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Wells Fargo’s 3rd-Quarter Earnings Show Continued Strain From Sales Scandal

By John Maxfield - Updated Oct 16, 2017 at 6:33PM

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Key metrics from the bank’s latest performance reveal the damage done to its reputation and business over the past year.

It was yet another difficult quarter for Wells Fargo (WFC 1.92%), which reported earnings on Friday for the three months ended September 30. The bank earned $0.84 per share in the third quarter, which was down almost 20% on a year-over-year basis.

The bank earned $4.6 billion in the third quarter, compared to $5.6 billion in the same quarter last year. The latest results include a $1 billion charge to cover anticipated legal costs stemming from pre-crisis mortgage-related regulatory investigations.

If you back the impact of the settlement out, Wells Fargo earned $1.03 per share, which was in line with analysts' expectations. Shares of the bank nevertheless fell more than 3% in intraday trading on Friday after the bank's $21.9 billion worth of revenue came up short of the $22.4 billion expected by analysts.

"Over the past year we have made fundamental changes to transform Wells Fargo as part of our effort to rebuild trust and build a better bank," said CEO Tim Sloan. "I am proud of the commitment of our 268,000 team members who put our customers first."

Tim Sloan, CEO of Wells Fargo.

Tim Sloan, CEO of Wells Fargo. Image source: Wells Fargo.

Looking beyond the headline numbers reveals the core challenges confronting Wells Fargo, as well as the damage done to the bank as a result of its sales scandal, disclosed last year, involving the creation of millions of unauthorized accounts for customers.

Most significantly, the bank has seen its profitability plummet. You can see this by looking at Wells Fargo's return on assets, which is calculated by dividing a bank's quarterly net income (multiplied by four to annualize it) by its total assets.

The equation for calculating return on assets.

Prior to revelations of the sales scandal, Wells Fargo had consistently generated a return on assets over 1%, a standard industry threshold delineating well-run banks from the rest. In the third quarter of last year, the bank earned 1.17% on its assets. But by the latest quarter, the figure had declined to 0.94%.

Wells Fargo's return on assets took a meaningful hit from the $1 billion legal accrual and should therefore bounce back above the 1% mark next quarter. Yet, Wells Fargo is unlikely anytime soon to get back to the 1.3% level that it reported in the third quarter of 2015, long before the size and extent of the bank's sales scandal became widely known.

Another critical metric that current and prospective investors in the nation's third-biggest bank by assets should keep their eyes on is Wells Fargo's efficiency ratio. This reflects the percent of revenue that a bank spends on operating expenses, and is calculated by dividing a bank's noninterest expenses by its net revenue.

The equation for the efficiency ratio.

Previously, Wells Fargo was known as one of the most efficient banks in the country, consistently reporting an efficiency ratio below 60%, which is a standard industry benchmark similar to returning 1% on assets. More recently, however, as the bank absorbs added costs from its legal issues and has seen its revenue lag as a result of its damaged reputation, the figure has come in well above that mark. In the latest quarter, it climbed to 65.5%, an almost unheard-of figure for the bank from San Francisco, California.

The Wells Fargo state coach traveling over grasslands.

Image source: Wells Fargo.

Finally, in a sign of the challenging environment that all banks are operating in right now, Wells Fargo also reported that its net interest margin went in the wrong direction in the third quarter. This is the yield a bank generates on its portfolio of earning assets, with bigger being better.

Wells Fargo's net interest margin was 2.9% in the second quarter. Fast forward to the third quarter, and the figure fell to 2.87%. It's not a huge drop, and it's largely out of the bank's control, given that it's heavily influenced by interest rate trends, but it's nevertheless yet another area in which Wells Fargo is struggling to regain its past glory as one of the most profitable and efficient banks in the country.

In sum, while it's now been a year since the wider world learned of Wells Fargo's sales scandal, the impact on the bank's top and bottom lines still continues to grow.

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