Wells Fargo (NYSE:WFC) had a tough 2017. This shouldn't come as a surprise. The bank issued its year-end earnings report, and as expected, the bank's performance definitely suffered as a result of its infamous "fake accounts" scandal. While earnings beat analysts' estimates for the fourth quarter, revenue, net interest income, and net interest margins all fell short of expectations. Shares were virtually unchanged after the report, indicating that the market wasn't too surprised by the mediocre results.

However, Wells Fargo's management emphasizes that 2018 should be a different story. With positive industry catalysts and several initiatives designed to restore consumer confidence in the bank, it's possible that 2018 could be a much better year for the bank. Here's what you need to know about the bank's fourth-quarter and year-end earnings, and what management has to say about the future.

Exterior of a Wells Fargo branch.

Image source: Wells Fargo.

Wells Fargo's results were worse than expected

On the bottom line, Wells Fargo's earnings beat estimates. The bank's fourth-quarter EPS of $1.16 per share surpassed analysts' expectations of $1.07.

However, there wasn't much more good news. Revenue of $22.05 billion missed estimates by $330 million, and the bank's net interest income came in below expectations as well. One reason for this was the bank's net interest margin, which actually contracted by three basis points to 2.84% and looks particularly troubling since interest margins are expanding for most other banks as the Fed raises rates.

Additionally, the bank took a $3.25 billion legal charge stemming from a combination of several issues, such as financial crisis-era mortgage charges as well as the recent scandals.

One of the few banks to get a 2017 benefit from tax reform

Most of the big U.S. banks are expected to take big one-time charges related to the Tax Cuts and Jobs Act. While banks are expected to benefit from the corporate tax cut over the long run, most carry deferred tax assets on their balance sheet, the value of which declined substantially. In the most extreme example, Citigroup is expected to take a $20 billion charge, and many others are expected to take smaller, but significant, one-time losses.

In contrast to most of the rest of its industry, Wells Fargo actually reported a one-time gain as a result of tax reform. Without getting too technical, instead of carrying a lot of deferred tax assets, Wells Fargo has a lot of deferred tax liabilities on its balance sheet. Because these liabilities are now based on a 21% corporate tax rate, not 35%, the company got a $3.89 billion benefit from its deferred tax liabilities, which was partially offset by smaller losses related to deferred tax assets and repatriation of foreign cash.

In all, Wells Fargo's fourth-quarter earnings got a $3.35 billion benefit from the tax reform bill, which translated to a $0.67 boost in earnings per share.

Looking to the future

According to Wells Fargo CEO Tim Sloan, "In 2017 we continued executing on our plan to build a better bank for the future, and I'm proud of the hard work and dedication of our team members to put our customers first as we transform Wells Fargo."

It's important for shareholders to know that some of the efforts to transform Wells Fargo's culture and make it more consumer-friendly will certainly cost the bank some profit potential. For example, the company's recently launched "Overdraft Rewind" program resulted in a $30 million hit in deposit service charges in the fourth quarter. However, these should ultimately have a positive impact, especially when it comes to boosting consumers' general opinion of the bank.

Sloan went on to highlight some of the progress the bank made in its fourth-quarter results. Specifically, the bank's deposit growth (up $5.2 billion quarter over quarter), commercial loan growth (up about $1.6 billion), and higher credit card transaction volume (up 6% year over year) could indicate that the effects of the scandals are finally starting to pass.

Furthermore, in branch customer experience surveys, the scores for "loyalty" and "overall satisfaction" improved during the fourth quarter.

The company is certainly optimistic as it heads into 2018, and CFO John Shrewsberry said Wells is on track to hit its targets of $2 billion on expense reductions by the end of 2018, and another $2 billion by the end of 2019, which should help the bank regain the profitability and efficiency advantages that have disappeared in recent quarters.

How to look at Wells Fargo's 2017 earnings

Wells Fargo certainly had a bad year in 2017, but this was mainly due to (hopefully) temporary issues. So, while there are certainly some troubling signs in the earnings report, take the information in it with a big grain of salt. For example, the bank's fourth-quarter efficiency ratio of 76.2% is mainly due to the massive legal expense incurred by the bank, and not necessarily due to any permanent loss of efficiency.

The same can be said for the future plans. It's one thing to say you're going to cut expenses and restore customer confidence, but it's another to actually execute on them. That's why the bank's stock has dramatically underperformed the sector -- and could continue to do so until it proves to investors that it can again become a highly profitable and efficient banking powerhouse.

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