Wells Fargo's next stage: Cost cuts

Article by: CHRIS SERRES , Star Tribune
Updated: April 20, 2011 - 10:30 PM

An ambitious cost-control initiative, called "Project Compass," marks a shift for a bank that has long focused on revenue growth.

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Exterior view of a Wells Fargo Bank is seen in Sunnyvale, Calif., in this April 16, 2007 file photo.

Photo: Stf, Associated Press - Ap

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Wells Fargo & Co. has embarked on an ambitious effort to cut expenses, as the nation's fourth-largest bank puts a new emphasis on cost controls amid lackluster revenue growth.

The San Francisco-based bank, which employs about 20,000 people in Minnesota, said the initiative -- called "Project Compass" -- aims to reduce fixed costs across all of Wells Fargo's divisions, from its retail branches to its giant mortgage servicing operation.

"This is about getting more efficient, but it's also about getting more nimble," Chief Executive John Stumpf said in a conference call with analysts Wednesday.

Project Compass began in mid-2010 and is a "bottom-up initiative," in which ideas for cutting expenses will come directly from the bank's employees rather than senior management, a bank spokeswoman said. Currently, the initiative does not involve a set number of job cuts or expense reductions.

However, the cost-cutting effort reflects a growing concern at Wells Fargo that the bank's revenue growth hasn't kept pace with its expenses. Like many large banks, Wells Fargo is struggling with anemic loan demand, tighter regulatory limits on debit-card and overdraft fees, and a sharp downturn in mortgage applications.

With fewer avenues for growth, the bank will be under increased pressure from investors to take costs out of its many business units.

"They need to react to the realities of banking right now, and it doesn't look like those realities are going to change anytime soon," said Nancy Bush, a bank analyst and contributing editor at SNL Financial in Charlottesville, Va.

Bush said she expects "thousands more" jobs to be eliminated at Wells Fargo by the end of the year, particularly in the bank's mortgage servicing area.

The focus on expense cuts reflects a major shift for the bank. Revenue growth, not expense controls, have been the hallmark of Wells Fargo's strategy for the past two decades. Former CEO Richard Kovacevich, who retired last year, championed the idea of increasing revenue by cross-selling multiple banking products to the same customers. If someone wanted a checking account, they were also pitched a credit card, car loan and savings account. The strategy worked so well the company did not have to focus on expense cuts.

However, the banking environment has changed considerably over the past two years. Weak loan demand and new limits on debit card fees and overdraft charges have curtailed banks' ability to grow. And since its 2009 acquisition of Charlotte, N.C.-based Wachovia Corp., Wells Fargo has become so large -- with $1.2 trillion in assets -- that its ability to grow through acquisitions is limited. There are simply fewer banks it can buy that would generate a meaningful boost to its revenue, analysts say.

"This company is undergoing an interesting evolution," Bush said. "Under Kovacevich, they never had to worry about expenses. Now, expenses are going to have to be a bigger part of the equation."

On Wednesday, Wells Fargo said its first-quarter net income surged 48 percent from a year earlier to $3.8 billion. However, these strong profits were overshadowed by weakness in its core lending business. The bank's loan portfolio has declined nearly 4 percent from $781.4 billion a year ago to $751.2 billion. The news sent the stock down $1.24, or 4.1 percent, to $28.83 a share Wednesday.

Wells Fargo is hardly alone in its struggle to generate growth. In the past week, KeyCorp of Cleveland, Regions Financial Corp. of Birmingham, Ala., Comerica Inc. of Dallas and New York-based Citigroup have all posted declines in loan activity. U.S. Bancorp reported a modest gain in its first-quarter loan balances Tuesday, but its CEO called it "wholly inadequate" in a conference call with analysts.

One reason that big banks are shrinking their loan balances is that corporations are still holding on to hundreds of billions of dollars in cash. Many companies can dip into these reserves rather than borrow.

As the nation's largest home lender, Wells Fargo is particularly vulnerable to downturns in the mortgage market. A recent rise in long-term interest rates has already had a major affect on the bank's mortgage business. The bank reported Wednesday that its mortgage banking noninterest income plunged 26 percent to $2.02 billion in the first quarter.

In this environment, Wells Fargo's expenses are "beginning to stand out," said Jaime Peters, a bank analyst at Morningstar of Chicago. The bank's "efficiency ratio," or its noninterest expenses as a percentage of revenue, stands at about 59 percent, while many of its big-bank peers are closer to 50 percent, Peters said.

"Their cost basis is a bit high given their size and scale," Peters said. "There is ample room to cut."

Wells Fargo already eliminated 4,500 positions in its mortgage division in the first quarter. However, most of those laid off were in interim positions that involved processing mortgage applications, and they were hired to deal with a huge inflow of mortgage applications last year. These job cuts are not part of the company-wide expense cutting initiative discussed Wednesday.

Mary Eshet, a Wells Fargo spokeswoman, said the bank will update investors on the progress of Project Compass sometime this summer.

Chris Serres • 612-673-4308

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