Wells Fargo & Company — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; comparisons are primarily with Q1 2019 unless stated otherwise. Wells Fargo is a diversified U.S. financial services company. Results reflect the initial effects of the COVID-19 pandemic and adoption of the CECL expected-credit-loss standard on January 1, 2020.
Financial performance and condition
- Earnings: Net income was $653 million, versus $5.86 billion; diluted EPS was $0.01, versus $1.20. Net income applicable to common stock was $42 million after $611 million of preferred dividends and other items, including a $272 million charge associated with preferred-stock redemptions.
- Revenue and expenses: Revenue was $17.72 billion, down 18%. Net interest income was $11.31 billion, down 8%; noninterest income was $6.41 billion, down 31%, including $1.40 billion of net losses on equity securities. Noninterest expense fell 6% to $13.05 billion. The efficiency ratio was 73.6%, versus 64.4%; pre-tax, pre-provision profit was $4.67 billion, down 39%.
- Margins and returns: Net interest margin was 2.58%, down 33 basis points. Annualized return on assets was 0.13% and return on common equity was 0.10%, versus 1.26% and 12.71%, respectively.
- Credit costs: Provision for credit losses was $4.01 billion, including $3.83 billion for loans and $172 million for debt securities; loan provision was $845 million in Q1 2019. The loan allowance was $12.0 billion, or 1.19% of loans, at quarter-end. Net charge-offs were $909 million, or 0.38% annualized, versus $695 million, or 0.30%. Nonperforming assets rose to $6.4 billion from $5.6 billion at year-end. COVID-related forecasts and oil-and-gas exposure drove significant reserve building.
- Balance sheet and funding: Assets were $1.98 trillion; loans were $1.01 trillion, up $47.6 billion from year-end, largely from commercial credit-line draws. Deposits were $1.38 trillion, up $53.9 billion from year-end and 9% year over year. Long-term debt was $237.3 billion. Cash, cash equivalents and restricted cash totaled $150.8 billion, compared with $141.3 billion at year-end.
- Cash flow: Consolidated cash flows were $17.3 billion provided by operating activities, $44.3 billion used in investing activities and $36.6 billion provided by financing activities. These figures include substantial loan, deposit and securities movements and are not a direct measure of bank earnings or liquidity.
- Liquidity and capital: Average quarterly LCR was 121%, above the 100% minimum. Unencumbered primary liquidity sources were $416.9 billion, with approximately $273.5 billion of available Federal Reserve and Federal Home Loan Bank borrowing capacity. CET1 was 10.67%, above the company’s 10% internal target and stated 9% minimum; total equity was $183.3 billion. External TLAC was 23.27% of risk-weighted assets, against a 22% requirement.
Material changes and unusual items
- The sharp earnings decline reflected higher credit provisions, lower net interest income and noninterest income, and impairment and market-related losses. Nonmarketable equity-security impairments were $935 million; net equity-security losses also included $621 million of deferred-compensation investment losses, largely offset in employee-benefits expense.
- Lower interest rates reduced asset yields and net interest margin. Mortgage-banking income fell to $379 million from $708 million; MSR valuation losses were substantially offset by economic-hedge gains.
- Wells Fargo adopted CECL, recording a $1.3 billion pre-tax reduction in the opening loan allowance. Subsequent Q1 reserve increases reflected the deteriorating economic outlook; the filing notes that allowance comparisons are affected by the accounting change.
- Common shares repurchased during Q1 totaled 75.4 million, for $3.4 billion. The company suspended repurchases for the remainder of Q1 and Q2 2020. The quarterly common dividend declared for Q1 was $0.51 per share.
- Operating cash flow was positive, but investing cash use included $53.4 billion of net loan originations by banking subsidiaries; financing cash flow included $53.9 billion of deposit inflows.
Outlook, management commentary and risks
- Management said the duration and severity of the pandemic and its economic effects were highly uncertain. The allowance forecast assumed a sustained recession through 2020, with higher unemployment and lower GDP. The filing provides no specific earnings or revenue guidance.
- The company reported customer relief including payment deferrals, fee waivers and loan maturity extensions. Through April 24, it had deferred approximately 1.4 million payments representing more than $4.6 billion of principal and interest, and provided over 1.8 million fee waivers exceeding $75 million. These accommodations, and further deterioration in the economy, could affect credit losses, servicing advances and revenue.
- Commercial customers drew over $80 billion on revolving credit lines in March. Credit risks include oil and gas, commercial real estate and industries affected by pandemic-related restrictions. Management cautioned that further credit losses and allowance increases could result.
- The Federal Reserve asset cap remained in effect under the 2018 consent order. Although period-end assets exceeded the December 2017 cap reference level, Wells Fargo said its two-quarter daily average remained below the cap. An April 8 amendment excluded qualifying PPP and Main Street Lending Program exposures, subject to transfer of certain program economics; the cap and required reviews remain material constraints.
- Regulatory and legal matters remain significant, including governance and risk-management consent orders, customer remediation and retail-sales-practices matters. In February 2020 the company agreed to pay $3.0 billion to resolve DOJ and SEC retail-sales-practices investigations. The high end of reasonably possible legal losses above accrued amounts was approximately $2.5 billion at March 31; actual outcomes may differ.
- Other risks include market and securities impairments, mortgage-servicing and foreclosure costs, operational and compliance challenges, and credit-rating pressure. Fitch affirmed ratings but revised the outlook to negative in April 2020. Management also continued work on the announced transition to five principal lines of business.
Most important facts for investors to verify
- Whether pandemic-driven credit deterioration, charge-offs and customer payment accommodations require further allowance increases.
- How quickly earnings recover from the unusually high credit provision, equity losses and lower interest-rate environment.
- Whether Wells Fargo continues to comply with the Federal Reserve asset cap and makes progress toward satisfying consent-order requirements.
- Developments in legal proceedings, customer remediation and the estimated $2.5 billion of reasonably possible losses above accruals.
- Capital, liquidity, dividend and repurchase capacity under changing regulatory requirements and economic stress.
- That Q1 cash-flow movements, CECL adoption and preferred-stock charges are understood when assessing recurring earnings and comparability.