Why Was Wells Fargo Left in the Dust Last Quarter?

Wells Fargo (NYSE: WFC) is ordinarily one of the best-performing banks each quarter when it comes to earnings, but the first three months of this year stand as an exception. While bottom lines surged at JPMorgan Chaseand Citigroup, Wells Fargo's net income fell last quarter on a year-over-year basis.

In this segment of Industry Focus: Financials, The Motley Fool's Gaby Lapera and contributor John Maxfield explain the factors behind Wells Fargo's performance.

A full transcript follows the video.

10 stocks we like better than Wells FargoWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Wells Fargo wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of April 3, 2017

This video was recorded on April 17, 2017.

Gaby Lapera: The other bank I wanted to talk about is what used to be America's sweetheart of a bank, which is Wells Fargo. They're probably going to be the only big bank to see its earnings decline on a year-over-year basis. Do you think that's related to the account scandal?

John Maxfield: I think that it is. Michael Douglass, who is an editor at The Motley Fool, he describes Wells Fargo as "the fallen angel," and I think that's the perfect way to describe it. If you go back 150 years, Wells Fargo has one of the best reputations, and one of the best brands in the bank industry in the United States for a long, long time -- back since the Gold Rush in the late 1840s and 1850s, when it was established. But because of that fake-account scandal that was revealed last September -- thousands of Wells Fargo employees, in an effort to meet sales quotas, in terms of selling additional credit cards, selling additional checking accounts, selling additional savings accounts, they opened up fake accounts for customers that customers either didn't need, didn't approve of, or didn't even know were being opened. So that has really tarnished Wells Fargo's reputation. And if you look at Wells Fargo's numbers from the most recent quarter, it isn't strikingly obvious. It isn't like the revenue fell by 10% as a result of this, or their expenses went up by 20%. It's a much more marginal impact. But what we're seeing is a continued erosion in a number of key metrics at Wells Fargo. The efficiency ratio is a perfect example. It has long been one of the most efficient banks in the country. But because of potential revenue pressure as a result of what happened, the reputational damage it suffered, and that sales scandal last year, combined with the potential that they're going to have to increase their compliance costs, their regulatory costs to deal with that, it's slowly eroding its bottom line at this point.

Lapera: Yeah. And that's something you're just going to have to look out for long-term. The thing with Wells Fargo is that basically all things have been held equal except for the reputational damage that we mentioned from the account scandal. As a result of the account scandal, they changed some of their internal practices for selling, as one might expect, to encourage their employees to stop creating these fraudulent accounts, which means that some of their numbers don't look as good anymore for account openings. Because there's fewer fraudulent accounts. So when you throw all that into the mix, we'll see whether or not Wells Fargo pulls out of it. It's not quite a nosedive yet, but it's definitely something to keep your eye on.

Maxfield: To that point, Gaby, if you listen to Wells Fargo's executives prior to the crisis, for years, they stressed the cross-sell ratio. That is the number of financial products -- so, checking accounts, credit cards, mortgages, all those types of financial products and services -- the number of those that the average customer at Wells Fargo used. And they always trended two times, three times the industry average in terms of the number of products that each of their customers used. Then, if you listened to the way their executives talk about getting those large cross-sell numbers, what they would do is go after primary checking accounts for a customer, which is the principal banking product, and then build on top of that -- and now, we're seeing new checking account numbers falling on a year-over-year basis by 30%, 40%, new credit card applications at Wells Fargo falling by 40%-plus on a year over year basis -- in the short term, that's not going to have a big impact on their numbers. Because it's not like a bank makes a whole bunch of money when a credit card application is submitted, or any money, quite frankly, or when a new checking account is opened. But it's that deepening of the relationship where the profitability comes from. So the question is, when they announced that they were getting rid of their sales quotas in their branches as a result of the scandal, what is that going to look like over the long term for Wells Fargo, given that its model has been predicated on cross-selling for all of these years?

Lapera: Yeah, definitely. It's an interesting story, and one that we will definitely continue to cover on Industry Focus.

Gaby Lapera owns shares of JPMorgan Chase. 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.