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FBR: Wells Fargo’s next move is critical, for the bank and for the industry

CEO John Stumpf to face grilling on Capitol Hill

What happens over the next few days will go a long way to determining how well Wells Fargo, and the banking industry as a whole, will weather the storm currently swirling around the megabank from the “widespread unlawful” practices of more than 5,000 former employees who opened more than 2 million fake accounts in order to get sales bonuses, analysts from FBR & Co. said in a note Monday.

As reported last week, Wells Fargo’s CEO, John Stumpf, is due to testify before the Senate Banking Committee this week to discuss the bank’s actions that led to a $185 million fine being levied against the bank over a fake account scandal that shook up the banking industry.

In a note to clients, FBR analysts Edward Mills, Paul Miller, Tim Hayes and Ian Swanberg write that Stumpf’s testimony could prove to be a turning point for Wells Fargo and the industry as a whole.

The only question is what direction that turn will take.

According to the FBR analysts, a strong performance from Stumpf would obviously be a positive for the bank, while a poor performance would “intensify calls” for Stumpf to resign.

“Stumpf and Wells Fargo should prepare for Tuesday’s hearing before the Senate Banking Committee as if it was the immediate aftermath of the financial crisis, rather than use the ‘London Whale’ hearings and testimony of Jamie Dimon as a guide,” the FBR analysts write.

“We are right before a critical election, where the majority in the Senate is very much in play and no member wants to be perceived as siding with a ‘Wall Street bank’ over the average consumer,” the analysts continue.

“We believe Mr. Stumpf needs to go into the hearing taking full personal responsibility for the enforcement action, announce that he will not be taking a bonus this year (or work for $1), and outline which other senior executives have been penalized or fired and what compensation has been clawed back,” the FBR analysts write. “Any attempt to lay blame on ‘rogue employees’ will likely backfire. This hearing cannot be about a debate over a toxic culture versus too big to manage.”

As the FBR analysts note, Wells Fargo is also now facing investigations from the House Financial Services Committee and the Department of Justice.

Combine those investigations with the Senate inquiry, plus the original discipline from the Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency, and it shows that the banking business is nowhere close to being out of the crosshairs yet.

“Beyond the impact to Wells Fargo, we believe this enforcement action and congressional reaction are warning signs for the banking industry as a whole,” the FBR analysts state. “Banks and executives need to recognize that six years post passage of Dodd-Frank, the law continues to get stronger, and no real meaningful rollback appears on the horizon.”

That’s despite the best efforts of the Republicans on the House Financial Services Committee, who last week passed a new bill out of the committee that would abolish Dodd-Frank.

The bill, which would significantly and substantially change the financial regulatory landscape, is highly unlikely to pass out of the Senate, if it even gets that far, and even less likely to avoid a veto from President Obama.

The bill’s improbability of passage signifies the prevailing view that still surrounds the banking business in the aftermath of the financial crisis, the analysts suggest.

“Conduct and sales practices of banks are under more scrutiny than many appreciate. Anti-bank populism is very popular among the bases of both political parties, providing little room for error in the financial services industry and considerable political cover to regulators,” the analysts write. “New regulations are aimed at always maintaining the best interest of consumers when selling financial products, consistently raising the capital standards for the largest institutions and making it harder for the largest banks to earn their cost of capital.”

As for Wells Fargo, the analysts also suggest that the looming DOJ investigation comes at a particularly unfortunate time.

“(The DOJ investigation) comes at a politically inopportune time for Wells, as there is real frustration over the lack of individual prosecutions by DOJ following the financial crisis,” the FBR analysts write.

“The difficulty proving the case and winning convictions has generally been the reason given for DOJ and other prosecutors shying away from similar cases,” the analysts continue. “The threat of potential DOJ action adds an extra layer to any crisis management response by Wells and places more scrutiny on senior executives than in past enforcement actions.”

And all of that makes this week critically important for both Wells Fargo and the industry as a whole.

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