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High expenses cast cloud over Wells Fargo earnings beat

This file photo taken on May 27, 2016 shows a woman walking into a Wells Fargo bank in Washington, DC.

NICHOLAS KAMM/AFP/Getty Images

Analysts pressed Wells Fargo & Co executives about the bank's expenses on Friday after it failed to meet revenue expectations and indicated that costs may remain elevated in the near term.

Wells, the third-largest U.S. bank by assets, spent 61.1 cents for every dollar of revenue it generated in the second quarter. While that was an improvement from the first quarter, Wells' efficiency ratio remains above a targeted range of 55 to 59 cents in costs per dollar of revenue.

"Operating at this level is just not acceptable," Chief Executive Officer Tim Sloan said on a conference call with analysts to discuss results, echoing comments on costs he made earlier this year.

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Wells Fargo has been taking measures to cut $4-billion from its annual expenses by 2019, including branch closures, curtailing travel and entertainment costs and even reducing the amount of postage it uses.

However, it takes about a year for savings to trickle down to the bottom line once branches close, said Chief Financial Officer John Shrewsberry.

The bank is also facing elevated costs for technology as well as legal and regulatory matters. Some of that relates to a sales scandal that erupted last year involving the bank's creation of as many as 2.1 million accounts in customers' names without their permission.

Wells had to spend an additional $110-million on third-party services related to the scandal last quarter. It also added to legal reserves for various matters, including regulatory investigations into its residential mortgage-backed securities business.

Four analysts brought up expenses during the call, including Deutsche Bank analyst Matthew O'Connor, who pushed executives to explain why they do not offer an absolute target for costs the way some other big banks do.

"I think it's something worth considering," he said. "I think it would be helpful for your stock."

Wells shares were down 1.9 per cent at $54.54 on Friday afternoon, with analysts citing high expenses and weak revenue as disappointments, even though the bank managed to beat Wall Street's profit expectations.

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Its net income rose 4.5 per cent to $5.40-billion, or $1.07 per share, in the quarter ended June. 30, topping the average analyst estimate of $1.01, according to Thomson Reuters I/B/E/S.

Revenue remained flat at $22.17-billion and missed analysts' average estimate of $22.47-billion, with weakness in mortgages and wholesale banking.

Non-interest expenses rose 5 per cent to $13.54-billion.

It was not all gloom, however. Net interest income, a measure that reflects earnings relative to funding costs, rose 6.4 per cent to $12.48-billion thanks to loan growth, higher interest rates and keeping a lid on deposit costs.

Oppenheimer & Co analyst Chris Kotowski called the results "lackluster," and questioned whether problems related to the sales scandal were hurting Wells' underlying businesses. The one bright spot, he said, was that customers' delinquency and default rates looked good.

"While we've said many, many times over the years that credit improvement is a gift that will keep on giving, it is not a substitute for core revenue growth," he wrote in a note to clients.

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