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Wells Fargo's noninterest income engine shows signs of life

Revenue at Wells Fargo & Co. sputtered and stalled as the bank faced a string of consumer scandals that have forced it to try to rewire a sales culture that was once central to its identity.

But there are some signs that fees are nearing a growth path again after taking a hit from "customer-friendly changes" the bank has made to mend its reputation and rebuild customer trust.

For many periods, the company's quarterly and annual reports have started with lengthy statements of penance, covering steps it is taking to make restitution to customers hurt by fake accounts, unwanted auto insurance and other products, accounts that were frozen or closed due to suspected fraud, and other practices. The bank has also instituted a more forgiving approach to overdraft charges and monthly account fees that it said was a major driver behind a $656 million drop in deposit service charges between 2016 and 2018.

The second quarter may have represented an inflection point, however, with service charges up $112 million from the previous quarter. On the company's earnings call, CFO John Shrewsberry said the increase was expected "now that the customer-friendly changes we've made, which meaningfully reduced these fees, are fully in the run rate."

The short-term hit might translate into more profitable customer relationships over time. "If they're not charging as much, and not charging as many times, then they're reducing that revenue line," Moody's Senior Vice President Allen Tischler said in an interview. "But the flip side of it is, the customers are maybe more appreciative, and maybe think of them more highly and will continue to bring more business to them."

Overall, Wells Fargo's noninterest income jumped almost 8% from the first quarter to $8.85 billion, according to S&P Global Market Intelligence data. In addition to deposit account charges, the bounce was fueled by an increase in retail brokerage advisory fees tied to the market value of assets under management, and the beginnings of a mortgage refinancing boom driven by lower interest rates.

Still, at an annualized rate of $34.12 billion in the first half of this year, Wells Fargo's noninterest income is well below the $37.65 billion it posted in 2015, the year before the fake accounts scandal broke into the open. By comparison, noninterest income has been roughly flat for Bank of America Corp. over the same period, and JPMorgan Chase & Co. has shown substantial growth since 2017.

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Moreover, Wells Fargo has also underperformed its two national consumer banking peers in net interest income, with the annualized $48.8 billion it reported for the first half of the year representing a 2.4% decrease from 2018. The bank has forecast that its net interest income could decline 5% for the year from 2018, citing an adverse interest rate environment.

Broadly, Wells Fargo's growth outlook is constrained by regulatory scrutiny and a consent order that caps its assets at their year-end 2017 level, as well as the attention it needs to devote to its risk and compliance overhaul and a lack of long-term direction as it searches for a new CEO.

"It took a long time, or longer-than-expected time, for branch personnel to really get back in the groove of making as many recommendations or referrals as they had previously," Shrewsberry said on the second quarter call.

The bank has also shed some businesses and exited some markets — including the sale of 52 branches to Flagstar Bancorp Inc. in late 2018 — as part of a simplification process. On the call, Shrewsberry said that it "probably makes sense" to sell some additional groups of branches outside Wells Fargo's core markets, but that "the list is pretty short right now" in terms of further business line divestitures the company is considering.

Measured by deposits — one proxy for the traction the bank is achieving with consumers — Wells Fargo has grown during its crisis years. But with a 5% increase from 2015 through the second quarter this year, the bank is far behind JPMorgan Chase's 19% and BofA's 15% growth.

Despite its efforts, Wells Fargo continues to draw negative headlines and drubbings from high-profile lawmakers for its consumer practices. Public assessments from regulators have also continued to be negative. Federal Reserve Chairman Jerome Powell said in July that the bank's problems are "deep-seated," echoing remarks he made shortly before former CEO Timothy Sloan stepped down.

"They've been able to grow deposits, albeit at a much slower pace than many peers over the last few years while retooling how they deal with their customers," Tischler said.

Recently, a considerable amount of investor attention has been focused on Wells Fargo's guidance that its expenses in 2020 will be about flat with this year, a level Shrewsberry called "too high" and that has contributed to efficiency ratios that are far worse than at JPMorgan Chase and BofA.

The expenses are being driven largely by efforts to build up risk management technology and processes, and they are creating a drag on the bank's revenue outlook.

Shrewsberry argued that risk-related spending produces high economic returns, in view of the costs Wells Fargo's mistakes have generated in the last few years. But he acknowledged that the bank's concentration on compliance issues has resulted in a "de-prioritization" of "offensive activity."

"On the investment spend front, if you're thinking about enabling technologies or new capabilities, etc., it's a minority," he said.