Livinglies's Weblog

Wells Fargo & Co. (NYSE: WFC) turned in a “peer-beating” return on equity performance in the first quarter of 2017 of 11.54 percent.

That is the good news. From here it is all “downhill.”

The ROE was down from the first quarter in 2016, and down from the 2012-2015 period when returns were generally well above 12.0 percent and Wells Fargo was considered to be the commercial bank of the future.

One important factor here is that Wells Fargo was and still is a commercial bank, unlike most of its large competitors. Wells Fargo does not have investment banking and trading departments that can goose up earnings during times when financial markets are volatile, like JPMorgan Chase (NYSE: JPM) and Citigroup (NYSE: C).

Both JPMorgan and Citigroup posted impressive first-quarter gains in net income, boosted by 17.0 percent increases in trading results and substantial gains in fee income from debt issues.

Wells Fargo has to rely primarily upon dull old consumer and commercial banking business for most of its revenue.

Higher interest rates, for example, have resulted in some borrower pull back in recent months. Mortgage production was down, as were the fees on mortgage originations, which fell by 26 percent. Mortgage servicing income dropped by 46 percent.

Commercial and industrial loans were up, year over year, but by only one percent.

The net interest margin earned by Wells was actually down, year over year, falling from 2.90 percent to 2.87 percent this year. Note that the NIM at JPMorgan Chase and Citigroup rose over the same time period.

Perhaps the greatest hit to the Wells Fargo bottom line was the increase in expenses. Costs at the bank were up by almost 6.0 percent, and expenses as a share of revenue, an important gauge for management referred to as the “efficiency ratio,” rose to 62.7 percent above the banks’ target range of 55 percent to 59 percent.

There were two major contributors to the increase in the efficiency ratio. First, there were the direct costs associated with the retail banking “scandal” and the efforts of the consumer areas to repair relationships and maintain customers.

Second, there were the costs associated with hiring lawyers, consultants and other “risk professionals” to deal with the aftermath of the scandal.

But, the greatest challenge that Wells Fargo has to overcome is the decline in the brand.

The top management at Wells just cannot seem to get over the scandal and move on into the future. This, to me, is a shame and points to a real concern over the leadership of the bank.

As I have written about before, the reputation of a management is an all-important element of the culture of an organization. Once damaged, it is hard to build up, once again.

Earlier on, Wells Fargo had an outstanding record and its top management received high marks for the culture that was embedded in the organization. The return on equity of the bank was well above 15.0 percent, making it a leading performer in a tough industry.

Wells Fargo retained its image as a commercial bank, emphasizing commercial lending and mortgage lending and staying away from investment banking. Its focus kept it at the top of large bank performance during the Great Recession and put it in an enviable position for the subsequent economic recovery.

Something had changed, however, and the drive to sustain business led to practices that were unacceptable. The culture of the bank, at least in certain areas, declined and created a cancer. And, these practices were denied and covered up from others along the way.

And, as I have written before, these cancers eat away at the organization and have longer-term impacts on overall performance. And, these impacts linger.

Wells Fargo is facing the longer-term consequences right now and can’t seem to get rid of them. It appeared as if the top management changes were in the right directions and that the bank was, in fact, restarting,

Subsequent events, like the $75 million claw back last week of compensation from two top executives keeps the scandal before the public.

And, there was the release by the bank’s board not long ago of an independent investigation into what had gone on. This is just one of several investigations going on conducted by state and federal officials, including the US Department of Justice and the Securities and Exchange Commission.

Finally, the Board is facing a shareholder’s meeting on April 25 and there is a movement to vote against 12 of the 15 bank directors, including the Chairman Stephen Sanger.

“Crap” happens when you lose control of your culture. Right now, the new top management team is not doing what it needs to do to get Wells Fargo “restarted.” It must gain control over the message.

The bank is performing remarkably well given all that is going on at the bank and the distractions being faced by all employees and management, not only just the top management.

However, this is the time that the “new” leader needs to step up to the podium and show us what he (or she) is made of. It is time to “get the past behind it.”

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article