Wells Fargo’s Shrinking Loan Portfolio, Swelling Expense Ratio Remain A Drag On Earnings
Wells Fargo (NYSE:WFC) reported underwhelming results for the third quarter of the year late last week, as the third-largest U.S. bank in terms of assets missed revenue expectations and barely met earnings expectations as it continues to reel under the effect of a series of sales-related scandals. The bank – which doubled in size during the economic downturn of 2008 and reported steady growth in the aftermath – was a poster child for the traditional loans-and-deposits banking industry before it was revealed last September that its employees fraudulently opened millions of accounts. Since then, internal investigations by the bank have unearthed other improper practices by some employees, including making unsuitable mortgage modifications, selling unwanted auto insurance, improperly charging fees for locking-in mortgage rates, and adding chargeable add-ons to accounts without the customers’ permission.
Wells Fargo’s misgivings have hurt the bank on two fronts over recent quarters. Firstly, the reputational hit has resulted in some customers shying away from doing business with the bank. The loss of customer faith stands out in the fact that the bank’s total loan portfolio has shrunk for three consecutive quarters now – from a peak of $967 billion at the end of 2016 to below $952 billion at the end of Q3 2017. This is in sharp contrast to the ~3% growth in the total U.S. loan portfolio as compiled by the Fed for the same period. Secondly, Wells Fargo has already incurred millions in settlement costs and fines, and is staring at a long list of class action lawsuits and federal investigations into its operations, which could cost it millions more. This is expected to keep the bank’s expense ratio figure elevated in the near future – eating into profits.
Wells Fargo is also dealing with headwinds in its cornerstone mortgage business, as origination volumes have remained depressed for several quarters now. That said, we expect profits for Wells Fargo to largely trend higher in the long run due to the Fed’s ongoing rate hikes, as its existing interest-earnings assets will generate higher interest revenues. We maintain a price estimate of $56 for Wells Fargo’s stock, which is slightly 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 Q3 2017 compared to the figures in Q3 2016 and Q2 2017. And the bank fared poorly on all fronts compared to the previous quarter, with revenues falling and expenses and loan provisions increasing. While the bank’s net interest income was notably better than the figure a year ago, these gains were an expected outcome of the Fed’s rate hikes.
While Wells Fargo’s fee revenues were largely level for its asset and wealth management, investment banking and card operations, the sharp decline compared to Q2 2017 and Q3 2016 was mostly due to poor mortgage banking fees. Total mortgage fees (origination and servicing combined) for Q3 2017 were barely over $1 billion. This is well below the average quarterly figure of $1.6 billion over 2014-16, and is the worst performance for the mortgage banking unit since Wells Fargo acquired Wachovia at the peak of the 2008 economic downturn.
The table below summarizes the changes in Wells Fargo’s mortgage-related fees for the quarter compared to Q3 2016 and Q2 2017.
Notably, the sharp increase in non-compensatory expenses for the bank in Q3 2017 was primarily because of a one-time $1 billion charge linked to its legacy mortgage-related lawsuit. Although settlements and fines from the various misgivings will keep this figure high in the near future, it is unlikely to touch the billion-dollar mark.
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