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Will Litigation Issues Hurt Wells Fargo (WFC) Q3 Earnings?

Zacks

Wells Fargo & Company WFC is scheduled to report third-quarter 2017 results on Oct 13, before the opening bell. Its earnings are likely to improve year over year, but revenues might decline.

This San Francisco-based banking giant has been much in the news following the sales scam that came into light in September 2016. The revelation of the fake account scandal that marked the beginning of numerous problems for the bank was followed by the disclosure of issues in its auto insurance business and online bill pay services.

Therefore, the bank has been subjected to severe political and public outrage, and faced several lawsuits and investigations as well.

Wells Fargo has undertaken a number of steps to restore its reputation, post scandal. Recently, at a heated senator meeting, Wells Fargo’s chief executive officer — Timothy Sloan — vigorously tried defending America’s third-largest bank for its past wrongdoings amid a volley of questions raised by the senators.

Sloan apologized for causing its customers trouble and promised to take appropriate steps to make it a better bank in the times to come. The bank still has a long way to go before it can put all these troubles behind and focus on improving its performance.

Amid such adversities, shares of Wells Fargo have gained just around 1% so far, this year, significantly lagging 10.5% growth recorded by the industry.

Will the upcoming earnings release exert more pressure on the stock? Notably, Wells Fargo delivered an earnings beat in each of the trailing four quarters, with an average positive earnings surprise of 2.99%. However, our proven model does not conclusively predict an earnings beat in the third quarter.

A stock needs to have the right combination of the two key criteria — a positive Earnings ESP and a Zacks Rank #1 (Strong Buy) or 2 (Buy) or at least 3 (Hold) — for increasing the odds of an earnings beat.

Unfortunately, this is not the case here, as elaborated below.

Zacks ESP:The Earnings ESP for Wells Fargo is 0.00%. This is because both the Most Accurate estimate and the Zacks Consensus Estimate are pegged at $1.06. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Zacks Rank: Wells Fargo’s Zacks Rank #3 increases the predictive power of ESP. However, we also need to have a positive ESP to be confident of an earnings beat.

It should be noted that we caution against stocks with a Zacks Rank #4 or 5 (Sell rated) going into the earnings announcement, especially when the company is seeing negative estimate revisions.

Factors to Influence Q3 Results

Expenses May Trend Higher: Wells Fargo may record escalated costs given its franchise investments in areas, including mobile banking technology, digital lending and brokerage offerings. Notably, management projects technology costs to remain at an elevated level in the third quarter, before declining in the fourth quarter. Wells Fargo anticipates the efficiency ratio to be in the range of 60-61%, but the company is targeting around $4 billion of cost savings by year-end 2019.

Notably, legal costs related to sales scam scandal might also escalate expenses for the bank.

Mortgage Business to Surge: Wells Fargo — one of the largest mortgage lenders in the nation — might record rise in mortgage banking revenues. Higher mortgage banking is expected on stronger origination volumes. However, the bank projects decline in the auto portfolio to reflect lower origination volumes. Management tightened credit underwriting standards in response to early signs of rising delinquencies in the industry and declining used car values. As a result, the quality of originations has improved and the company expects the size of the auto portfolio to decline persistently in 2017.

Expectations of a higher rate environment might have encouraged refinancing activities during the quarter under review. Nevertheless, with the refinance boom nearing its end, no major help is expected from this segment.

Loan Growth: Per the Federal Reserve’s latest data, loans grew on a sequential basis during the third quarter. Particularly, growth in commercial and consumer loans, with slowdown in commercial real estate loans is expected. However, the auto portfolio run-off is likely to continue in the near term on tightening of underwriting standards by Wells Fargo. Notably, the bank is cutting back its auto lending business amid stressful markets and adherence of more centralized risk controls.

Rise in Net Interest Income: In addition to higher interest rates, a moderate improvement in lending might perk up interest income.

Stocks That Warrant a Look

Here are some stocks you may want to consider, as according to our model they have the right combination of elements to post an earnings beat this quarter.

Comerica Incorporated CMA is slated to release results on Oct 17. The company has an Earnings ESP of +0.28% and carries a Zacks Rank of 3. You can see the complete list of today’s Zacks #1 Rank stocks here.

The Earnings ESP for The PNC Financial Services Group, Inc. PNC is +0.07% and it carries a Zacks Rank of 2. The company is scheduled to release results on Oct 13.

State Street Corporation STT has an Earnings ESP of +0.57% and carries a Zacks Rank of 2. It is scheduled to report results on Oct 23.

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