Business context and reporting period
Wells Fargo & Company is a diversified U.S. financial services company. This Form 10-Q covers the quarter and nine months ended September 30, 2018; amounts are U.S. dollars unless stated otherwise. The company reported $1.87 trillion in assets and operated under a Federal Reserve asset-growth cap tied to a consent order.
Financial performance and condition
| Metric | Third quarter 2018 | Comparison |
|---|---|---|
| Net income | $6.0 billion | Up 32% year over year |
| Net income applicable to common stock | $5.45 billion | Up 32% year over year |
| Diluted EPS | $1.13 | Versus $0.83; included a $0.03-per-share reduction related to Series J preferred-stock redemption |
| Total revenue | $21.94 billion | Up $92 million year over year |
| Net interest margin | 2.94% | Versus 2.86% year over year |
| Efficiency ratio | 62.7% | Improved from 65.7% |
| Return on assets / common equity | 1.27% / 12.04% | Versus 0.93% / 8.96% |
| Net charge-off rate | 0.29% annualized | Versus 0.30% |
For the first nine months, net income was $16.33 billion versus $16.03 billion; revenue was $65.43 billion versus $66.34 billion. Lower income taxes and credit-loss provision supported earnings, partly offset by lower noninterest income and higher noninterest expense.
- Revenue and costs: Third-quarter net interest income was $12.57 billion, up from $12.45 billion; noninterest income was $9.37 billion, slightly lower year over year. Noninterest expense fell 4% to $13.76 billion, mainly on lower operating losses. Mortgage banking income declined 19%; mortgage originations were $46 billion versus $59 billion.
- Credit: Provision for credit losses was $580 million, down from $717 million, and included a $100 million allowance release. Nonaccrual loans were $7.1 billion, down 18% year over year. The allowance for credit losses was $10.96 billion, or 1.16% of loans, versus 1.27% a year earlier.
- Balance sheet and funding: Period-end assets were $1.873 trillion, loans $942.3 billion, deposits $1.267 trillion, and long-term debt $221.3 billion. Assets declined $78.8 billion and deposits $69.4 billion from year-end 2017. Average loans and deposits were down 1% and 3%, respectively, year over year. Average deposit cost rose to 47 basis points from 26 basis points.
- Cash flow: For the first nine months, operating cash flow was $21.0 billion and investing cash flow $10.5 billion; financing cash outflow was $88.0 billion. Cash, cash equivalents, and restricted cash declined $56.4 billion to $159.5 billion, largely reflecting lower deposits and shareholder returns.
- Capital and liquidity: CET1 was 11.91%, above management’s stated 10% internal target; supplementary leverage ratio was 7.8%. The quarterly average liquidity coverage ratio was 124%, above the 100% minimum. Total equity was $199.7 billion, down from $208.1 billion at year-end 2017.
Material changes versus prior comparable periods
- Net income and diluted EPS increased substantially year over year, helped by the lower federal tax rate, lower provision, and lower third-quarter expenses. A $168 million discrete tax expense affected third-quarter results.
- Nine-month revenue declined 1%, principally due to lower mortgage banking, insurance, deposit service-charge, and debt-security income. Insurance income also reflected the sale of Wells Fargo Insurance Services in 2017.
- Loans and deposits contracted, in part due to portfolio runoff and actions to comply with the Federal Reserve asset cap. Loan declines were concentrated in auto and junior-lien mortgage lending.
- Shareholder distributions rose: Wells Fargo returned $8.9 billion through dividends and net repurchases in the quarter and repurchased 146.5 million shares.
Outlook, commentary, risks and unusual items
- The Federal Reserve consent order caps consolidated assets at the December 31, 2017 level until required governance and risk-management improvements are accepted, implemented, and reviewed. Wells Fargo planned to operate under the cap into the first part of 2019; assets calculated under the order were below the cap at quarter-end.
- Separate April 2018 OCC and consumer-protection-agency consent orders require $1 billion in civil penalties and remediation, and enhanced compliance and audit plans. The company accrued an additional $241 million in the quarter for auto collateral-protection insurance remediation after expanding the affected population and payments.
- Customer remediation and reviews remain ongoing across sales practices, auto lending, mortgage rate-lock fees, deposit-account closures, add-on products, wealth-management referrals and fees, foreign exchange, and mortgage modifications. The mortgage modification review identified approximately 870 affected customers; approximately 545 had experienced foreclosure after the relevant denial or ineligibility determination.
- Legal proceedings remain a significant uncertainty. The high end of reasonably possible losses above accrued probable losses was approximately $2.2 billion at September 30, 2018; actual losses could exceed accruals. The filing states the ultimate outcome of retail sales-practices matters cannot be determined for materiality to consolidated financial condition.
- Management expected a fourth-quarter 2018 effective tax rate of approximately 19%, excluding future discrete items. It expected continued share repurchases in 2018, subject to regulatory and other conditions; a $1 billion forward repurchase was expected to settle in first-quarter 2019. No broader earnings or revenue forecast is provided in the supplied filing text.
- Interest-rate, mortgage-servicing-rights valuation, cyber, operational, compliance, reputational, and credit risks remain relevant. Higher rates supported net interest margin but also increased deposit costs and contributed to unrealized losses on available-for-sale debt securities.
Important facts for investors to verify
- Progress, timing, and regulatory acceptance of the Federal Reserve asset-cap remediation plans and third-party reviews.
- Future customer-remediation accruals, the final scope of affected customers, and remaining legal and regulatory exposures.
- Whether lower mortgage income, declining loan and deposit balances, and rising deposit costs persist or materially affect revenue and margins.
- Credit performance and allowance adequacy as portfolios run off and economic conditions change; note that allowance coverage declined year over year.
- Capital distributions and capital ratios, including the impact of repurchases, applicable regulatory approvals, and upcoming regulatory capital requirements.
- One-time and accounting-related items affecting comparability, including Pick-a-Pay loan-sale gains, tax adjustments, and changes in financial-instrument and revenue-recognition accounting.