite conservative in its lending standards and portfolio management.

The result of this conservatism shows up in the fact that the bank's allowance for loan losses is down to 1.33 percent of loans in the second quarter compared to 1.42 percent a year earlier and its ratio of nonperforming assets is now at 1.37 percent, down from 1.62 percent a year earlier. These numbers are quite good by industry standards.

This has been a big reason why the bank has been able to continue to per form as well as it has in spite of all that has been going on and how other institutions have been acting.

Recently, I have stayed away from the current upheaval going on at the bank, the "cross-selling" flap, the congressional hearing, and all the finger pointing and all else.

Certainly, Wells Fargo needs to be called to account and I believe that current Chairman and CEO of the bank, John Stumpf did the right thing by assuming full responsibility for what the bank had been doing.

Right now, I am not going to delve into what should be done to the bank itself and to what penalties should be assessed to Mr. Stumpf and other executives of the organization.

There is no question wrong was done and there should be consequences. It has always been my belief that the CEO of an organization is responsible for the culture of that organization. If something of a major nature happens, like the widespread nature of the cross-selling fiasco, the CEO should be held responsible for the culture that created the problem.

What I am concerned about right now, however, is the future of the banking industry. Although Wells Fargo did not pursue some of the paths that the other major banks did, it did create an environment in which extreme, destructive behavior resulted.

And, although this behavior may not seem as extreme as what some of the other large banks did, it was, in my mind, a result of the same mentality, a mentality crafted in a highly competitive, highly driven situation that was not entirely the fault of the banks, themselves, or of the banking industry.

Banking in the 1950s was kind of a sleepy, well-regulated industry that generally drew talent that was not necessarily the best around. The joke was that a family had three sons: one son was extremely intelligent and very talented and he became a doctor; another son, was not quite the equal of the first son mentioned, but smart and capable, and he became a lawyer; and the third son, who lagged both in terms of brains and all other abilities, became a banker.

This all started to change in the 1960s as world trade began to pick up and the US government moved into the business of achieving low rates of unemployment through fiscal and monetary stimulus, through credit inflation.

By the end of the decade, inflation was becoming a problem and smart investors began to take advantage of inflation by speculating in houses, gold, and other assets that could rise in value.

The world became one in which people and businesses moved more and more into risk assets, substantially increased financial leverage, and engaged in major rounds of financial innovation.

The larger commercial banks, in order to compete with rising competition, not only from other banks but also from non-banks, moved their business more and more into the realm of exotic finance with all kinds of different acronyms.

Wells Fargo did not move as far along this scale as others did, but the competitive banking environment created by the government's credit inflation forced it to push in other directions getting business and lowering costs so as to post exceptional returns.

As is obvious from the results posted by Wells Fargo, it did very well.

However, some of the things it did were on the edge but were not noticed in the way that the practices of other banks were. Wells Fargo stayed under the radar as regulators focused on the new instruments banks created and the investment banking practices that expanded as the Glass-Steagall Act was repealed. But, Wells Fargo was pushing a limit as well.

I am not suggesting here that Wells Fargo management should be excused for what it did. I am suggesting, however, that the US government also had a role in the problems of the banking industry because of the economic and financial environment it created, beginning in the 1960s and continued through to this day.

In the current situation, the commercial banking industry is facing a very difficult future. Not only is it facing increased scrutiny from Congress and the regulators, it is facing a major technological disruption that is going to re-draw the map of the financial industry. This disruption is due to the information technology revolution. So, Wells Fargo and the banking industry have a substantial transformation to go through and I am not sure that anyone is really prepared to do it.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.