Should the Latest Wells Fargo Developments Change Your Investment Thesis?

By Markets

The situation at Wells Fargo (NYSE: WFC) continues to deteriorate. Most recently, the bank announced that it would dial back cross-selling of financial products and services. This represents a dramatic departure from its long-time strategy.

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In this clip fromIndustry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield discuss whether or not this (as well as other facts that have come to light) changes the investment thesis onWells Fargo stock.

A full transcript follows the video.

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This podcast was recorded on Sept. 15, 2016.

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Gaby Lapera: Let's start with an updatewith what's going on with Wells Fargo,as of about an hour ago.

They said they'regoing to curb cross-selling. In case you don't remember, cross-selling isWells Fargo'spractice of offering customers products every time they come into the store. Sayyou going to deposit a check, they're like, "Oh, butdo you need a home mortgage today?" Orwhatever it is they try to sell you. They're dropping what they call "product sales goals" byJan. 1, and they've told people to stop selling for the time being, as well. This is a huge shift fromwhat they used to be like, right, John?

John Maxfield:That's right. One of thequestions, thinking about Wells Fargo and all the issuesthat they're having right now,from an investor's perspective, the question iswhether or not this changes the investment thesis on a stock. Andfor a while there,and I guess this is alltranspiring very quickly, because it was just revealed last week that it haddefrauded all these customers from 2011 to 2015, and they paid a fine.

But allthe regulatory fines and the things that Wells Fargo hasto do are pretty minimal,when you consider that this is a bank that earns $5.5 billion per quarter. So, it had a $185 million fine. That's just a drop in the bucket compared to how much it earns. So, unless any other shoes dropped,this really didn't fundamentally alter the fact thatWells Fargo is still one of the most profitable banks in the country. And it is still one of the most efficient banksin the country. It's still one of the best when it comes to managing credit risk.

So,the thesis was still intact,but these other shoes have started to dropthat are starting to erode that thesis. Andone of them is the fact that John Stumpf, the CEO,came out and said that they aresuspending the cross-sells offinancial products. Thisgoes to the absolute core ofone of Wells Fargo's competencies, and that is the ability to get the retail customersto use more Wells Fargo financial products than most other banks can gettheir customers to use. And that boosts revenue, it boosts growth, it ties thesecustomers in more tightly to Wells Fargo,making it harder for them to leave. So when you hear the CEO of Wells Fargo come out and say, "We're going to dial back cross-selling," while it has to do that in response to all the trouble it's in,it's really starting to cutdirectly into an investor's thoughtstoward Wells Fargo.

Lapera:Yeah. And to give you guysreference, we'refilming this on Sept. 15,and our initial show on Wells Fargowas on Sept. 12, and this hadn't come out whenwe filmed in the morning. So,in the last three days,this has happened,and these other things have also happened. Federal prosecutors areinvestigating to see if they should filea case against them. Andit's not just one.Wells Fargo has received subpoenas from threedifferent prosecutors' offices, which is a lot,and a little bit worrisome for them.

Maxfield:Yeah,and the rumor is,what federal prosecutors are looking for,they haven't decided if they're going to file a case,evidently, and alsothey haven't decided, if they do file a case,whether it's going to be civil or criminal. But the thing that they're looking at iswhether or not high-level executives at Wells Fargo knew that thousands of its employees were opening up to 2 millionunauthorized accounts for Wells Fargocustomers in order to boost cross-sells.

So,these are really difficult investigations,because you have to prove what, in law, we callscienter,which is that there was an intenton behalf of the executives at Wells Fargoto actually get behind this,as opposed to it being a group of rogueemployees, if you will. It's a really important thing,because if a number of additionallawsuits come out, it willfurther impact Wells Fargo'sreputation. And,presumably, they're also going to haveinvestor lawsuits againstthe executives. So you're going to have those; youcould potentially haveadditional fines fromthe federal regulator,for federal prosecutors. It's getting to be a much bigger issue thanit originally looked like it was going to be.

Lapera:And thisactually leads nicely into my next point. Guesswho said this quote: Are you ready, John?

Maxfield:I'm ready, go for it.

Lapera:"This was astaggering fraud. Come on,this went on for years andthey didn't smell anything in the airabout fake accounts?" she said. There's a hint.

Maxfield: Is thatElizabeth Warren?

Lapera:That isElizabeth Warren, who hasdemanded that Wells Fargo appear before the Senate's Banking Committee. John Stumpf hasagreed to testify. Just in case you don't knowanything about Sen. Elizabeth Warren ...there's no love lost between big banksand Sen. Warren. This isgoing to be a really interesting testimony. The House Oversight Committeehas also started demanding documents. I will tune into that.

Maxfield:Yeah,that's going to be a really interesting thing to watch. Let me add anotherelement to this.On last week's show, we really focused on Wells Fargo, and the misdeeds and the malfeasance that went on there. But, I think,to be fair,I think you have to step backand appreciate all the goodthat Wells Fargo brings to the table. Let me give you some specific examples. When you are thinking about banks,these are incrediblyimportant institutionsfor economic growth. They keep our capital,they make it possible to get loans, to invest that capital,which pushes economic growth. These are incredibly important things. And when you look at the nation's biggest banks -- Wells Fargo is the third largest bank -- it is arguably the safestand the soundest of them.JPMorgan Chase(NYSE: JPM)probably comes in a close second. But,that's important.Wells Fargo holds something like 10% of our nation's deposits. The fact that it is so good at credit risk,and so responsible in terms of keeping itscustomers' money safe -- that needs to be recognized and appreciated to offset some of this.

Lapera:That's fair.Wells Fargo is,from a federal perspective, a safe bank. It'snot going to go belly up anytime soon. But it has to shakeconsumer confidence in the bank -- and potentially the bank's businessif consumers start leaving -- that the bank was lying anddoing these things.

Maxfield:There's no excuse for whatWells Fargo did. But let me adda little bit more context behind this. If you go back to the financial crisis,the federal government pumpedtens of billions of dollarsintoBank of America (NYSE: BAC) andCitigroup(NYSE: C). It even did the samewith JPMorgan Chase, when the federal government went toJPMorgan Chase and asked it to, in effect, torescueBear Stearns. Well,JPMorgan Chase wouldn't do thatwithout a $30 billion loanfrom the federal governmentthat would cover any potential lossesfrom Bear Sterns.

Wells Fargodidn't need a bail out. It went into the crisis,it avoided the worst of the subprime mortgage mess, soit wasn't in that same type of dire situation. And as a result of that, whenWachovia was on the verge of failing,Wells Fargo was able to step in, buy that bankwithout any government assistance, andincorporate it into its model. That savedUnited States taxpayersmany billions of dollars. And keep in mind,before Wells Fargo stepped in to buyWachovia,which at the time was actually bigger thanWells Fargo -- it was a huge bank -- before it did that, Wachovia was going to be sold toCitigroup, of all banks.

Andit was not only going to be sold to Citigroup,but it was going to be sold to Citigroup --this is my understanding --after it was acquired, after the FDIC or the federal regulators stepped in and took possession of it. So,in that way, not only wouldCitigroup get it foran extremely inexpensive price,but the federal government would then be on the hook to coverpotential lossesfrom Wachovia.

The point I'm trying to make is: There is noexcuse for thesystemic fraud that took place at Wells Fargo between 2011 and 2015. However,we have to keep in mindthat this is an incrediblyimportant cog that actsresponsibly in a lot of other capacities,with respect to the economy.

Gaby Lapera has no position in any stocks mentioned. John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short October 2016 $50 calls on Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.