Costs weigh on Wells Fargo as new CEO prepares to take reins

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One of the biggest tests that Charles Scharf will face when he starts next week as Wells Fargo’s CEO will be how to control expenses without antagonizing the bank’s regulators.

The scandal-plagued company, which has spent heavily over the past few years on efforts to satisfy its overseers in Washington, D.C., is facing pressure from investors to cut costs. The problem is that the bank acknowledges it still needs to do much more to satisfy its regulators, and that includes continuing to invest in its operational risk management capacities.

Wells’ third-quarter results, announced Tuesday, included a $1.6 billion litigation accrual in connection with sales-related issues that the bank said it has previously disclosed. But even without that one-time item, the bank’s expenses were higher than Wall Street analysts had expected.

Chief Financial Officer John Shrewsberry told analysts Tuesday that he now expects expenses for 2019 to total approximately $53 billion, which is at the high end of the bank’s target range. During a later call with reporters, he said that the bank’s previously announced target of $50 billion to $51 billion for total expenses in 2020 is no longer operative.

During the most recent quarter, Wells Fargo’s efficiency ratio, which measures expenses as a percentage of net income, ballooned to 69.1%, its highest level in recent memory. Its efficiency ratio in the second quarter was 62.3%.

The San Francisco company has long sought to reduce its efficiency ratio to a range of 55% to 59%. Shrewsberry said Tuesday during a call with reporters that the target range is still in effect, before adding: “It’s a little aspirational from where we’re sitting today.”

Wells reported net income of $4.6 billion during the quarter, which was down from $6.0 billion in the same period a year earlier. The bank’s earnings were boosted by a $1.1 billion gain from the sale of its institutional retirement and trust business, which partially offset the litigation accrual.

Wells Fargo announced its quarterly results six days before Scharf, who has done stints in the top job at Bank of New York Mellon and Visa, is scheduled to take over as its next chief executive.

“We have had lots of discussions to help get him up to speed on where we are from a regulatory perspective,” Shrewsberry told reporters. “He knows a lot, as much as one can know about Wells Fargo from the outside.”

Since February 2018, Wells has been operating under an asset cap that was imposed by the Federal Reserve. The $1.9 trillion-asset bank also faces pressure from the Office of the Comptroller of the Currency to implement and maintain a better compliance risk management program.

Interim CEO Allen Parker said Tuesday that the bank has over the last six months redoubled its efforts to satisfy its regulators. But he added, “I think it’s fair to say that we have a substantial amount of additional work to do.”

Wells Fargo’s efforts to move beyond its regulatory woes have been hampered by a stream of new revelations. In August, The New York Times reported on allegations by current and former employees that the bank charged overdraft fees to customers who believed they had already closed their accounts.

In the wake of that article’s publication, Wells officials have been trying to determine whether changes need to be made, according to Parker, who will resume his previous role as the company’s general counsel next week. But he provided little insight into what the review has found so far.

Wells Fargo executives declined to provide specific information about the $1.6 billion litigation accrual, though they did acknowledge that it relates to lingering issues related to the bank’s sales practices. In an August securities filing, the bank said that it has engaged in settlement talks with the Department of Justice and the Securities and Exchange Commission regarding investigations that were launched in the wake of the bank’s phony-accounts scandal in 2016.

Meanwhile, regulatory costs at Wells Fargo continue to mount.

Shrewsberry acknowledged Tuesday the bank’s investments in risk management have been more expensive than expected. But he also expressed hope that the spending will yield long-term benefits by paving the way for simplification efforts that lead to cost reductions.

“There is a big opportunity once we’ve established what best-in-class looks like,” he told reporters.

One bright spot for Wells Fargo during the third quarter was that its average loans rose by 1% to $950 billion, the largest increase in loan balances at the bank in two and a half years. The improvement was driven by growth in mortgage originations and auto loans.

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