Buffett Probably Had Stumpf Fired, And That's Good For Shareholders

| About: Wells Fargo (WFC)
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Summary

John Stumpf resigned last week after saying he wasn't going anywhere.

Buffett has dealt with situations like this before, stretching all the way back to the Salomon Brothers Treasury Bond Scandal in 1991.

John Stumpf and the scandal is the bathwater and Wells Fargo is the baby.

This is a short term issue and should not substantially affect long-term valuations, unless there are further revelations of similar magnitude.

Or maybe he "encouraged him to resign", whatever the current term for important executives is. I have noticed that no one above a certain level is ever "fired", even if they completely fail in their supervisory duties. Consider what would happen to a loan officer who was caught opening fake accounts by himself. He would be out of a job as soon as the branch manager was 50% sure he was defrauding the system. And fired too, possibly criminally charged with fraud. Indeed over 5,000 Wells Fargo (NYSE:WFC) employees were fired for their involvement in this shameful scheme.

This is not a rambling screed about the evils of the powerful, simply a recognition that they are punished less and gain more. I truly believe that if this had been another bank, one where Berkshire Hathaway (BRK.B, BRK.A) was not the largest shareholder, Mr. Stumpf would still be at the top. He would be contrite, but secure in his place. He could say he "got us into this mess" and that he would be "the person to get us out of it". Five years later, when the stock price has recovered, he could step down with more stock options than when he started.

Actions speak louder than words

Warren Buffett is on record (literally, in a congressional hearing) saying:

"Lose money for the firm and I will be understanding. Lose a shred of reputation for the firm and I will be ruthless"

He said this while testifying to a congressional hearing on the Salomon Brothers Treasury Bond scandal in the 1990s. The context now is quite similar, not in regard to what happened, but in Warren's attitude toward it. Buffett recently said that he would wait until November to comment on the fraudulent accounts issue. Now we see that his actions are speaking for him.

Here is what we know so far: On 9/13 Stumpf was interviewed by Jim Cramer on CNBC. He refuted the idea that he should resign, which some people were talking about at the time. Warren Buffett watched the interview and called Stumpf the next day. In the call he told Stumpf he was disappointed with the interview and that the problem was bigger than Stumpf realized. Stumpf of course agreed. All of this was confirmed by Buffett directly, and partially by Stumpf who only mentioned that they had spoken.

On 10/12 Stumpf told the world he changed his mind about resigning. I think the timing here is quite significant. Clearly Warren Buffett's approval was significant in Stump's decision to resign. Why else would he change his mind less than a month after telling the world he wouldn't leave? Someone convinced him otherwise, and the most likely person is Warren Buffett.

I believe this is an indication that Buffett wants to take some more actions with regard to Wells Fargo. He may want to purchase more shares, but that requires Federal Reserve approval since they already own more than 10% of the company. Before Stumpf resigned this past week, I was on the fence on Buffett's stake. Everyone knows it's his favorite bank, especially because of its strong home loan department. But a loss of confidence among retail consumers might damage that brand. Why would you get a loan from Wells Fargo? They might open 10 accounts in your name and charge you fees that are impossible to dispute!

Now that Stumpf is gone, the new CEO has a strong mandate and incentive to change the culture at Wells Fargo. Analysts are not convinced, but I believe that Buffett is mostly satisfied. I'm sure he wants to see how new Tim Sloan solves the culture issue, but I doubt he will sell his stake now. Buffett uttered the quote referenced earlier while testifying as interim chairman of Salomon's board. He was offended by what they had done, but clearly saw past that to a brighter future. For Buffett, everything worked out. For others at Salomon, things weren't so rosy. Two members of their bond arbitrage department (John Meriwether and Merton Scholes) went on to found Long Term Capital Management, an even bigger failure of internal governance.

Valuation

As this story broke last week, many other writers commented similarly while others recommended caution. One author, curiously claimed "Stumpf didn't deserve this" since the "size of the problem was small" and "Wells has done great things for shareholders, the economy, and 95% of customer accounts." Most authors appear to have come down on the side of being cautiously optimistic.

The stock has fallen about 10% in the meantime, with some investors staying on the sidelines until they are comfortable all this is over with. WFC has only dropped to a PE ratio of 11. That is right in the middle of other large banks right now, and doesn't indicate a good buy by itself. We will have to wait until the Q4 results come out to see the full effect of the scandal on earnings. So the PE may rise back up slightly as Return on Tangible Common Equity (RoTCE) falls. The short term future is murky, and anyone who says otherwise is just guessing.

Long term, as long as Wells Fargo doesn't have any more "material events" that are expected to affect their stock price, they will be fine. Stumpf, who said during his congressional testimony that this did not represent one, was the material event himself. You can't brag "eight is great" specifically about accounts per customer and then say you had no idea something was amiss. It's either an admission of guilt or incompetence. Culture is a hard thing to change, but if anyone can get it done, it's Buffett.

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Disclosure: I am/we are long BRK.B.

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.