We have downgraded our stewardship rating for Wells Fargo WFC to Poor after more details emerged from two reports published by the U.S. House Committee on Financial Services, and Elizabeth Duke (the former chair of Wells Fargo’s board of directors) and James Quigley (another former board member) resigned. In the past, we readily admitted that pre-2016 stewardship at the company was lacking, but we kept our rating at Standard after the sales scandals became public because of all the changes occurring in management and on the board of directors. Part of our thesis on wide-moat Wells Fargo has been that the bank’s board and management would improve as the old members and executives were replaced. We believed that this would, over a reasonable period, lead to a rebuilding and a re-emergence of Wells Fargo as a better bank.
Given the information made public in the House reports, we can now see that our thesis was not correct. Board members like Duke, who came in after the sales scandals broke, were apparently just as bad as outgoing directors. It also appears that former CEO Tim Sloan was not even remotely up to the task, with very little progress made on his watch. We’ve had a difficult time explaining to investors why it was taking so long for Wells Fargo to satisfy certain consent orders; we now have a much clearer picture of what was holding things up. With part of our thesis about the bank seeing improvements in board oversight and management acuity (following the departure of such key characters as Carrie Tolstedt and John Stumpf) shown to be wrong, which throws into doubt the stewardship of the bank in general, we decided a downgrade of our stewardship rating to Poor was warranted. Additionally, given the uncertainty surrounding how long it will take for Wells Fargo to finally turn things around, we are increasing our fair value uncertainty rating to high from medium.
We still believe that our fundamental analysis of the franchises of Wells Fargo is largely correct. However, the longer it takes to right the ship, the more likely it is that these franchises could deteriorate to a point where permanent structural damage has occurred. This is especially true for the wealth and investment management segment. We also recognize that the longer it takes to turn things around, the more investors will lose money simply due to opportunity cost and the time value of money.
From a quantitative standpoint, we still think that Wells Fargo looks cheap. But time duration, potential further impairment of the franchises down the road, and managerial issues all raise significant risks for investors. In one of the reports released by the House committee, new details from the Office of the Comptroller of the Currency’s quarterly management reports on Wells Fargo were made public. These reports suggest that Wells Fargo is unlikely to satisfy the 2016 OCC sales practices consent order until September 2021. Also, the bank has not provided a timeline for when it will satisfy the 2018 OCC consent order. This suggests that this drama could drag on into 2022, with Wells Fargo unlikely to get its asset cap lifted in 2021 as we had originally hoped.
As for current management, we have not yet come across information that would suggest new CEO Charles Scharf is doing a poor job, and he may yet be the one to turn things around at Wells. But until he and his new slate of managers in place prove to us that stewardship at Wells Fargo has improved, we expect to maintain our Poor stewardship rating.