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Wells Fargo mired in one of the most sordid scandals

Filed on September 18, 2016
Wells Fargo mired in one of the most sordid scandals
Wells Fargo bankers opened more than two million unauthorised accounts without the knowledge of clients to meet sales targets.

(AP)

Wells Fargo was, until last week, America's most valued money centre bank, the crown jewel of Warren Buffet's investment portfolio, a model of corporate excellence whose pedigree goes back to the rise of San Francisco as a financial hub in the 1850s after the California gold rush. Yet Wells Fargo is now mired in one of the most sordid scandals in post 2008 global banking. Wells Fargo retail bankers opened more than two million unauthorised accounts without the knowledge of clients to meet sales targets. The bank has fired more than 5,300 employees (its retail banking empire, called the Community Bank, has a payroll of 100,000) and its CEO John Stumpf, Mr Clean of banking will be grilled by a hostile Congress in the Senate. The bank's shares have plunged from a 52 week high of 56 to 46. While Goldman's Blankfein survived the Abacus CDO and J.P. Morgan's Jamie Dimon survived the London Whale scandal, Stumpf's scandal comes amid an election season where Big Banking is in the crosshairs of both Mrs Clinton and Trump. Wells Fargo has paid $185 million to settle charges but I can easily envisage criminal charges of property/identity theft against supervisors in the bank's California branch network.

Warren Buffett owns 10 per cent of Wells Fargo, the biggest mortgage lender in the US that avoided the capital markets losses and toxic derivatives disasters of 2008. Wells Fargo has agreed to end its controversial incentive linked sales target and cross-selling strategies that led to this scandal. The fired retail bankers opened unauthorised accounts to hit sales targets and receive bonuses. It does not help Wells Fargo's public reputation that Carrie Tolstedt, the head of retail banking, has taken home $125 million in compensation. An executive pay clawback as mandated by Dodd Frank is now inevitable, as was the case in J.P. Morgan's London Whale trading scandal.

It is entirely possible that Wells Fargo will have to pay much higher fees before this scandal is over. The bank's decision to eliminate incentive based product sales goals and cross selling targets will also hit its formidable retail banking revenue generation machine. After all, retail banking is 57 per cent of total revenue and 60 per cent of pretax income for Wells Fargo, the reason it enjoyed such a valuation premium in the stock markets. Carrie Tolstedt will not survive but the Senate Banking Committee could demand a wholesale purge of senior executives at the bank. The bank has faced huge reputational damage with investors, regulators and customers. This will distract senior management from new growth initiatives. I would only become interested in Wells Fargo shares if the bank falls to 40. It is impossible to quantify the legal bill and reputational damages the bank will face as Elizabeth Warren grills CEO john Stumpf in the Senate and the global media.

United Technologies (UTX) is one of the world's most highly respected industrial conglomerates, the owner of such iconic brands at Pratt and Whitney aircraft engines, Otis elevator and HVAC systems. At 100, the bank trades at 14.5 times earnings based on a consensus 2017 estimate of $6.92 EPS. The company beat second quarter Street estimates thanks to stellar results in its Climate Controls and Security units, a business that generates 20 per cent plus operating margins and is the firm's growth engine. The shares have sagged due to exposure to the UK, European and Chinese building markets. However, I doubt if there is more than $7 downside in the shares even if Wall Street gets ugly in October. This means downside at UTX is limited to 94 or 13.4 times forward earnings at a time when management is poised to raise guidance and implement a share buyback that could be at least three per cent of market capitalisation.

United Technologies is a global industrial colossus because 45 per cent of its $56 billion revenue is recurrent and CEO Greg Hayes divested Sikorsky Helicopter for $9 billion to boost shareholder returns via buybacks. With a dividend yield of almost three per cent, this Dow 30 stock is in the value zone. A 94-120 trading range means the enables myriad money making options based strategies.

Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager.

 


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