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What Wells Fargo’s High Expenses Mean for 2017

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WFC’s high expenses in 2Q17

In 2Q17, Wells Fargo (WFC) saw noninterest expenses of nearly ~$13.5 billion, which represents a rise of 5% over 2Q16 and a decline of 2% from 1Q17. Sequentially, WFC’s expenses fell $251 million, driven by lower commissions, employee benefits, and equipment expenses, which were partially offset by higher salaries and other professional services.

Commercial banks (XLF) have been targeting lower spending, and efficiency ratios to boost margins since the era of low-interest rates. Compensations have risen for banking peers JPMorgan Chase (JPM), Bank of America (BAC), and Goldman Sachs (GS) in recent quarters, mainly due to improved performances, sales, credit, and trading.

But as the outlook for 2H17 is weaker for banks, incentives and commissions are expected to decline in coming quarters.

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WFC’s rising efficiency ratio

Wells Fargo’s efficiency ratio (a metric of non-interest expenses to total revenue) improved sequentially to 61.1% on lower commissions and benefits. But this ratio rose on a YoY (year-over-year) basis, reflecting declining margins, higher employee spending, equipment, FDIC (Federal Deposit Insurance Corporation) and other deposits, and professional services.

In 1Q17, WFC’s efficiency ratio peaked at 62.7% on higher expenses. In 2Q17, Wells Fargo posted salaries, commissions, and employee benefits of nearly $8.2 billion, equipment of $529 million, professional services of $1.0 billion on outside consultancy, and net occupancy of $706 million. The bank’s other expenses rose 5% YoY to over $2.5 billion, including contract services, advertising expenses, donations, travel expenses, and operating losses.

Wells Fargo’s ability to garner higher margins and valuations depends largely on its ability to control spending. In the second half of 2017, WFC expects to see subdued growth in its top line, and so the bank will likely need to slow down spending if it wants to maintain its valuation premium.

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