Wells Fargo's Earnings Continue to Suffer After Last Year's Fake-Account Scandal

By John Maxfield Markets Fool.com

Wells Fargo (NYSE: WFC) reported first-quarter earnings on Thursday. While there was little obvious direct impact from the bank's scandal-plagued 2016, the $29 million year-over-year drop in its quarterly earnings reflects Wells Fargo's ongoing efforts to put its fake-account scandal in the rearview mirror.

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"Wells Fargo continued to make meaningful progress in the first quarter in rebuilding trust with customers and other important stakeholders, while producing solid financial results," said CEO Tim Sloan. "We have taken significant actions throughout the company to date and we are committed to building a better bank as we move Wells Fargo forward."

The iconic Wells Fargo stagecoach. Image source: Wells Fargo.

There were two particular bright spots in Wells Fargo's performance. In the first case, its loan loss provisions fell 44%, or $481 million, compared to the same quarter last year, when banks boosted provisions in anticipation of loan defaults throughout the energy sector as oil prices dropped below $30 a barrel.

"First quarter credit results reflected strong performance in our commercial portfolios and consumer real estate portfolios," said chief risk officer Mike Loughlin. "Improvement in the oil and gas portfolio, as well as continued improvement in residential real estate, drove a $200 million reserve release in the quarter."

On top of this, Wells Fargo saw the amount of money it earned from its portfolio of loans and securities increase by 5%, or $633 million. This was fueled by the Federal Reserve's decision to raise the fed funds rate twice since the beginning of December.

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Metric

Q1 2017

Change (YOY)

Net revenue

$22 billion

(1%)

Provision for credit losses

$605 million

(44%)

Noninterest expenses

$13.8 billion

6%

Net income

$5.1 billion

(1%)

Data source: Wells Fargo. YOY = year over year.

However, these two positive trends were outweighed by a drop in Wells Fargo's noninterest income and an increase in its operating costs. Its noninterest income suffered in particular from a 23% drop in mortgage banking income. Meanwhile, its costs were higher on a sequential basis due to seasonally higher employee benefits and incentive compensation expenses -- heightened regulatory and compliance expenses related to the Dodd-Frank Act of 2010 aren't helping either.

It's here where the ongoing impact of Wells Fargo's fake-account scandal is most pronounced. The bank'sefficiency ratio, which measures the percent of revenue consumed by operating expenses, increased to 62.7% in the first quarter of 2017, compared with 58.7% in the year-ago period. Given the singular importance of efficiency when it comes to maximizing profitability in the bank industry, this is a concerning trend. And it's all the more so given that Wells Fargo long had a reputation for being one of the leanest banks in the industry.

The net result is that Wells Fargo will almost certainly be one of the only big banks in the country to report a year-over-year decline in first-quarter earnings and profitability. Analysts expected this, but Wells Fargo's stock was nevertheless down by more than 3% in intraday trading on Thursday.

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John Maxfield owns shares of Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.