Wells Fargo & Company — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Wells Fargo is a diversified financial services company with $1.44 trillion in assets. The filing was signed August 7, 2013.
Financial results and key metrics
| Metric | Q2 2013 | Comparable period |
|---|---|---|
| Wells Fargo net income | $5.52 billion | $4.62 billion in Q2 2012; up 19% |
| Diluted earnings per share | $0.98 | $0.82 in Q2 2012; up 20% |
| Total revenue | $21.38 billion | $21.29 billion in Q2 2012; approximately flat |
| Net interest income | $10.75 billion | $11.04 billion in Q2 2012; down 3% |
| Noninterest income | $10.63 billion | $10.25 billion in Q2 2012; up 4% |
| Noninterest expense | $12.26 billion | $12.40 billion in Q2 2012; down 1% |
| Provision for credit losses | $652 million | $1.80 billion in Q2 2012 |
| Net interest margin | 3.46% | 3.91% in Q2 2012 |
| Efficiency ratio | 57.3% | 58.2% in Q2 2012 |
| Return on assets / return on equity | 1.55% / 14.02% | 1.41% / 12.86% in Q2 2012 |
For the first half of 2013, net income was $10.69 billion, up 21% from $8.87 billion; diluted EPS was $1.90 versus $1.57. Revenue was $42.64 billion, down 1%, while net interest income was $21.25 billion versus $21.93 billion. Net interest margin was 3.47%, compared with 3.91%.
- Balance sheet and funding: Total assets were $1.44 trillion at June 30, up from $1.42 trillion at December 31, 2012. Loans were $802.0 billion; deposits were $1.02 trillion, up $18.8 billion from year-end. Core deposits were $941.2 billion at period-end and averaged $936.1 billion, up 6% year over year. Average core deposits funded 117% of average loans.
- Debt and liquidity: Long-term debt was $123.4 billion and short-term borrowings were $57.0 billion. Cash and due from banks was $17.9 billion; federal funds sold, resale agreements and other short-term investments totaled $148.7 billion; available-for-sale securities were $249.4 billion. The company cites core deposits and liquid securities as key funding sources.
- Cash flow, six months: Operating activities provided $22.1 billion, investing activities used $41.0 billion, and financing activities provided $14.9 billion. Cash and due from banks declined $3.9 billion to $17.9 billion. These bank cash-flow totals include significant loan, securities and mortgage banking activity.
- Credit and reserves: Q2 net charge-offs were $1.15 billion, or 0.58% of average loans annualized, versus $2.20 billion and 1.15% a year earlier. Nonperforming assets declined to $21.1 billion from $24.5 billion at year-end 2012. The allowance for credit losses was $16.6 billion, including $16.1 billion for loan losses; the company recorded a $500 million allowance release during Q2.
- Capital and shareholder returns: Basel I Tier 1 common equity was 10.71%, Tier 1 capital 12.12%, total capital 15.03%, and Tier 1 leverage 9.63%. Management estimated Basel III Tier 1 common equity at 8.62%. Total equity was $163.8 billion. The quarterly common dividend increased to $0.30 per share; the company repurchased about 26.7 million shares during Q2.
Material changes and management commentary
- Q2 marked a record quarterly profit and record diluted EPS, with management citing growth across its diversified businesses. Pre-tax, pre-provision profit was $9.12 billion, up 3% year over year.
- Fee income gains—including investment banking, brokerage, deposit service charges and card fees—largely offset lower net interest income. Management attributed margin pressure to low rates, balance-sheet repricing and growth in low-yielding short-term investments.
- Credit quality improved, particularly in residential real estate; management said it expects further allowance releases if the economy does not deteriorate significantly. Personnel expense increased, partly reflecting revenue-based compensation and mortgage staffing, while lower operating losses and foreclosed-asset expense reduced total expenses.
- Available-for-sale securities had $5.1 billion of net unrealized gains at June 30, down from $11.9 billion at year-end, largely reflecting higher long-term rates. The decline reduced equity through other comprehensive income.
- Mortgage originations were $112 billion in Q2 versus $131 billion a year earlier; the unclosed first-mortgage pipeline was $63 billion versus $102 billion. Mortgage banking income was $2.80 billion, down 3%. MSR and hedge valuation movements were material and volatile.
Outlook, risks and contingencies
- Management targets an efficiency ratio of 55%–59%, ROA of 1.3%–1.6%, and ROE of 12%–15%; Q2 results were within those ranges. It expects continued net interest margin pressure in the low-rate environment. Its 24-month sensitivity analysis estimated after-tax earnings 2.7% or 0.5% below plan under two lower-rate scenarios, and 0%–5% or more than 5% above plan under two higher-rate scenarios.
- Mortgage repurchase liability was $2.22 billion. The high end of reasonably possible losses beyond the recorded liability was an additional $2.2 billion; management’s estimate depends on uncertain investor demands, appeals, collateral values and counterparty recoveries.
- The company reported a $1.1 billion high end of reasonably possible litigation losses above recorded liabilities. It stated that current information, counsel advice, insurance and reserves did not indicate a material adverse effect on consolidated financial position, while noting an unfavorable outcome could materially affect results in a particular period.
- After quarter-end, a court entered an approximately $203 million judgment in the California debit-card transaction-posting case; Wells Fargo appealed. The filing also reports continuing mortgage-servicing and foreclosure obligations, including a $1.2 billion foreclosure-prevention commitment due by January 2015.
- Other risks include interest-rate and securities valuation changes, housing and credit conditions, regulation and capital requirements, mortgage servicing and repurchase claims, legal proceedings, and cyber or other operational disruptions. The company said it had not experienced material losses from reported cyber attacks.
- After quarter-end, Wells Fargo completed an agreement to acquire a UK commercial real estate loan portfolio involving £3.5 billion of loans; a third party acquired approximately £1.0 billion of nonperforming assets, with Wells Fargo providing financing.
Most important facts for investors to verify
- Whether earnings growth can persist as net interest margin remains under pressure and mortgage production and pipeline decline.
- Whether credit improvement continues, and how much of future earnings may depend on allowance releases rather than recurring revenue growth.
- The sensitivity of equity and regulatory capital to interest-rate-driven securities losses, including the assumptions underlying the estimated 8.62% Basel III common equity ratio.
- The adequacy of mortgage repurchase reserves and the potential outcomes of litigation, including the appealed $203 million judgment and the stated additional litigation-loss range.
- The progress and financial impact of mortgage settlement commitments, and the terms and risk profile of the post-quarter UK loan portfolio transaction.