When Price per Share Considerations Disorient Rational Thought
November 12, 2016
By: Larry Martin
Thinking about the Wells Fargo* cross-selling, sales quota situation reminded me of a situation when I first started consulting three decades ago.
My first bank client was the largest bank in a multi bank Colorado holding company (BHC). Colorado did not allow branch banking at the time and our client, like all other banks in the state, was a single location unit bank. The BHC was publicly traded. The client bank had historically experienced strong asset growth and profitability. This was driven by a strong local economy and significant oil extraction development activity in its service area.
A large national petroleum company announced in July it was stopping all development and operations in the area ASAP. Shortly, other extraction industry firms followed suit. The client bank hired our firm to help them evaluate their options and to help them define an appropriate strategy.
In working with the client and using data from a similar withdrawal of an economic driver a couple of decades earlier, the team identified the likely economic impact the current situation would cause, its impact of real estate values, impact on population and on loan quality and demand.
The expected withdrawal of petroleum operations and the associated job losses would produce a 30% plus decline in population with associated implications to businesses and real estate values. The ability of commercial and household borrowers to repay debt would be severely stressed.
As you would expect, the bank chose a capital preservation asset quality strategy. The bank strengthened the requirements for new loans dramatically, ALLL levels were ramped up in anticipation of future losses, and reducing asset levels and non-core deposits were goals; all focused on maintaining strong capital levels.
The President of the bank traveled to the holding company headquarters in Denver to share the situation and strategy with them. After he made his presentation to the BHC leadership group, the BHC CFO said, in essence, "You are the largest bank in our holding company. We can't go to the investment bankers/analysts and tell them our largest and most profitable bank is going to shrink in assets and not contribute to the earnings of the BHC." He went on to add they expected the bank to continue to grow assets and contribute earnings.
Long story short, after a change in bank President to continue asset growth, the BHC finally arrived at the asset preservation asset quality strategy, two years too late. My point is that trying to satisfy the needs/expectations of those that recommend stocks sometimes blinds management teams to doing the right thing.
Back to Wells Fargo. From what I read, Wells knew for some time there were issues of fudging of sales, they also knew that the investment bankers/analyst lauded the strong-cross sales results of the bank. So put yourself into the leadership team of Wells, what are your options when the fudging is discovered. 1. Rationalize as a few rogue employees and try to stamp it out/minimize it by hiring consulting firms to identify the problem areas (keeps the investment bankers happy), 2. And, as the fudging continues on for years, recognize that sales goals (quotas) might be a problem that need to significantly rethought (puts investment bankers on alert and could cause a stock recommendation problem)? We know what they chose.
Granted there are other options to consider. The point is that once the expectation was created with the market makers on service per customer and "eight is great," it was baked into the mindset of bank leadership as the thing to do. After all, the investment bankers/analysts like it, it must be good. Keeping investment banks happy is good for the price per share. (I won't get into the implications to leadership incentive compensation.)
Kind of like my client's BHC leadership that could not accept that their largest bank needed to shrink assets and conserve capital. Accepting that reality would have likely decreased the price per share. Instead, the BHC ignored the facts, continued business as usual, and only recognized the situation rationally when regulators forced them with a Formal Agreement. Price per share considerations can disorient rational thought. Just saying.
*Neither Bank Strategies LLC or I have any direct knowledge of the Wells Fargo situation. They have never been clients of our firm.
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