Wells Fargo Earnings: There’s Still a Long Way to Go

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Wells Fargo (NYSE: WFC) has been a major underperformer over the past couple of years in an otherwise very strong banking industry. With its infamous fake-account scandal and other lingering issues, many investors are wondering when, if ever, Wells Fargo will return to being one of the most profitable and efficient banks in its peer group.

With that in mind, here's a rundown of its first-quarter results and the progress the bank is making toward its goal of restoring the public's confidence.

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The headline numbers

At first glance, Wells Fargo's first-quarter results look pretty good. The bank's earnings came in at $1.12 per share, which handily beat estimates of $1.06 and represents an 8.7% year-over-year increase. Revenue beat estimates as well, with the bank's $21.93 billion figure coming in $200 million ahead of expectations.

However, investors were clearly less than thrilled with the bank's earnings report, as the stock was down by more than 3% following the announcement. So, let's take a closer look at the numbers.

Benefit from tax reform

First let's discuss another good data point. Wells Fargo received a pretty strong boost from tax reform, as was widely expected.

The bank recorded a $1.37 billion income tax expense for the quarter on pre-tax income of $7.50 billion, which translates to an effective tax rate of 18.3%. When compared with a 27.1% rate in the same quarter a year ago, it's easy to understand why Wells Fargo's return on equity (ROE) of 12.37% and return on assets (ROA) of 1.26% both handily surpassed the industry benchmarks of 10% and 1%, respectively, despite a lack of significant improvement in the bank's business.

Still hurting from its scandals

Unfortunately, there isn't much else in Wells Fargo's earnings that is giving investors a reason to cheer, aside from the bank's cost-cutting efforts, which I'll get to later on. In fact, unlike most other banks, many of Wells Fargo's numbers have actually gotten worse over the past year thanks to the fallout from its fake-accounts scandal and other lingering consumer trust issues.

Just to name some of the key points investors should know:

  • Wells Fargo's revenue fell by $0.4 billion from the same quarter a year ago. This includes a 1% drop in net interest income, which is more troubling during a period of rising consumer interest rates.
  • On a similar note, while most banks have seen net interest margins expand significantly since the Federal Reserve began raising interest rates, Wells Fargo's net interest margin has actually declined by three basis points over the past year.
  • Wells Fargo's deposit base has slid by $2 billion.
  • Total loans are down by 1%, or $12.6 billion.
  • The bank's 64.9% efficiency ratio is among the worst of its peer group, and is up (lower is better) from 62% a year ago.

Ongoing litigation could change the results

Wells Fargo also cautioned investors that that the discussions with the Consumer Financial Protection Bureau (CFPB) and Office of the Comptroller of the Currency (OCC) are ongoing, and that while the two agencies have offered a $1 billion resolution in regards to certain Wells Fargo auto lending and mortgage practices, the final outcome of the case cannot be predicted just yet.

In its earnings report, Wells Fargo said that the results in its earnings report might potentially need to be changed:

Expense reductions

One way that Wells Fargo plans to boost its profits over the next few years is with expense reductions. Specifically, the bank aims to reduce its ongoing annual expenses by $2 billion by the end of 2018 and by $4 billion by the end of 2019.

In the earnings report, management said that this is still a realistic goal. "We continued to make progress on our expense savings initiatives and remain on track to achieve our target of $4 billion in expense reductions by the end of 2019," CEO Tim Sloan said.

A turnaround that still has a long way to go

To be fair, Wells Fargo completely acknowledges that it's still in the early stages of a turnaround. As Sloan said, "I'm confident that our outstanding team will continue to transform Wells Fargo into a better, stronger company; however, we recognize that it will take time to put all of our challenges behind us."

And with the recent Federal Reserve penalty that prohibits the bank from growing its asset size until it has made significant improvements to address its mistakes, the bank's growth should be expected to lag the rest of the sector.

Having said that, it's important to realize that Wells Fargo isn't the same bank it was just a few years ago. It's certainly possible that management's efforts to restore trust in the bank will succeed, but investors shouldn't expect it to happen overnight. If the bank is successful, however, the current depressed stock price could seem like a long-term bargain for patient investors.

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Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.