Wells Fargo’s Account Opening Scandal Weighs On Q1 Results; Impact Likely To Linger

by Trefis Team
Wells Fargo & Co.
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Wells Fargo (NYSE:WFC) continues to face headwinds on multiple fronts as a result of its fraudulent account-opening scandal, as the banking giant’s top line for Q1 was hurt by a notable reduction in customer activity while costs stemming from the scandal eroded profits. ((Q1 2017 Results, Wells Fargo Press Releases, Apr 13 2017)) The first quarter of the year is usually a lukewarm period for traditional loans-and-deposits banking services, as many people use bonuses and tax refunds to reduce their loan burdens – leading to an overall reduction in loan balances for the industry over the period. And the Fed’s rate hike also slowed industry-wide loan growth. But Wells Fargo’s loan portfolio was also hit by a sizable decline in new card openings, which led to its total loan portfolio shrinking by $9.2 billion from $967.6 billion at the end of 2016 to $958.5 billion now. To make things worse, the bank’s cornerstone mortgage business remained under pressure from weak origination activity in the industry.

But it was not all bad news for Wells Fargo in Q1, as the bank made the most of the seasonally elevated securities trading activity to boost its securities trading revenues to the highest level in the last four years. Fee revenues for the bank’s wealth and asset management unit were also upbeat compared to the year-ago period. Although Q1 results did not benefit from the Fed’s interest rate hike last December and again this March, these gains will be evident over subsequent quarters and will grow as the Fed sticks to its plan of normalizing interest rates. This leads us to conclude that Wells Fargo’s risk-averse business model and strong base of interest-earnings assets will drive value in the long run. That is why we stick to our price estimate of $57 for Wells Fargo’s stock, which is about 10% higher than the current market price.

See our complete analysis of Wells Fargo here


The table above summarizes the factors that aided Wells Fargo’s pre-tax profit figure for Q1 2017 compared to the figures in Q1 2016 and Q4 2016. As evident from the table, revenues for the bank fell y-o-y, but improved compared to the previous quarter. The sequential jump can be attributed to the one-time hedging charge of $592 million that the bank incurred in Q4 2016. Adjusting for this, revenues also fell sequentially due to a mix of seasonal factors as well as due to lower consumer activity witnessed by the bank after the scandal came to light.

The sequential increase in compensation expenses is primarily seasonal, as the bank hands out bonuses in the first quarter. That said, it should be noted that the y-o-y increase in compensation expenses of 5.6% was considerably higher than the 1.5% increase in headcount. The increase is likely due to Wells Fargo’s new compensation policy announced earlier this year, which hiked employees’ hourly pay by 12%. [1]

As for Wells Fargo’s non-compensation expenses, the sequential decline is due to the absence of the one-time settlement costs that the bank incurred last quarter to close investigation into its account opening scandal by several regulators. While these expenses have not increased too much compared to the year-ago period, one factor that contributed to it was roughly $80 million in costs “related to sales practices matters and meaningful spending on regulatory and compliance initiatives” and an additional $83 million paid to the FDIC for special assessment. [2] These expenses are directly linked to the scandal, and are likely to weigh on the bottom line for a few more quarters. On the positive side, improved economic conditions reduced loan charge-off rates – helping Wells Fargo report lower loan provisions for the quarter.

Mortgage Revenues Underwhelming In Q1, But Things Expected To Improve In Q2

Wells Fargo’s business model focuses considerably on the mortgage industry, with the bank making significant gains in market share over 2010-2012 even as key competitors like Citigroup and Bank of America slashed their mortgage operations – which is why the bank’s profits are very sensitive to mortgage banking fees. The bank’s total mortgage fees (origination and servicing combined) for Q1 2017 were just $1.2 billion – making it the worst period for the bank in this regard since it acquired Wachovia at the peak of the 2008 economic downturn. To put things in perspective, the average quarterly mortgage banking fees for the bank over 2014-16 were $1.6 billion. The table below summarizes the changes in Wells Fargo’s mortgage-related fees for the quarter compared to Q1 2016 and Q4 2016.


As seen here, the biggest contributor behind the lower mortgage fees was the weak mortgage origination figure. Wells Fargo originated mortgages worth $44 billion in Q1 2017 – a decline from the $72 billion figure in the previous quarter and identical to the figure for Q1 2016. While the increase in interest rates following the Fed’s rate hike is an important factor behind the lower origination volumes, there are seasonal effects also at play here. As the Fed is looking to raise interest rates at regular intervals in the near future, we believe that people looking to buy new homes will do so earlier rather than later to benefit from lower rates. This should help volumes recover in Q2.

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  1. Quarterly Supplement, Wells Fargo Press Releases, Jan 13 2016 []
  2. Wells Fargo Q1 2017 Earnings Transcript, Seeking Alpha []
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