Elevated Employee Costs Weigh On Wells Fargo’s Performance For Q1

Wells Fargo (NYSE:WFC) reported a year-on-year reduction in its pre-tax income figure for the first time in five years on Tuesday, April 14, as an overall strong operating performance for Q1 2015 was marred by a sharp increase in employee-related expenses. ^[1] The banking giant managed to beat investor expectations in terms of both revenues as well as income estimates for the period. But the unexpected 11% jump in employee costs compared to Q1 2014 was seen as a cause for concern by investors, who promptly sent the bank’s shares almost 1% lower over trading for the day. Wells Fargo’s effective expense management strategy had a major role to play in its maintaining a steady year-on-year growth in net income figure for every single quarter since early 2009 – despite the negative impact of a low interest rate environment and slowing mortgage activity over recent years.

That said, Q1 2015 was a strong period for Wells Fargo in terms of revenues. The bank saw its brokerage advisory fees reach a record high this time around, even as an uptick in mortgage refinancing activity helped boost mortgage revenues. Investment banking fees as well as card fees also saw notable improvements compared to the year-ago period.

We maintain a $58 price estimate for Wells Fargo’s stock, which is roughly 10% ahead of its current market price.

See our complete analysis of Wells Fargo here

Net Interest Margins Fall To An All-Time Low

Wells Fargo’s biggest concern over the last couple of years has been its rapidly shrinking net interest margin (NIM) figure. While the current prolonged low-interest rate environment has hurt interest incomes for the banking industry as a whole, the impact is particularly evident in Wells Fargo’s results as net interest revenues are responsible for more than half of its total revenues.

The table below summarizes Wells Fargo’s reported net NIM figures for the first quarter of each of the last seven years:

As can be seen here, Wells Fargo’s NIM figure has fallen steadily since early 2010 – shrinking by 132 basis points (1.32%) over the period. The figure fell to below 3% for the first time in Q1 2015. Although Wells Fargo has maintained its net interest income between $10.5 billion and $11 billion throughout this period, the bank has only been able to do so thanks to a steady increase in interest-earning assets.

The NIM figure is unlikely to improve over the next two quarters, as the interest margins will begin to rise only after the Fed hikes benchmark interest rates later this year.

Mortgage Refinances, Brokerage Fees Help Keep The Top Line Afloat

Wells Fargo originated $49 billion in mortgages this quarter – the highest level reached in five quarters. This is a good 36% higher than the $34 billion in mortgages the bank handed out in Q1 2014. Refinanced mortgages formed a bulk of these originations – making up 55% ($27 billion) of the total figure. The relative improvement in origination volumes helped Wells Fargo report more than $1 billion in mortgage origination and sales fees for the first time since Q3 2013. These fees amounted to just $572 million in Q1 2014.

Over the last couple of years, Wells Fargo has also grown its asset management and investment banking operations notably, and has also stepped up its equity investments. The bank’s trust and investment fees reached a record $3.7 billion for the quarter primarily thanks to a steady improvement in brokerage advisory commissions and fees.

High Employee Costs Will Need To Be Reined In

Wells Fargo reported total employee-related expenses in excess of $8 billion for the first time ever this quarter. This represents a 6.6% increase year-on-year and a 4.8% hike sequentially. This is notable because the bank’s revenues have only grown 3% since the same period last year, and they actually shrunk 1% quarter-on-quarter. While the first quarter of the year normally sees higher employee costs due to the bonus payouts made over the period, the notable increase in salaries, incentive payments as well as employee benefit costs compared to Q1 2014 stands out in particular because of the near-identical employee count over both periods.

Wells Fargo’s share price is extremely sensitive to its non interest expenses, as you can see by making changes to the chart below. As employee-related payments account for almost 60% of total expenses, it is imperative that the bank keep this figure in check to ensure long-term profitability.

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1. Wells Fargo Reports $5.8 Billion in Net Income, Wells Fargo Press Releases, Apr 14 2015 [↩]