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Wells Fargo takes $1.6 billion hit linked to fake-account scandal

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Wells Fargo’s fake-account scandal continues to haunt the big bank, exacerbating headaches caused by shrinking interest rates.

Wells Fargo revealed on Tuesday a 23% drop in third-quarter profit that disappointed investors. The decline was driven by a $1.6 billion charge for legal costs linked to the bank’s infamous retail sales tactics.

The legal hit underscores Wells Fargo’s struggles to move past a scandal that first came to light three years ago. It will fall to Charlie Scharf, Wells Fargo’s incoming CEO, to get the bank back on track.

“We thought we were past a lot of that and then you see a $1.6 billion charge. It’s a little disappointing,” said Kyle Sanders, an analyst at Edward Jones.

Wells Fargo did not detail what sparked the legal hit other than to say it is related to its previously disclosed retail sales practices trouble broadly.

“It’s not something new,” John Shrewsberry, Wells Fargo’s chief financial officer, told CNN Business during a call with journalists on Tuesday afternoon. “It does reflect something that is a few years old at this point. We’ll all be happy when it’s behind us.”

Wells Fargo has yet to resolve a trio of investigations launched in 2016 by the SEC, Justice Department, and Labor Department.

Scharf, who takes the reins from interim CEO Allen Parker next week, must also navigate a tricky business environment for banks. The recent slide in interest rates has slammed lending profitability, a crucial source of income for all banks, especially Wells Fargo.

Lending profit dropped 8% during the third quarter at Wells Fargo. Net interest margin, a closely watched measure of profitability, fell sharply. The bank blamed the impact of the lower interest rate environment.

However, Wells Fargo’s stock jumped on Tuesday after the bank reiterated its guidance for net interest income to fall by 6% for the year. Investors feared a sharper drop. And the bank said it expects a more moderate decline in 2020.

Like other lenders, Wells Fargo has been hurt by the Federal Reserve’s interest rate cuts and the flat yield curve — the gap between short and long-term rates.

Banks pay out interest on deposits at short rates, while they lend at long rates. They make money off the spread between the two. That gap has vanished in recent quarters. The yield curve even inverted last quarter, meaning long-term bonds had lower rates than short-term ones.

Sanders said Wells Fargo is particularly exposed to these interest rate problems because of its reputation difficulties. To attract business, the bank needs to pay higher deposits than its rivals. And Sanders said Wells Fargo can’t charge as much on loans.

Against that difficult backdrop, Wells Fargo reported revenue inched up less than 1%, although that exceeded expectations.

Wells Fargo continues to spend heavily despite pressure from Wall Street to get costs under control. The bank’s non-interest expense climbed 10% during the quarter to $15.2 billion. That was driven by the legal charge as well as an increase in personnel expenses caused by higher salaries, incentives and severances costs.

Despite its reputation issues, Wells Fargo is still recruiting new customers. The bank reported 24.3 million customers who actively use their checking accounts. That’s up 1.5% from the same quarter of 2018, and the eighth straight quarter of gains. Deposits grew by 2% to $1.3 trillion.

Scharf, the former Bank of New York Mellon and Visa CEO, must focus on resolving Wells Fargo’s regulatory problems. The top priority will be convincing the Federal Reserve to lift the unprecedented asset cap imposed on Wells Fargo in early 2018 for “widespread consumer abuses.” The asset cap prevents Wells Fargo from growing its balance sheet above $2 trillion, limiting the amount of loans the bank can make.

Wells Fargo reported tepid loan growth during the third quarter, although the bank didn’t blame the asset cap. Average loans outstanding stood at $949.8 billion, up 1% from the year before and little changed from the second quarter.

Still, Wells Fargo said that marks its first loan growth in nearly three years.

The bank has been aggressively leaning on share buybacks to pad its results. Wells Fargo rewarded shareholders by repurchasing $7.5 billion of stock during the third quarter. The buybacks shrank the bank’s share count by 3% from the second quarter.

Wells Fargo’s results were boosted by $1.1 billion from the sale of its institutional retirement and trust business. The bank sold the retirement-plan business in April to Principal Financial.

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