Wells Fargo & Company — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Wells Fargo is a diversified financial services company; it reported $1.375 trillion in assets at quarter-end.
Financial performance and condition
| Metric | Q3 2012 | Comparable period |
|---|---|---|
| Total revenue | $21.213 billion | $19.628 billion in Q3 2011; up 8% |
| Net income | $4.937 billion | $4.055 billion in Q3 2011; up 22% |
| Net income applicable to common stock | $4.717 billion | $3.839 billion in Q3 2011 |
| Diluted EPS | $0.88 | $0.72 in Q3 2011 |
| Net interest income | $10.662 billion | $10.542 billion in Q3 2011 |
| Noninterest income | $10.551 billion | $9.086 billion in Q3 2011 |
| Noninterest expense | $12.112 billion | $11.677 billion in Q3 2011; up 4% |
| Provision for credit losses | $1.591 billion | $1.811 billion in Q3 2011 |
| Net interest margin | 3.66% | 3.84% in Q3 2011 |
| Efficiency ratio | 57.1% | 59.5% in Q3 2011 |
For the first nine months of 2012, revenue was $64.138 billion, net income was $13.807 billion, diluted EPS was $2.45, and net interest margin was 3.82%. Year-over-year changes were +6%, +17%, +17%, and down 14 basis points, respectively.
Cash flow: Nine-month operating cash flow was $50.2 billion, investing cash flow was negative $85.8 billion, and financing cash flow was positive $33.1 billion. Cash and due from banks fell $2.5 billion from year-end 2011 to $17.0 billion. Operating cash flow included substantial mortgage origination and sale activity.
Balance sheet and funding: Total assets were $1.375 trillion, loans $782.6 billion, deposits $952.2 billion, short-term borrowings $52.0 billion, and long-term debt $130.8 billion. Core deposits were $901.1 billion, or 115% of average loans. The allowance for loan losses was $17.4 billion, 2.22% of loans.
Capital: Tier 1 capital ratio was 11.50%, total capital ratio 14.51%, Tier 1 leverage ratio 9.40%, and Basel I Tier 1 common equity ratio 9.92%. Management estimated a Basel III Tier 1 common equity ratio of 8.02%, based on proposed rules and subject to change.
Material changes versus prior periods
- Higher mortgage banking and trading income were major contributors to Q3 revenue growth. Mortgage banking income rose 53% year over year to $2.8 billion; originations were $139 billion, up 56%.
- Trading gains were $529 million, versus a $442 million loss in Q3 2011. Mortgage loan origination and sales gains were $2.610 billion, versus $803 million.
- Net interest income grew modestly, but margin declined as higher-yielding assets ran off and deposit growth kept short-term investments elevated.
- Credit quality generally improved: year-over-year net charge-offs fell to $2.4 billion from $2.6 billion, and nonperforming assets were $25.3 billion versus $26.0 billion at December 31, 2011. Core loans and deposits grew; total loans rose 3% year over year.
- Reported credit metrics were affected by new OCC guidance: $1.4 billion of performing consumer loans moved to nonaccrual, $567 million of charge-offs were recorded, and $4.3 billion of loans were classified as troubled debt restructurings. Excluding those charge-offs, the annualized net charge-off rate was 0.92%, versus the reported 1.21%.
- Card fees fell 27% in Q3, primarily reflecting lower debit interchange rates under Durbin Amendment rules. Noninterest expense increased, partly from higher personnel and mortgage-volume costs; merger integration costs declined after completion of Wachovia integration activities.
Outlook, commentary, risks and unusual items
- Management targeted an efficiency ratio of 55%–59% and expected to remain within that range in Q4 2012. Q3’s 57.1% was the lowest in 10 quarters.
- Management expected continued net interest margin pressure in the low-rate environment. It anticipated future allowance releases absent significant economic deterioration or material Hurricane Sandy effects.
- Hurricane Sandy occurred after quarter-end. The company was assessing exposure, primarily in consumer and commercial real estate lending, but could not reasonably estimate potential losses.
- The mortgage repurchase liability was $2.033 billion, up from $1.326 billion at year-end 2011. The high end of reasonably possible losses in excess of the recorded liability was $2.5 billion. Repurchase demands, housing conditions, appeals outcomes, and counterparty recoveries remain uncertain.
- Mortgage servicing and foreclosure matters include a federal/state settlement with approximately $5.3 billion of program commitments. Separately, Wells Fargo paid $175 million in Q3 under a DOJ settlement concerning mortgage pricing and product placement allegations, which the company denied.
- For litigation matters, the high end of reasonably possible losses beyond recorded liabilities was $1.2 billion. The company said an unfavorable resolution could materially affect results in a particular period, though it did not expect a material adverse effect on consolidated financial position.
- Other risks include housing and economic conditions, mortgage servicing and repurchase obligations, legal and regulatory developments, low rates, market volatility, cyber and operational risks, and evolving Basel III and Dodd-Frank requirements.
Most important facts for investors to verify
- Whether mortgage banking volumes and elevated origination gains persist, and how retention of conforming mortgages affects future spread income and fees.
- Underlying credit trends after separating OCC-guidance effects, especially nonaccruals, charge-offs, TDRs, allowance releases, and mortgage performance.
- Ultimate mortgage repurchase losses relative to the $2.033 billion reserve and $2.5 billion reasonably possible excess-loss estimate.
- Progress and financial effects of mortgage servicing settlement commitments, related operating costs, and remaining legal exposures.
- Net interest margin, deposit costs, and earnings sensitivity as assets and liabilities reprice; the filing forecasts continued margin pressure.
- Potential Hurricane Sandy credit losses and the effect on the allowance, which management could not estimate at filing.
- Capital ratios under final regulatory rules and any effects on distributions, repurchases, or funding requirements.