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-for-all 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.
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 banking 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.
“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.