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Effects of scandal linger, but Wells execs paint picture of improvement

Wells Fargo & Co. continues to grapple with the aftershocks of a sales-fraud fiasco. But during the company’s annual investor day May 11, executives touted improvements and vowed to bolster an efficiency ratio recently headed in the wrong direction.

Driven in part by higher regulatory and legal costs tied to the fallout from a sales scandal that erupted last September, when regulators fined Wells and said it had opened millions of phony accounts to meet overly aggressive sales goals, the San Francisco-based bank’s expense base expanded in 2016.

The trend continued during the first quarter of this year, when expenses rose 6% from a year earlier. That increase, combined with a roughly 1% decline in revenue generation that was hindered by customer apprehension tied to the sales matter, pushed up the company’s efficiency ratio. Wells’ first-quarter efficiency ratio, which measures noninterest expense as a share of revenue, increased to 62.7% from 58.7% a year earlier.

“Operating at this level is completely unacceptable,” President and CEO Timothy Sloan told investors and analysts. First-quarter earnings were flat, again hindered by the sales issue and lower levels of lending and new customer generation tied to it. Wells said new consumer checking account openings in March declined 35% from a year earlier, while new credit card applications fell 42%, continuing a trend that took hold early in the fourth quarter of 2016. Total average loans declined during the first quarter.

In previous years, Wells targeted a sub-60% efficiency ratio, and during the investor day presentations, executives said they will build on a sweeping branch reduction effort already in motion to squeeze out billions of dollars in costs and bring the efficiency ratio down into a range of 55-59% in coming years. “We’ve undertaken a rigorous review across the company,” CFO John Shrewsberry said. Wells executives previously said they planned to close about 200 branches in 2017 and 200 more in 2018, among other steps to reduce expenses by $2 billion annually. Mary Mack, head of Wells’ community bank division, told investors May 11 that the bank is on pace to meet the 200 goal for this year and that executives now envision
closing some 250 in 2018. Savings from those efforts are slated to be reinvested in new technology and other innovation endeavors, among various business needs, with the goal of both operating more efficiently and driving revenue growth.

Wells joins a broader industry movement toward fewer branches amid a yearslong trend of customers visiting branches less and increasingly doing routine banking online and via mobile devices.

“Branch visits have been free-falling for years,” Jon Winick, president of bank adviser Clark Street Capital, said in an interview. “In my opinion, the banks in
this country can’t close branches fast enough.”

In addition to the branch consolidation, Wells executives say they now aim to ring out another $2 billion in annual expenses by the end of 2019. These savings would flow directly to the bottom line, executives said.

Mack and other Wells leaders spoke mostly in generalities about how the additional savings would be produced. But they emphasized Wells is capitalizing on advancing technology to improve efficiency in everything from call centers to the delivery of products, including plans for the second half of this year to begin allowing customers to submit one credit application for multiple product approvals.

Executives also noted efforts to increase the use of data to more quickly identify and meet customer needs, as well as ongoing facility reductions, among other efforts. Wells also is reportedly considering business line divestitures. Bloomberg News reported this week that Wells is exploring the potential sale of an insurance brokerage unit that employs about 3,500 people.

In the near term, Mack said that while Wells continues to endure the effects of the sales scandal, its consumer account openings have begun to improve on a month-over-month basis, and customer satisfaction surveys also are now trending favorably. “We are emerging stronger than before,” Mack said. Winick, however, said that at least in the near term, with the cloud of scandal still hovering over it, Wells likely will struggle to grow lending and revenue. That makes the cost-cutting paramount, he said.

Longer term, it could prove difficult for big banks such as Wells that are reliant on loan growth to boost revenue meaningfully, said Ken Mayland, president of ClearView Economics and a bank adviser. He said the strong credit quality environment that banks have enjoyed for years has begun to deteriorate and recent indications from the likes of Wells suggest a trend could be forming.

Wells’ first-quarter credit card charge-off rate of 3.54% was up from 3.09% at the end of last year and up from 2.82% at the end of the third quarter of 2016. Its first-quarter auto loan charge-off rate, at 1.10% of average loans, was up from 1.05% at the end of the 2016 fourth quarter and up from 0.87% atthe close of the 2016 third quarter.

After Wells reported those figures, Mayland said in an interview that the bank may need to pull back on lending in key areas. “I think risk aversion only grows from here,” he said. During the investor day, Wells executives said they had already eased up some in auto lending and are more broadly willing to give up some market share to guard against risks to the strength of the company’s balance sheet.

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