Wells Fargo’s profitability suffers from low interest rates and global weakness
In this part of our series, we’ll take a look at the profitability ratios of Wells Fargo & Company (WFC) in the fourth quarter of 2015. A key element gripping the US banking sector (XLF) is the near-zero interest rate environment and global uncertainty that have acted as drags on banks’ earnings.
The important thing to remember is that although interest rates have increased, they are still considerably low. When interest rates are low, US banks earn lower returns on their assets as well as lower interest-based income. And so in order to boost profitability in the low-interest rate environment, banks are reducing expenses by restructuring their businesses and focusing on their fundamentals.
Wells Fargo’s return ratios
During the fourth quarter of 2015, net income for Wells Fargo was flatter than in 4Q14 at $5.7 billion. However, the company’s return on equity declined to nearly 12.2% from 12.6% in the previous quarter and approximately 12.8% during the same period last year. Its return on assets also declined, dropping to 1.27% from 1.32% in 3Q15 and from 1.36% in 4Q14.
Wells Fargo’s cost-cutting abilities
Expense control has been a key focus for US banks (XLF) as they struggle to remain profitable while containing rising costs in the current uncertain and volatile environment. And Wall Street analysts keep a close eye on efficiency ratios of banks.
Efficiency ratios are measures of operating expenses as a percentage of net revenue. They show how revenues fuel a bank’s operating expenses. A lower percentage, for example, is better as it means lower expenses compared to revenues. Efficiency ratios are especially important in the upcoming results as low interest rates and global events have eaten into bank’s revenues.
For 4Q15, Wells Fargo reported an efficiency ratio of 57.4%, which is lower than the 59% the company reported for the same period last year. This ratio is also the lowest among Wells Fargo’s peer group, which includes JP Morgan Chase & Company (JPM), Citigroup (C), Bank of America Corporation (BAC), and Goldman Sachs Group (GS).
During 2015, Wells Fargo operated within its targeted efficiency ratio range of 55%–59%. The company’s efficiency ratio for 2015 was 57.8%. For 2016, however, it expects its efficiency ratio to inch higher toward 59%, and it attributes these high levels of expenses to spending on compliance, risk management, and technology.
Now let’s examine Wells Fargo’s capital position after 4Q15.