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5 Alarming Figures in Wells Fargo's Third-Quarter Earnings Report

By Matthew Frankel, CFP® - Oct 19, 2017 at 7:48AM

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Wells Fargo's latest earnings show that the bank is still plagued by its fake-accounts scandal.

It's been over a year since news of Wells Fargo's (WFC 1.92%) infamous fake-accounts scandal broke, and several other scandals have also come to light during that time. Investors have been wondering not just if the scandals would affect the bank's performance, but for how long. Well, the bank's third-quarter earnings show that the fallout from the scandal isn't done just yet. Here are five things in particular that stand out.

1. A big revenue drop

First, let's discuss the headline numbers, specifically revenue. Wells Fargo's revenue of $21.93 billion not only missed analysts' estimates of $22.4 billion, but it also did so in a quarter when most peers produced revenue and earnings beats. Wells Fargo's revenue fell 2% year over year, while JPMorgan Chase's revenue increased by 2.7%, Citigroup's rose by 2%, and Bank of America's went up 1%.

While we can't say with absolute certainty that Wells Fargo's revenue decline was a direct result of its numerous scandals, it sure does look that way.

Yellow "caution" tape.

Image source: Getty Images.

2 and 3. ROE and ROA

Wells Fargo's most attractive quality from an investment perspective is arguably its ability to generate superior profits when compared with the rest of the "big four" banks. Two of the key banking profitability metrics are return on assets (ROA) and return on equity (ROE), and Wells Fargo has consistently been ahead of the competition on both, quarter after quarter.

WFC Return on Equity (TTM) Chart

WFC Return on Equity (TTM) data by YCharts

Now that's no longer the case. Wells Fargo's ROA has eroded from 1.17% to just 0.94% over the past year, not even enough to meet the 1% industry benchmark. Similarly, its ROE fell to just 9.06%, the first time in years that it failed to top 10%. JPMorgan Chase beat Wells Fargo handily on both metrics for the third quarter, and even Bank of America's ROA of 0.98% came in ahead of Wells Fargo.

To be fair, some of this was due to increased legal expense, which is not a permanent issue. However, some of it was due to other potentially scandal-related fallout, such as the declines in lending and consumer deposits.

4. Efficiency ratio

Wells Fargo's historically strong profitability is a result of its ability to manage risk and to run an efficient operation. During the third quarter, Wells Fargo's efficiency (or, more accurately, its inefficiency) was significantly different than in previous quarters.

A bank's efficiency ratio is a measurement of how much it spends to generate its profits. For example, a 50% efficiency ratio implies that the bank spends $0.50 to generate every $1 in net income.

Generally speaking, an efficiency ratio below 60% is considered to be strong for a brick-and-mortar banking operation. With this in mind, take a look at Wells Fargo's efficiency ratio for the past five quarters.

Quarter

Efficiency Ratio

Q3 2016

59.4%

Q4 2016

61.2%

Q1 2017

62.7%

Q2 2017

61.1%

Q3 2017

65.5%

Data source: Wells Fargo Q3 2017 earnings.

5. Net interest margin hasn't improved

Bank profits have been depressed for several years, partially as a result of persistently low interest rates that are keeping margins low. With the Federal Reserve implementing several rate increases over the past year, it was widely expected that banks' net interest margins would begin to rise. And in many cases, this expectation proved to be correct.

However, while Wells Fargo's net interest margin (NIM) is 5 basis points above where it was a year ago, it has been virtually flat over the past four quarters. Here's Wells Fargo's NIM for the past four quarters, compared with a couple of its peers.

Quarter

Wells Fargo NIM

Bank of America NIM

JPMorgan Chase NIM

Q4 2016

2.87%

2.23%

2.08%

Q2 2017

2.87%

2.39%

2.18%

Q2 2017

2.90%

2.34%

2.16%

Q3 2017

2.87%

2.36%

2.19%

Four-quarter improvement

None

13bps

11bps

Data source: WFC, BAC, JPM third-quarter earnings reports.

Is the stock still a buy?

I should point out that I've written a few times recently that Wells Fargo looks like a long-term bargain, despite the fallout from the company's scandals. I stand by that sentiment, but there's a big caveat I should point out.

Specifically, I emphasize that Wells Fargo looks like a long-term bargain. The stock has significantly underperformed the rest of the financial sector, and this is certainly justified in the near term as the scandal and its aftermath play out. While none of the damage should be permanent, it could easily take years for the bank to fully recover, so approach a potential investment accordingly.

To be clear, I like Wells Fargo at the current price level and believe it will eventually recover and generate fantastic profitability and efficiency once again. If you invest in Wells Fargo now, you may not be too happy with your decision in a month, or in a year. However, I'm confident that after several years go by, the current share price will seem like a bargain.

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