(Bloomberg) -- Forget trading. Cross-selling is Wall Street’s new bugaboo.
When Wells Fargo & Co. kicks off U.S. banks’ third-quarter earnings season on Friday, all eyes will be focused on its practice of selling more products to retail customers. Long a source of strength for a company largely insulated from Wall Street’s trading malaise, cross-selling has embroiled the San Francisco-based lender in a scandal involving the creation of as many as 2 million unauthorized accounts. Now, as most banks are expected to report an increase in fixed-income trading, the tables are turned on Wells Fargo.
“Last quarter, Brexit was topic du jour, and this quarter it moves over to Wells Fargo’s sales practices,” said Jason Goldberg, an analyst at Barclays Plc. “Both from the perspective of if competitors are seeing any market-share shifts away from Wells Fargo as a result and any potential thoughts on the Office of the Comptroller of the Currency, which said it’s going to step up its examination of cross-sell services and incentives.”
Analysts aren’t expecting the scandal to have much impact on Wells Fargo’s earnings for the period. But in the month since the bank agreed to pay $185 million to settle claims, the average of analysts’ estimates for its 2017 adjusted earnings per share dropped by 1.3 percent to $4.14, the largest decline among the six biggest U.S. banks, on growing concern that challenges to the firm’s cross-selling practices could lead to increased litigation costs and erode revenue in consumer and wholesale banking. Mark Folk, a spokesman for Wells Fargo, declined to comment.
On a call Monday with senior management, Chief Executive Officer John Stumpf said that net new business for the retail bank is expected to be “down for a while,” but added that efforts by states to penalize Wells Fargo by suspending relationships with the bank weren’t having much effect, the Wall Street Journal reported. Chief Operating Officer Timothy Sloan told the executives that more accounts were being opened than closed, though growth in checking accounts has slowed, according to the newspaper, which reviewed a recording of the call.
Oscar Suris, a bank spokesman, declined to comment on the Journal’s story.
JPMorgan Chase & Co. and Citigroup Inc., which also report earnings Friday, are expected to post year-over-year gains in fixed-income trading, a trend analysts estimate will be reflected when other banks provide results next week. Still, combined net income at the six biggest U.S. lenders -- a group that also includes Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley -- probably fell 16 percent in the third quarter from a year earlier, according to the estimates, as persistently low interest rates crimp lending margins.
Earnings Drop
The surge in fixed-income trading isn’t expected to help Wells Fargo, where trading accounted for just $614 million of the bank’s $86.1 billion in revenue last year. Wells Fargo probably earned $1.01 per share on an adjusted basis for the quarter, a 3.8 percent drop from the same period a year ago, analysts’ estimates show. Its net interest margin, the difference between a bank’s income from lending and its cost of funding, declined 2 basis points from the prior quarter to 2.84 percent, according to the average of 15 analysts’ estimates compiled by Bloomberg.
“The fundamental performance of the quarter I don’t think is going to be that relevant to how people view the stock at this stage, it’s going to be all about their legal risks,” said Eric Wasserstrom, an analyst at Guggenheim Securities LLC. “The questions that they need to address are: How are they viewing their legal liabilities at this stage and how are they going to be accruing for them?”
Wells Fargo may face “significant fines,” Wasserstrom wrote in a Sept. 28 note to clients, estimating the U.S. Department of Justice could levy a $2 billion penalty.
Stumpf Grilled
The Consumer Financial Protection Bureau found that Wells Fargo employees, under pressure to meet targets to sell more products, opened deposit and credit-card accounts without customers’ permission. Since a settlement was announced Sept. 8, the fallout has widened.
The Department of Labor said it’s conducting a review, and dozens of current and former customers and employees have filed lawsuits. The Justice Department and state attorneys general offices are also investigating. Stumpf was vilified at two congressional hearings, where he faced calls to resign. On Sept. 27, he agreed to forgo more than $41 million in pay.
“The fear of the unknown is the biggest issue right now,” said Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods. “What does this mean to cross-sell overall? What does this mean to their sales practices overall? Does it mean this is a completely changed company? That’s what investors are grappling with. That’s what everyone is grappling with.”
The states of California and Illinois have suspended Wells Fargo from handling billions of dollars of investments and the underwriting of state debt, signaling that the scandal is beginning to impact revenue outside the lender’s community-banking division. Wells Fargo COO Sloan said Monday he expects to win back lost business with state and local government agencies within a few years.
“What we don’t know is where this ends, be it with additional settlements, fines and/or management changes, any and all of which can be both distracting and financially costly,” Susan Roth Katzke, an analyst at Credit Suisse Group AG, wrote in a Sept. 23 note to clients. Katzke lowered her estimate for the bank’s 2017 earnings by 15 cents to $4 per share.
Loan Growth
Wells Fargo will be among banks benefiting from accelerating growth in consumer loans and a surge in commercial real estate lending that’s making up for a broader slowdown in commercial and industrial borrowing. Outstanding loans at Wells Fargo increased to almost $970 billion in the third quarter, a 4.7 percent jump from a year ago, according to the average of six analysts’ estimates compiled by Bloomberg.
Katzke said in a separate note that average loan growth at the six largest U.S. banks and regional lenders U.S. Bancorp, SunTrust Banks Inc. and PNC Financial Services Group Inc. is expected to be 6 percent for the full year, which would be the fastest rate since 2008 for that group. It may slow to 4 percent in 2017, her estimates show.
The six big banks are expected to report an 18 percent increase in fixed-income trading and a 12 percent gain in debt-underwriting revenue, according to an average of analysts’ estimates. The pick-up in trading probably won’t be enough to ward off questions during earnings calls about regulatory and compliance issues as analysts try to decipher how the industry will enhance risk management to avoid future cross-selling scandals, said Shannon Stemm, an analyst at Edward Jones & Co.
“Cross-selling is something all the banks want to do, and I think they’d be a lot more reluctant to do it now,” said Jeff Harte, an analyst at Sandler O’Neill & Partners. “That’s certainly not a revenue tailwind for the industry, if they’re going to have to look less to cross-selling.”
--With assistance from Dakin Campbell and Laura J. Keller. To contact the reporter on this story: Jenny Surane in New York at [email protected] To contact the editors responsible for this story: Peter Eichenbaum at [email protected] Robert Friedman, David Scheer