Monday , December 17 2018

Wells Fargo hasn’t dealt with its scandal

There is a typical arc of bank scandals. Wells Fargo appears to be caught in a feedback loop, and its first-quarter earnings provided more evidence of that.
Wells Fargo recently said that its quarterly earnings per share rose just 8 percent to $1.12, which was slightly more than the $1.06 analysts were expecting. The bank’s revenue of $21.9 billion was down from $22.3 billion a year ago. Its shares opened down more than 1 percent.
Wells Fargo watchers will surely, once again, scour the bank’s report for signs that its continuing scandals are denting its operations. There are plenty. Lending in the first quarter dropped 1 percent, down $11 billion from a year ago. Deposits dropped $32 billion from the previous quarter. Rival JPMorgan Chase & Co., which also announced its earnings, posted a 4 percent jump in lending from a year ago and a $43 billion jump in deposits from the last quarter of 2017. And Wells Fargo’s reported earnings contained a question mark. The bank confirmed that regulators are looking to fine it $1 billion and said that it might revise its earning down to reflect that. A hit of that size would bring Wells Fargo’s EPS down to 93 cents, down 10 percent from a year ago. JPMorgan’s earnings were up 35 percent.
But the real problem is that there is little evidence in the numbers that Wells Fargo is taking its challenge head on. The bank’s costs in the first quarter were up just 2 percent. But that included $668 million in various one-time charges of legal and related costs from its continuing scandals. Exclude that, and the bank’s non-interest expenses fell about $200 million from a year ago. That’s not what should be happening. The way a bank should respond to a wave of problems like those Wells Fargo has been facing is to ramp up its compliance and risk managers. That should be costly, if only temporarily. Wells Fargo’s costs have risen from a few years ago, but not by much. The bank’s efficiency ratio, which is its costs as a percentage of its total revenue, is at 64.9 percent, up from a few year ago, but again not by much. And it was down from 76 percent in the fourth quarter. Last year, Wells Fargo announced that it planned to cut $2 billion in expenses, though it hasn’t quite followed through on that.
Wells Fargo, for the past few years, has achieved financial acrobatic act not matched by any of the other banks. It has maintained a return on equity that is consistently in the double digits. Most of its rivals were in the high single digits. One narrative of Wells Fargo’s recent scandals was that its problems stemmed from a poorly designed incentive structure. But another reason could be that the bank wasn’t spending the money it should have to monitor its operations.
Part of the problem is that CEO Tim Sloan has to address the bank’s problems while tamping down the impression that they are big. That is in part a problem of his own making. In a recent interview with Bloomberg, Sloan said that the bank’s problems have mostly been cleared up. The lack of increase in expenses, other than on direct fines and legal fees, propels that view. But it also may keep the problems at the bank going. In February, the Federal Reserve put new limits Wells Fargo’s growth, saying the bank still did not have the correct controls in place. Clearly, the Fed thinks Wells Fargo needs to spend more.
Increased spending now might seem like the wrong way to go, for Sloan and the bank. Falling earnings, one could argue, would add to the bank’s woes. But Wells Fargo is no longer being rewarded for its large ROE. Higher ROEs typically get rewarded by higher price-to-book values. But Wells Fargo shares now trade at 1.4 times it book value, less than the 1.7 times that JPMorgan’s shares trade at, despite their relatively similar ROEs. Wells Fargo’s investors seem to understand that the bank needs to spend more as well.
Wells Fargo’s scandal has taken a toll on its revenue. To get through it, it’s time for it to take a toll on costs as well.

—Bloomberg

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