Wells Fargo Beats Expectations, Despite Fake-Account Scandal

By Markets Fool.com

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The fake-account scandal that's plagued Wells Fargo (NYSE: WFC) over the past few weeks didn't stop the bank from beating analyst expectations when it reported third-quarter earnings last Friday.

The nation's third-biggest bank by assets earned $1.03 per share compared to the consensus forecast of $1.01 per share. On the top line, Wells Fargo's revenue came in at $22.3 billion versus an expected $22.2 billion.

"I am deeply committed to restoring the trust of all of our stakeholders, including our customers, shareholders, and community partners," said newly appointed CEO Tim Sloan. "We know that it will take time and a lot of hard work to earn back our reputation, but I am confident because of the incredible caliber of our team members. We will work tirelessly to build a stronger and better Wells Fargo for generations to come."

If you've followed Wells Fargo closely over the past few weeks, its better-than-expected results shouldn't have come as a big surprise. In a conference call at the beginning of last week, its executives had said that the scandal in which thousands of employees opened up millions of fake accounts for customers wouldn't have a material impact on its third-quarter profit.

That prediction came to fruition. While Wells Fargo paid a $185 million fine as a result of the companywide scam, that's a drop in the bucket when you consider that the bank tends to earn more than $5.6 billion a quarter. Moreover, the amount of revenue that Wells Fargo generated from the fake accounts was nominal, at around $2.6 million.

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What's important to appreciate, however, is that the long-term implications for Wells Fargo may not be so benign. The scandal led to the resignation of now-former chairman and CEO John Stumpf, who had led the bank since the financial crisis. Wells Fargo also announced that it has suspended all sales goals in its branches, which many people, myself included, believe incentivized its employees to open the unauthorized accounts.

To this end, as a part of its third-quarter earnings release, Wells Fargo offered quantitative evidence that its businesses have been impacted by revelations of the scam. Data from September showed that:

  • Customer visits to its branches fell 10% compared to the same month last year.
  • Consumer checking account openings dropped 25%.
  • Credit card applications were down 20%.
  • Mortgage referrals from its retail bank were off by 24%.

Most of these don't generate revenue in the short-run, so it makes sense that they wouldn't have had a material impact on last quarter's results. But they most certainly will hurt Wells Fargo in the quarters and years ahead. At the very least, they'll temper its growth.

The question for investors is whether the current scandal changes the thesis underlying Wells Fargo stock, which has long been one of the best and steadiest performers in the bank industry. On the one hand, all of this could blow over, as scandals at major companies tend to do over time. On the other hand, if it incites regulators to push for more change at Wells Fargo, as well as other banks, it could make the current environment even more inhospitable for the California-based lender.

And to be clear, even before the fake-account scandal was revealed, Wells Fargo's performance had already begun to lose some of its luster. Its return on equity dropped to 11.6% in the quarter, its lowest level in years. And a major share of its earnings growth over the past five years have come not from revenue growth or expense contraction, but rather from the release of loan loss reserves.

Given all of this, there's no reason for investors to rush into Wells Fargo stock now -- nor, to be clear, is there any reason to flee from it. Sure, its stock has fallen 18% since the beginning of the year. And sure, it will eventually emerge from all of this intact. But a lot could happen between now and then that could make its shares even cheaper.

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John Maxfield owns shares of Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.