Second quarter earnings results for Wells Fargo They were a major disappointment to the bank, which reported a loss of $ 2.4 billion and cut its common dividend by approximately 80%. But CEO Charlie Scharf left analysts and investors with a bright spot: The bank is looking to cut annual expenses to the tune of $ 10 billion.
Wells Fargo has lagged behind its peers in terms of expense management, and since revenue is likely to be limited in the future due to the low rate environment and asset cap in which Wells Fargo currently operates, reducing expenses it is a way for the bank to take control of its own destiny.
Image source: Wells Fargo.
Fall behind your peers
Wells Fargo’s spending has long been higher than its peers. A measure commonly used by banks to judge a company’s spending structure is the efficiency ratio, a measure of a bank’s expenses as a percentage of its total revenue. A lower percentage is better because it means that the bank is generating more income with a lesser amount of expense.
Wells Fargo had a much higher efficiency rate than its peers in 2019. One thing to note is that this rate has been steadily increasing and has been much higher than normal since the bank’s fake account scandal in 2016. The The bank has had to spend more on costly litigation, and the Federal Reserve also placed a $ 1.95 trillion asset cap on the company. As a result, total revenue decreased while expenses increased, which ultimately sent the efficiency ratio in the wrong direction. However, even in 2017 and 2018, the company’s efficiency ratio was not less than 65%.
Where the company can start cutting
I am sure that Scharf is a very capable cost cutter. After all, in the first part of his career, he worked closely with JPMorgan CEO Jamie Dimon, who made a name for himself as a cost cutter by breaking into banks and cutting everything from corporate country club memberships. up to newspaper subscriptions.
As the country’s largest bank employer, the first and most obvious move for Scharf will be layoffs: Personnel is often the biggest expense in a bank. In 2019, Wells Fargo spent approximately $ 35 billion on wages, employee benefits and commissions, and incentive compensation. The bank is already planning to cut thousands of jobs this year and eventually cut its staff by tens of thousands when all is said and done, according to Bloomberg. It’s a tough reality, but as digital banking trends accelerate, it just won’t make sense to have the same number of employees.
Then the bank can continue to consolidate and close branches. With 5,455 U.S. branches as of March 31, according to the FDIC, Wells Fargo still has a greater physical presence than JPMorgan (5,061), Citigroup (710), and Bank of America (4,259).
Why the task can be difficult
The first thing I wonder about are the bank’s assumptions. Wells Fargo’s interest-free expenses in 2019 totaled nearly $ 58.2 billion. When Matt O’Connor, an analyst at German bankOn what the starting point for spending cuts is, Wells Fargo Chief Financial Officer John Shrewsberry said he believes it is about $ 54 billion in annual interest-free spending once “overspending that are loaded this quarter. ” So one could really say that the bank is looking to cut expenses by $ 14 billion from its current level.
Certainly, there have been expenses charged in recent quarters due to litigation over the fake account scandal, but the bank’s interest-free expenses were $ 56.1 billion in 2018 and $ 58.5 billion in 2017. In 2016, the bank’s expenses They were $ 52.4 billion, so $ 54 billion could be a fair guess without all of the expenses charged, but that was almost four years ago.
Also, the bank will still have to spend money while spending cuts are made. It has been widely documented that the bank needs and plans to invest much more in technology. Wells Fargo spent $ 2.8 billion on technology and equipment in 2019, compared to JPMorgan’s $ 9.8 billion on technology, communications and equipment; Citigroup’s $ 7.1 billion in technology and communications; and $ 4.6 billion at Bank of America, although the bank refers to the line item as “information processing and communications.”
Also, Betsy Graseck, analyst at Morgan Stanley, He asked Wells Fargo executives more about where the cuts would come from, given the work the bank must do to eventually remove the asset cap:
You have new heads of business units in various places. Usually, people like that are going to want to make investments. You are not going to touch the regulatory side. So where should we anticipate that you have room to start cutting costs before changes in the regulatory framework?
When will we see progress?
The company is likely to start moving forward with job cuts later this year. But in the company’s earnings call, Scharf was not entirely clear whether he expected total spending to actually decrease in 2021, although he said that “any sense of urgency that existed before will be small relative to what is happening in the future. ” The company is in a very difficult position right now with the need to invest in technology and continue to improve its regulatory infrastructure so that the Fed can eventually remove the asset cap it placed on the bank nearly two and a half years ago. That’s why cutting expenses by $ 10 billion could take some time.
