Did Wells Fargo's Fake Account Scandal Hurt the Bank's Bottom Line?

By Markets Fool.com

Continue Reading Below

Image source: The Motley Fool.

Wells Fargo (NYSE: WFC) reported third-quarter earnings that topped expectations on both the top and bottom lines. While this is certainly welcome news to investors, the center of attention is still the bank's recently revealed fake accounts scandal, since this is the first earnings report since news of the scandal broke. Here's what we know so far about the effects of the scandal, and what Wells Fargo is trying to do to minimize any long-term damage.

What we learned from Wells Fargo's earnings

Wells Fargo generated $5.64 billion in net income during the third quarter, down from $5.80 billion in the same quarter last year, despite higher revenue and significant growth in the loan and deposit portfolios.

However, it doesn't appear that the bank's fake account scandal was the reason for the profit decline. In fact, the affected product lines were all up year over year. The bank has 4.5% more consumer checking accounts, even after including a small drop in September in the wake of the scandal, and more of Wells Fargo's customers now have a credit card with the bank. Rather, the main culprit simply appears to be a lower net interest margin of 2.82% compared to 2.96% a year ago.

Continue Reading Below

Having said that, there are a few things investors should know about the possible effects of the scandal:

  • Mortgage referrals from retail banking were down 24% from August to September.
  • Customer visits with bankers, account openings, and applications were down.
  • 30% fewer consumer checking accounts were opened in September than in August.
  • Customer visits with branch bankers declined 10% year over year.

I'm not too concerned about the drop in referrals and new checking accounts. This is to be expected in the wake of the scandal, and since the bank eliminated sales goals, and it shouldn't impact the bank's revenue long term in a meaningful way. Plus, a short-term drop in new business is natural while the scandal is still fresh in consumers' minds. While customer visits with branch bankers dropped, it's also important to mention that digital (online and mobile) banking sessions increased 13% year over year.

How the bank is fixing the problem

Also included in Wells Fargo's third-quarter earnings release was a list of steps the bank has taken to ensure the problem is corrected.

  • The bank has eliminated product sales goals for all retail banking employees as of October 1, 2016.
  • Customers will now receive an email confirmation about an hour after a deposit account is opened, and they'll receive an acknowledgement letter after applying for a credit card.
  • Wells Fargo is planning to contact all of its retail and small business banking customers in order to invite them to review their accounts with a banker.
  • The bank is identifying customers who may have unauthorized credit accounts to confirm that the customers want and need the cards.

In addition, the bank now has new leadership at the top. Chairman and CEO John Stumpf retired on October 12, 2016. The CEO position is now filled by former COO Tim Sloan, and board member Stephen Sanger is now non-executive chairman. The split of the CEO and chairman roles had been called for by regulators, and it should be viewed as a positive move by investors, as far as accountability is concerned.

It's important to mention that the bank's $185 million settlement is not the full extent of the financial risk, here. There will be an ongoing legal risk for some time, both in terms of lawsuits and additional fines from regulators, so this definitely needs to be taken into consideration before you consider investing in the bank.

The bottom line on Wells Fargo

Wells Fargo absolutely did a bad thing, but as I've written recently, the scandal is unlikely to have any significant or lasting effect on the profitability of the bank. Wells Fargo is still one of the best-run banks in the United States from a credit risk and efficiency perspective, and the bank's new leadership and corrective actions should help it to begin mending its damaged reputation.

In the meantime, the bank is trading for a discount of more than 10% compared to its pre-scandal price. To sum up how I feel about Wells Fargo as an investment, I think any effects (and potential effects) of the scandal are priced in and more, and now is a good time to get into one of the most profitable banks in the industry at a great price.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early, in-the-know investors! To be one of them, just click here.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. 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.