The leak of confidential supervisory information about Wells Fargo's examination rating is fueling speculation that further regulatory action may soon be taken against the San Francisco megabank and raising renewed questions about its regulator's oversight.

A recent report said that the management component of Wells' Camels rating — one of the most subjective parts of the test — had been downgraded to 3 in mid-2017, a warning shot to management indicating ongoing supervisory concerns or weakness.

"If there's been a management downgrade, the reasons have been articulated to management and there are issues and remediation steps they are expected to take to get out of the trap," said C.K. Lee, a managing director at Piper Jaffray and a former regulator with the Office of Thrift Supervision and the Federal Deposit Insurance Corp.

A man uses a Wells Fargo ATM inside a branch in New York.
The downgrade has also put the spotlight on why the OCC took so long to reflect Wells Fargo's problems in its exam rating. Bloomberg News

Both Wells and the Office of the Comptroller of the Currency, the bank's primary regulator, have declined to comment on the disclosure made in The Wall Street Journal. But the very fact that it was leaked at all was seen as a bad sign. Banks are prohibited by law from disclosing their Camels rating, making it a federal crime.

Industry analysts said it's clear Wells is being closely scrutinized.

"Senior supervision personnel are going to be looking at the bank more closely and maybe stumbling across other problems," said Bert Ely, an independent analyst in Alexandria, Va. He said a downgrade in the management component to a 3 is "a bright, flashing caution light."

The management component is just one part of the Camels test, which is an acronym for the six essential components looked at by regulators to rate a bank's financial condition: Capital, asset quality, management, earnings, liquidity and sensitivity to market risk. The scale runs from 1 to 5, with 1 being the best score and 5 indicating a bank with severe problems. The downgrade of the management component for Wells could mean risk management practices may be considered less than satisfactory relative to the megabank's size and complexity.

The bank says it is working on correcting any problems.

"At Wells Fargo, we are very focused on prudent and effective risk management and continue to enhance our risk infrastructure and organization," said Richele J. Messick, a Wells spokeswoman.

Richard Parsons, an author and retired Bank of America executive, said Camels ratings are one of the most protected pieces of information about a bank. He considers the leak a red flag.

"This is not the first leak," Parsons said. "People are talking about the management component, but another question is whether the controls in governance [are] so broken at Wells that they cannot control the dissemination of highly confidential information."

(It is not clear where the leak originated—whether from parties connected to Wells or the OCC.)

Karen Shaw Petrou, managing partner at Federal Financial Analytics, said the situation is another reminder of why Camels ratings shouldn't be confidential information. If they were public, banks would have more incentives to avoid a bad rating. It would also put more pressure on regulators.

"The bank has been subject to a series of leaked information about its demonstrably significant problems, all of them embarrassing," said Petrou. "Camels ratings should be publicly disclosed, because if [a key part of] Wells' Camels rating was downgraded last year, the question is, why only then? Because I think regulators should be held accountable."

Martin Pfinsgraff, a former senior deputy comptroller for large-bank supervision at the OCC, said the leak may spur distrust between the bank and its examiners.

"Leaks of confidential information can hinder transparency and result in larger and or longer-duration problems," said Pfinsgraff, who oversaw Wells while at the OCC.

Some experts said they were not surprised by a downgrade and think it should have come sooner given that Wells has been rocked by repeated scandals. In September 2016, Wells paid $190 million in fines and restitution for opening millions of unauthorized bank and credit card accounts and fired 5,300 employees for illegal sales practices.

Since then, there has been a steady drip of accusations of wrongdoing leaked to major newspapers. Wells is being investigated for forcing more than 500,000 customers into unwanted auto insurance policies that resulted in auto loan defaults and vehicle repossessions. The bank also allegedly forced mortgage borrowers to pay millions in fees to extend interest rate locks that expired due to the bank's delays in processing mortgage applications.

In addition, Wells may not have been forthcoming with regulators about the scope of its illegal sales practices. CEO Tim Sloan has repeatedly apologized for the fake-account openings while also raising the estimate of consumers affected to potentially 3.5 million, a nearly 70% jump from Wells' original estimate.

Scott Siefers, a principal and equity research analyst at Sandler O’Neill, said the downgrade could result in another financial penalty.

“Financial penalties I think would be unfortunate, but on par for the course,” Siefers said, adding that ongoing regulatory actions serve as a lingering reminder of the scandal over Wells' illegal sales practices and other abuses.

For now, the bank appears to have at least a 2 Camels rating overall. If its overall rating were to fall to 3, the consequences would be significant. It would face a number of sanctions, including higher deposit insurance premiums and restrictions on acquisitions and branch openings.

Moreover, if any component of a bank's Camels rating drops to a 4, that would cause the overall rating to fall to a 4, automatically triggering a formal enforcement action.

Of 6,000 banks, only around 50 have a 4 or a 5 Camels rating, according to the OCC's 2017 semiannual risk perspective report. Camels are assessed yearly, but regulators can make adjustments if they identify concerns.

If the management piece of Wells' Camels rating was downgraded to a 3, then Wells "is in the penalty box," Lee said. "Regulators have to tell them why they're in trouble and what they need to do to fix it. It's more a message being sent that is reflective of things being found, but that didn't rise to the level of actually triggering an enforcement action or a formal rating."

Spotlight on OCC

The downgrade has shone another light on the OCC, which some believe failed to act soon enough in the Wells matter. The OCC issued a mea culpa last year about its failures to identify and act from 2010 on when regulators first learned that Wells employees had been creating fake accounts to meet aggressive sales goals.

"Regulators are reluctant to hit banks on the 'm' component too quickly and that's the first thing regulators should have hit them on," said Tom Hinkel, author of the website ComplianceGuru and vice president of compliance at Safe Systems, a technology service provider in Alpharetta, Ga. "Why has it taken them this long to draw the conclusion that all of these things are related to management in Wells' case?"

The OCC has been faulted for having three examiners in charge at Wells in the past five years including Scott Wilson, Brad Linskens, who sued the OCC last year for being removed from his role, and Tanya Smith, the current acting examiner in charge.

Another source of contention came last March when former Comptroller Tom Curry issued a double downgrade of Wells' Community Reinvestment Act rating to "needs to improve" from "outstanding," citing a pattern of consumer violations.

"Why did they get a double-downgrade on their CRA rating, when CRA is not a consumer enforcement statute and the violations had nothing to do with community reinvestment?" asked Petrou.

Wells also may have been able to successfully stop an earlier Camels downgrade, arguing that Sloan, who took over as CEO in late 2016, needed time to reorganize management.

Regulatory pressure on Wells likely contributed to the heavy turnover on the company’s board, Ely said. Five board members resigned last year and Wells added six new independent directors, increasing its board size to 17 members, from 16. Betsy Duke, a former Federal Reserve governor, became the independent chair of the Wells board on Jan. 1.

The bank has also made significant changes to its structure and management. A new chief compliance officer, Mike Roemer, who had been group head of compliance for Barclays, will join the bank next week.

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