Wells Fargo's latest problems go beyond potential $1 billion fine

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Nineteen months into a wide-ranging sales scandal, Wells Fargo is still stuck in limbo.

The company’s announcement Friday that its first-quarter financial results are only preliminary, and subject to revision based on the outcome of ongoing negotiations with its regulators, was the latest illustration of the uncertainty that is plaguing the San Francisco bank.

To the frustration of shareholders, the company has already been barred from adding assets for at least the next six months, and now investors will likely have to wait until May, when final results are expected to be released, to fully evaluate the bank’s first-quarter performance.

Also weighing on investors’ minds: Will the bank’s ongoing regulatory troubles hurt its ability to pass its stress test this year?

In its earnings announcement, Wells disclosed that the Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency have offered to resolve certain investigations for $1 billion in penalties, and said that discussions are ongoing. The implication of the disclosure is that Wells believes that the proposed penalties are too steep, though bank officials declined to elaborate.

CEO Tim Sloan would not even say whether the bank’s preliminary first-quarter results include any provision for an eventual settlement with the two agencies.

“At this time, we’re unable to predict the final resolution of the CFPB, OCC matter and cannot reasonably estimate our related loss contingency,” Sloan said during a conference call.

The problems identified by the CFPB and the OCC involve the bank’s compliance risk management program, certain fees that were charged to mortgage customers who were looking to lock in their interest rate, and certain insurance policies that were charged to auto loan customers, the bank said.

The massive penalty that is expected to be levied on Wells follows the Federal Reserve Board’s decision in February to impose an the asset cap on the $1.92 trillion-asset bank.

Earlier this month, Wells submitted to the Fed plans for how to make various improvements to its governance and controls, the first step in its effort to get the asset cap lifted. Still, the cap is expected to remain in place until at least the fourth quarter of this year.

On Friday’s call, some analysts expressed concern that the consent order in which the Fed imposed the asset cap will hurt the company’s ability to pass the annual stress tests for big banks. The Fed-run stress tests, known as the Comprehensive Capital Analysis and Review, include a qualitative assessment of capital planning practices.

Wells Chief Financial Officer John Shrewsberry responded that the bank is working harder this year to make sure that it submits a sound plan to the Fed, in light of the problems raised in the consent order. But he also offered a note of caution.

“The qualitative process is far-reaching. It always has been,” Shrewsberry said.

For the quarter, Wells reported preliminary net income of $5.9 billion, up from $5.6 billion in the same period a year earlier. The company’s stock price fell by 3% on Friday, to close at close at $50.89. Its shares are down 22% since the Fed imposed the asset cap in early February.

Below are three additional takeaways from Wells Fargo’s first-quarter results.

Sales-scandal fallout weighs on fee income

Wells reported fee income of $9.7 billion, or $235 million lower than in the first quarter of 2017.

The decline was driven in part by changes that the bank has made in the wake of the sales scandal in an effort to hold onto retail customers. For example, Wells now refunds overdraft fees from the prior day in instances where the bank receives the customer’s paycheck by the following morning.

“So we lose revenue as a result of that. We lose overdraft fees. It costs us hundreds of millions of dollars, but as a result, people are happy with their relationship with Wells Fargo,” Shrewsberry said.

Service charges on deposit accounts, which include overdraft fees, fell by 11% compared with the first quarter of last year.

Loan growth was sluggish, partly by design

In a result that disappointed analysts, average loans outstanding during the quarter totaled $951 billion, a 1% decrease from a year earlier.

Balances outstanding on credit cards and in student loans, personal loans, auto loans and second mortgages all declined, though some of that retrenchment was by design.

Wells has been intentionally shrinking its footprint in auto lending and in second mortgages. And last quarter, the bank sold $1.6 billion worth of pre-crisis mortgages.

Commercial and industrial loans rose by 2%, but that improvement was offset a decline in commercial real estate loans, which the bank attributed to its decision to maintain risk discipline during a period of increased competition.

Notably, Sloan said that the asset cap is not hindering the bank's ability to grow loans.

Credit quality remains strong

Wells Fargo’s efforts to reduce risk in some of its business segments, including auto lending, appear to be paying off.

During the first quarter, the bank’s net charge-off rate was 0.32%, or 2 basis point lower than in the first quarter of 2017.

Loan performance was particularly strong in the bank’s commercial lending division, where net charge-offs fell by 45% from a year earlier.

The bank reduced its allowance for loan losses by 7%, thanks in part to lower than expected losses in hurricane-battered parts of Texas, Louisiana and Puerto Rico.

In the aftermath of last fall’s storms, Wells granted 90-day payment holidays to customers in affected regions, but those grace periods have subsequently ended.

“Our customers got back on their scheduled payment plans,” Shrewsberry said, “which gave rise to an understanding that the loss has been negligible as a result of the hurricanes.”

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