Wells Fargo Misses 4th Quarter Earnings Expectations

Company loses $592 million in net hedging ineffectiveness

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Jan 13, 2017
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Wells Fargo & Co. (WFC, Financial) reported net income of $5.3 billion and diluted earnings per share of 96 cents during fourth-quarter 2016. These values slightly underperform comparable figures during fourth-quarter 2015. Heavy losses in the company’s net hedging ineffectiveness contributed to weaker earnings performance.

Brief summary of earnings report

Although Wells Fargo reported strong results during third-quarter 2016, the company reported modest earnings performance during fourth-quarter 2016. Net incomes declined $300 million from fourth-quarter 2015, which led to a decrease in diluted earnings per share of 3 cents. For full-year 2016, Wells Fargo reported net income of $21.9 million, down $1 million compared to full-year 2015 net income.

CEO Tim Sloan praised the company’s efforts to make progress in “rebuilding the trust of [the company’s] customers, team members and other key stakeholders” after the sham account scandal from the prior quarter. Wells Fargo launched a new “retail bank compensation program” for 2017, based on “building lifelong relationships with [the company’s] customers.”

While the company’s net interest income increased, noninterest income declined from the prior quarter primarily due to “net hedge accounting ineffectiveness,” according to Chief Financial Officer John Shrewsberry. Wells Fargo reported a net loss of $109 million from trading activities, a “linked-quarter decline” of $524 million from third-quarter 2016. Lower secondary trading due to lower client volumes contributed to $223 million of the decline.

Hedge ineffectiveness loss leads to lower earnings

Wells Fargo, as part of its ongoing funding strategy, regularly issues long-term debt. The interest rates on the debt are typically fixed rate to meet debt investor demand, but the company usually switches the interest to floating rate to “balance the company’s deposit-oriented liability structure” and increase alignment with the interest-rate sensitivity of Wells Fargo’s assets. The company's long-term debt increased about $140 billion since July 2013.

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Although the hedge “effectiveness” should be minimal as long as the company remains the hedge, periodic hedge ineffectiveness can significantly affect Wells Fargo’s noninterest income. During fourth-quarter 2016, the 10-year Treasury constant maturity rate increased from 1.5% to 2.5% in light of Donald Trump’s Nov. 8 victory in the U.S. presidential election and major global bond selloffs. Sharp increases in interest rates and foreign currency fluctuations contributed to a loss of $592 million from fourth-quarter hedge ineffectiveness.

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Gurus sell shares as financial strength declines

Although the company’s financial strength ranks 5 out of 10, the company’s cash-debt ratio and equity-asset ratio are 0.05 and 0.11. The former ratio suggests that Wells Fargo cannot pay its debt with cash on hand while the latter ratio suggests that Wells Fargo has more debt than it has equity. Additionally, the company’s Piotroski F-score of 2 implies a poor business operation.

Warren Buffett (Trades, Portfolio) owns 479,704,270 shares of Wells Fargo, the largest stake among gurus. As the company offers minimal value potential, Sarah Ketterer (Trades, Portfolio) wiped out her Wells Fargo position during the past six months. Arnold Van Den Berg (Trades, Portfolio) pared his position 3.27% during fourth-quarter 2016.

Disclosure: No position in Wells Fargo.

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