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Letting Go of Wells Fargo

By Jim Pearce on September 20, 2017

It was only six weeks ago that I reiterated my confidence that Wells Fargo (NYSE: WFC) would fully recover from an embarrassing scandal triggered by the admission a year ago that bank employees had opened approximately 2 million bogus deposit and credit card accounts over several years to achieve ambitious sales targets.

But another shoe dropped in late August, when the bank disclosed that it had discovered another 1.4 million fake accounts that had been overlooked during the initial review.

That’s a big “discovery” and difficult to dismiss as nothing more than an unintentional oversight. It calls into question either the management team’s integrity or its competence, both of which are critical to running a successful bank. It also raises the question as to which other product areas may have engaged in illicit behavior, such as the bank’s substantial (and lucrative) investment advisory operation.

Perhaps more so than any other major bank, Wells Fargo has built a fully diversified financial services institution that puts equal emphasis on traditional banking products and related services such as mortgage lending and investments. In 2016 the bank’s noninterest income, which consists of fees and other charges unrelated to the interest rate spread earned on its deposits and loans, accounted for 46% of its revenue compared to 54% from net interest income. Of that amount, 35% comes from trust and investment fees.

That means roughly 16% of the bank’s total income derives from an area of the business presently excluded from the bogus account scandal that has engulfed its banking and mortgage operations. To be clear, no one yet has accused the bank of anything shady in its investment unit, but it is not unreasonable to fear that the same top-down sales mentality that poisoned some of the bank’s largest revenue generators may have also infected one of its other big money makers. If that turns out to be the case, WFC could be in for a beating. It’s time to pull the plug on WFC now while we still have a sizable gain in it.

There are many good reasons to sell a stock, not the least of which is an unreliable senior management team. Poor management is not something that can be easily quantified like revenue or earnings, but in the long run it is perhaps the single most crucial element to the success of an enterprise. Indeed, one of Warren Buffett’s key criteria for choosing a stock is the quality of the company’s management.

Of particular frustration with Wells Fargo is the needlessness of its reckless behavior. The relatively modest benefit that might have been realized from its overly aggressive behavior is greatly outweighed by the cost of rectifying the damage incurred.

In some cases, there simply is no immediate fix to the punishment being levied against Wells Fargo. The bank has been barred from underwriting municipal bond offerings in several states and acting as custodian for many state-administered retirement plans, and may soon find itself subject to a new round of sanctions once the details of its most recent admission have been parsed by regulators.

I don’t like reversing course on a stock so shortly after giving an “all safe” call, but this most recent revelation is too disturbing to ignore. Up until then, I believed Wells Fargo was a good bank that made a dumb mistake that would never be repeated. However, this latest development calls into question the bank’s fundamental integrity. Sell Wells Fargo.

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