Wells Fargo Leaves a Potential Smudge in Squeaky Clean

(Bloomberg Gadfly) -- Wells Fargo is having its annual meeting on Tuesday, and CEO Tim Sloan is expected to reiterate, as he did in his most recent interview with Businessweek, that the bank's cultural and regulatory problems are behind it.

Sloan provided some evidence for that argument last week when the bank paid a $1 billion fine to regulators to close an investigation into abusive practices in its auto lending and mortgage unit. In announcing the settlement, Sloan said, “For more than a year and a half, we have made progress on strengthening operational processes, internal controls, compliance and oversight, and delivering on our promise to review all of our practices and make things right for our customers.” 

Wells Fargo Leaves a Potential Smudge in Squeaky Clean

But a look at one of its lending businesses suggests that exposure to questionable practices isn’t so much an oversight as a business decision. Wells Fargo, according to reports over the past few years, is by far the largest lender among the big banks to payday loan companies and others that make high-interest loans to subprime borrowers, including some that regulators have accused of predatory practices.

And while other big banks have pulled back from the business because of credit or regulatory concerns, there is little evidence Wells Fargo has reconsidered its role as a funder of subprime lenders. As recently as last May, for example, Wells Fargo waived a provision that would have allowed it to cut off credit to FirstCash Inc., which is one of the largest pawn shops and subprime lenders, as well as a gun retailer, in the country. Instead, Wells Fargo extended its line of credit until 2022. Just a few years ago, JPMorgan Chase had been the largest lender to FirstCash, but Wells Fargo's amended lending agreement no longer shows JPMorgan, or any other of the nation's biggest banks, among FirstCash's sources of new cash.

Banks don't have to report how much they lend to subprime lenders, which falls broadly into the category of nonbank lenders. Wells Fargo, at the end of last year, had by far lent the most to nonbank lenders, with $81 billion in outstanding loans. Citigroup was the bank with next largest exposure, with just $30 billion outstanding.

Wells Fargo Leaves a Potential Smudge in Squeaky Clean

In terms of credit risk to the bank, Wells Fargo's overall subprime portfolio is relatively small, and it stands to lose less by lending to companies that lend to subprime borrowers rather than doing it directly. Wells Fargo, like the other big banks, has curtailed its direct lending to subprime borrowers. What's more, as my fellow columnist Matt Levine said recently, just because you lend to a hardware store doesn't mean you are in the hardware business

Still, lending to hardware stores or other businesses is different from lending to subprime lenders, an industry that has repeatedly been found to take advantage of its customers and drawn regulatory scrutiny. And Wells Fargo's involvement in the subprime lending space could expose the bank to more trouble. In February, U.S. Bank was fined $613 million for violating the Office of the Comptroller of the Currency's anti-money-laundering rules. The violation was in large part related to U.S. Bank's relationship with a subprime lender owned by former race car driver Scott Tucker, who was sentenced to 16 years in jail in January. Wells Fargo asked recently for an extension of a deadline to comply with the same rules.

In a statement to Bloomberg, a Wells Fargo representative said, "We do business only with companies that have demonstrated a strong, ongoing commitment to complying with all laws and regulations. Our total loan commitments to these customers represent a very small percentage of Wells Fargo's commercial lending portfolio. In addition, Wells Fargo exercises strict, enhanced due diligence with customers in the payday lending space to ensure that they do business in a responsible way and meet the highest standards. We continue to be highly selective about the companies to which we provide services in the sector."

Nonetheless, it appears Wells Fargo has been about as careful in choosing subprime lenders with which to do business as it has been monitoring its own behavior. Last month, California fined both Advance America and Check Into Cash for borrower abuses, including bait-and-switch and flat-out lying. Both appear to have been borrowers of Wells Fargo, according to a 2010 report from consumer advocacy group Public Accountability Initiative and a more recent one from Minnesotans for a Fair Economy, though it's not clear if either still is. In 2013, Wells Fargo was the largest lender to Cash America Inc., a subprime lender that was fined that year for violating the Military Lending Act. Like FirstCash, JPMorgan has been a lender to Cash America, but dropped it in early 2013. Cash America is now owned by FirstCash.

Wells Fargo also appears to be the largest lender to World Acceptance Corp., according to a 2015 report from another consumer advocacy research group, Reinvestment Partners. World Acceptance was until recently under investigation by the Consumer Financial Protection Bureau. Acting director Mick Mulvaney dropped the probe in January, drawing ire from consumer advocates in part because Mulvaney had received political donations from World Acceptance when he was in Congress. A 2013 ProPublica investigation into World Acceptance found that the company trapped borrowers in high-interest loans.

If a bank wants to boost its lending profits, there are a number of ways to do it. One is to take on more credit risk, like Citigroup appears to be doing with its expansion into credit cards. Another is to take on more regulatory risk, like Wells Fargo. Sloan wants to paint the bank's regulatory missteps, and the resulting fines, as the actions of a few bad apples that have seen been picked clean from the bank. But Wells Fargo has had regulatory problems in part because lending to industries with more regulatory and reputational risk is part of its strategy and business model. It may result in higher profits, but it’s not a risk that has been wiped out entirely.  

Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

To contact the author of this story: Stephen Gandel in New York at sgandel2@bloomberg.net.

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