Nearly two years ago, Wells Fargo (WFC -0.26%) launched a big initiative to improve its efficiency ratio, which looks at a bank's expenses expressed as a percentage of its revenue. The lower the efficiency ratio the better because it means a bank is spending less for each dollar of revenue it generates.
So far, the efficiency work has been pretty well received by the market and management has lived up to its promises. However, at a recent conference, CEO Charlie Scharf said he still thought the bank was "incredibly inefficient."
He's not necessarily wrong, as Wells Fargo's efficiency ratio has still been above 70% in most of its recent quarters. Ideally, investors will want to see Wells Fargo lower that number to below 60%, at least on a core basis. Scharf recently indicated that there is plenty of room for improvement on the expense and revenue side.
How expense initiatives are coming
When Wells Fargo first launched its efficiency initiative at the start of 2021, the plan was to realize $8 billion of gross cost savings over a three-to-four-year period by optimizing the bank's organizational structure, cutting branches, making layoffs, and installing new loan origination systems, among other actions.
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The work is moving along nicely. At the end of 2020, Wells Fargo had about $57.6 billion in expenses. At the end of last year, expenses fell to about $53.8 billion after the bank realized about $3.7 billion of gross cost savings. This year, Wells Fargo is on track to realize another $3.3 billion in gross cost savings, although the bank will likely exceed its $51.5 billion expense target due to operating losses for historic events such as the phony-accounts scandal that have run hot this year.
That's already about $7 billion of gross cost savings in two years. However, Wells Fargo now plans to achieve $10 billion of gross cost savings and Scharf recently said at the conference that he sees room for more. For instance, Scharf noted that the bank is "probably several years behind" its peers in terms of right-sizing its branch network and the staffing inside those branches. More details about future gross cost savings could come during Wells Fargo's next earnings call.
Wells Fargo sees revenue opportunities
Since the efficiency initiative started, a lot of the focus was on expenses. But Scharf is certainly seeing revenue opportunities in the future as well.
Wells Fargo has a smaller corporate investment bank than its peers but it does see an opportunity for measured growth within its current franchise, particularly around U.S. middle-market clients with whom it already does a lot of business. The idea is to essentially complement its incredibly strong commercial banking franchise and serve these customers with investment banking products.
The idea of serving clients in a more holistic manner is a common theme among Scharf's revenue ambitions. For instance, he said the consumer bank and wealth management business used to run very separately, even to the point where the bank wasn't really focusing on more affluent customers who could be ideal clients for the bank's wealth management division. Now, Scharf says the culture has changed and wealth management is in a place where the bank went from defense to offense.
Wells Fargo also started to ramp up credit card lending in recent years, a product that can be quite profitable if done in a disciplined manner that avoids excessive loan defaults. Credit card loan balances in the third quarter of this year were up 8% year over year at the bank.
A positive efficiency outlook
Although the bank realized a lot of gross cost savings in the first two years of its efficiency initiative, there still seems to be plenty of room to continue to cut expenses. At some point in the future, operating losses from the phony-accounts scandal and other past scandals will go away. They are unfortunate, but not part of core expenses.
Furthermore, the bank benefits from the rising interest rate environment, which drives up yields on its loans and securities, and Wells Fargo also seems to have other areas of the bank where it can grow fee revenue.
Any bank that can lower expenses and grow revenue will bring down its efficiency ratio and this usually results in good things happening to the stock.
