Wells Fargo (WFC +3.47%) may be one of the most profitable banks in the country, but that doesn't insulate it from the especially challenging environment right now for banks. Low interest rates, rising loan losses, and a heightened regulatory environment are weighing on bottom lines across the industry.
Wells Fargo's chief financial officer, John Shrewsberry, drove this point home at the bank's annual investor day on Tuesday. According to his presentation, Wells Fargo has reduced both of its primary profitability targets for the current year.
The first relates to Wells Fargo's return on assets. This measures how much a bank earns on a yearly basis relative to the total value of assets on its balance sheet. It's calculated by dividing the former by the latter.
As a general rule, most banks strive to earn at least 1% on their assets. Although many banks have come up short of this objective since the financial crisis, Wells Fargo tends to comfortably exceed it. The California-based bank's return on assets in the first quarter of this year was 1.21%. For all of 2015, the figure was 1.32%.
But even though Wells Fargo ranks behind only U.S. Bancorp with respect to return on assets, the nation's third biggest bank by assets has found it necessary to temper investor expectations with respect to profitability. To this end, Shrewsberry said the bank has lowered its full-year return on assets target to 1.1% to 1.4%. This is down from its previous range of 1.3% to 1.6%.
The second target relates to Wells Fargo's return on equity. This is a similar concept to return on assets, the difference being that a bank's equity is in the denominator of the calculation as opposed to its total assets.
Banks strive to generate a return on equity of at least 10%. Generally speaking, a bank that exceeds this tends to create shareholder value over the long run, whereas a bank that comes up short of the mark is typically assumed to do the opposite -- to destroy shareholder value.
This isn't a problem for Wells Fargo. Its return on equity in the first quarter of this year was 11.75%. The same figure for all of 2015 was 12.68%.
Just like above, however, Wells Fargo felt the need to moderate investor expectations. According to Shrewsberry, Wells Fargo reduced its 2016 return on equity target to a range of 11% to 14%. That's down from its previous range of 12% to 15%.
This isn't good news, as a bank's earnings drive shareholder returns. At the same time, however, to steal a line from JPMorgan Chase CEO Jamie Dimon, Wells Fargo can't control the weather. So long as interest rates remain near 0%, banks won't make as much money as they're accustomed to. That will change, but the catalyst for the change is in the hands of the Federal Reserve, not Wells Fargo.
