Buying into Charlie Scharf's 5-year turnaround plan for Wells Fargo just got a bit cheaper

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When Charlie Scharf took the reins at Wells Fargo five years ago, the bank was in turmoil. A series of scandals landed it in the regulatory doghouse — dealing a major blow to the 172-year-old firm's reputation and leading to a multi-billion-dollar plunge in its stock market value. Fast forward to 2024: Wells Fargo looks like a different bank altogether — and despite Friday's post-earnings decline, the turnaround is still humming. Wells Fargo tumbled more than 6% to under $57 per share after missing expectations on quarterly net interest income (NII), a key measure of lending profitability. Investors on Friday were more concerned about NII weakness than overall second-quarter revenue and earnings per share (EPS) beats. Management's drive under Scharf into fee-based businesses such as investment banking helped offset softer NII. However, since investment banking revenue is tied to compensation, the bank had to raise its expense outlook for the year. That's a good problem to have. In Friday's earnings commentary , the Club upgraded Wells Fargo back to our buy-equivalent 1 rating — viewing Friday's drop as an opportunity to add shares. Expansion into new markets has been a hallmark of Scharf's tenure, along with an overhaul of senior leadership and an improved standing with regulators. Taken together, it shows just how far the CEO has gone to rehabilitate Wells Fargo. Investors have taken notice. Despite Friday's setback, shares of Wells Fargo are still up more than 15% so far this year, compared to 13% for the KBW Nasdaq Bank Index , which tracks the performance of major U.S. banks. Since Scharf was announced as CEO in September 2019, Wells Fargo shares gained 12.5% — on par with the banking sector. The stock hit a multiyear high of $62.55 per share in May, which was only a few dollars off its January 2018 all-time record close of nearly $66. "Scharf has done an incredible job fixing up Wells Fargo," said Jeff Marks, director of portfolio analysis for the CNBC Investing Club. "Before he joined, the bank had a bloated cost structure, lagged in technology, and suffered from a horrible reputation. Scharf and his team have right-sized costs, invested in tech, and materially enhanced the bank's risks and controls." A big part of Scharf's job has been moving the company through all the regulatory hurdles that were put in place after the scandals of the late 2010s. In 2016, Wells was found to have opened millions of unauthorized bank accounts under customer names as employees tried to meet high-pressure sales goals. Just a year later, the bank was accused of charging hundreds of thousands of people for auto insurance they did not need, many of which resulted in delinquencies. Among those affected were active duty military service members. That same year, Wells Fargo admitted to improperly charging home lending customers for mortgage-rate-lock extensions as well. WFC YTD mountain Wells Fargo (WFC) year-to-date performance The Federal Reserve ordered Wells Fargo to freeze its balance sheet in 2018, keeping its assets below $1.95 trillion until senior management cleaned up its act. The most recent sign that Scharf is repairing that damage came in February when the company cleared a major regulatory hurdle tied to the 2016 fake accounts scandal. The bank said in a release that the Office of the Comptroller of the Currency terminated a consent order, or penalty, that forced it to change how it sells its retail products and services. This was a "huge accomplishment" and another big step toward removing the Fed's asset cap, said Bank of America analyst Ebrahim Poonawala. "As we know, getting regulatory issues resolved is not an easy task for large organizations, and I think that if the bank can get out of the asset cap over the next year or so, that will be a big boost of additional credibility for Charlie and his leadership," he added. The asset cap places a constraint on Wells Fargo's growth by prohibiting the bank from doing more lending and, in turn, increasing interest incomes. It also keeps the bank from acquiring other high-growth companies or making strategic investments that could increase its assets beyond that nearly $2 trillion threshold. To be sure, Scharf and Wells are not out of the woods yet. The bank has cleared six of 14 consent orders from the Office of the Comptroller of the Currency. While they don't all need to be cleared before the U.S. central bank lifts the cap, more progress is still needed. During a banking conference in May, Scharf said Wells had eliminated the aggressive sales targets and certain incentive plans at branches that initially spurred bad behavior. The bank has also paid billions to regulators over the years. In 2022, the Consumer Financial Protection Bureau ordered Wells to dish out $3.7 billion alone for violations across its auto loans, mortgages and deposit accounts. But ultimately, it's up to the regulators to decide if the cap will be removed. "We have to close these orders. We have to build the controls and make them part of the company," Scharf said. "So, we're not declaring victory." In addition, Wells Fargo's investment banking business, while growing, is small in comparison to the other banking behemoths that also reported Friday. Revenue from Wells Fargo's investment banking segment in the second quarter jumped 38% year over year to $430 million. JPMorgan Chase 's investment banking revenue surged 46% to $2.5 billion. The Club's other bank, Morgan Stanley , also has a bigger investment banking division. It reports earnings on Tuesday. There's still a lot to celebrate, however. Wells Fargo parted with most of its senior management from its pre-2019 era and remade its board of directors. Eleven out of the 15 members on Wells Fargo's senior leadership team have joined since Scharf assumed his role. The same goes for six out of the 13 board members for the financial behemoth. Poonawala said the new hires will help change the company's culture and build back its reputation for honesty and trust. "I think not having sort of a lot of intense legacy [in management] helps," he said, adding: "If you look at the org structure, most of these executives are new to the bank during his operating committee. When you look at the turnaround and how this plays out, he's been able to attract a lot of high-quality talent from competitors, and I think that helps" when fixing a company. Scharf's plan to move Wells beyond its traditional lending roots is also well under way. A CNBC analysis in late May found that Wells Fargo made at least 17 senior-level hires in its corporate and investment banking (CIB) division since the start of 2023. Under Scharf's leadership, the bank has poached top talent from Wall Street peers like Scharf's former employer, JPMorgan Chase. For example, Doug Braunstein, an M & A veteran who spent nearly two decades at the bank, joined Wells Fargo as vice chairman in February to oversee its corporate finance and advisory businesses. "Wells Fargo has historically been known as more of a mortgage bank, but they've taken some measures to reduce their sensitivity to the mortgage environment," Raymond James analyst David Long said in a recent interview. "Charlie and his team brought in several high-ranking bankers in the investment banking arena, and we're starting to see positive results in that regard." He added: "The higher-for-longer [interest rate] environment is not conducive to more M & A and other investment banking transactions, but if rates do start to come down, we're likely to see a pickup in that business, which Wells would be a beneficiary of." Thursday's cooler consumer inflation report boosted the case for the Fed to start cutting interest rates, with market odds growing for as many as three cuts by year-end. An expansion into investment banking is beneficial for Wells Fargo because it allows the firm to rely less on interest-based revenues, which are at the mercy of the Fed's monetary policy. Remember, management forecasted a NII decline between 7% to 9% for fiscal year 2024, and second-quarter earnings on Friday showed that it will likely come in at the top of that range. This is because customers are moving their funds to higher-yielding products as rates stay higher for longer. Instead, fee-based incomes — like those from advisory costs on M & A deals and other IB transactions — are a more durable and less volatile revenue stream. "We continued to see growth in our fee-based revenue offsetting an expected decline in net interest income," Scharf said on Friday. "The investments we have been making allowed us to take advantage of the market activity in the quarter with strong performance in investment advisory, trading and investment banking fees." Marks said the exec's strategy is "really working," citing the second-quarter's 19% year-over-year increase in non-interest income, which handily beat expectations. "Fee revenues were fantastic, we continue to see Charlie Scharf really make a really big push into this. He's gone on a hiring spree lately, hiring a lot of ex bankers throughout the industry," Marks said on Friday. "He wants to make the bank less tied to the yield curve and more tied to the sticky fee-based revenues, but it's going to take time." (Jim Cramer's Charitable Trust is long WFC, MS. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED. Charlie Scharf, CEO, Wells Fargo, speaks during the Milken Institute Global Conference in Beverly Hills, California on May 2, 2023. speaks during the Milken Institute Global Conference in Beverly Hills, California on May 2, 2023. 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