Wells Fargo & Company — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Amounts are in U.S. dollars; financial figures are consolidated unless noted.
Business context and reporting period
Wells Fargo is a diversified financial services company with $1.9 trillion in assets. Its three reportable segments are Community Banking, Wholesale Banking, and Wealth and Investment Management. The first half of 2016 included significant GE Capital business acquisitions and sales of the crop insurance and health benefit services businesses.
Financial performance and condition
| Metric | Q2 2016 | Comparable period |
|---|---|---|
| Total revenue | $22.2 billion | Up 4% year over year |
| Net income | $5.56 billion | $5.72 billion in Q2 2015 |
| Diluted EPS | $1.01 | $1.03 in Q2 2015 |
| Net interest margin | 2.86% | 2.97% in Q2 2015 |
| Efficiency ratio | 58.1% | 58.5% in Q2 2015 |
| Provision for credit losses | $1.07 billion | $300 million in Q2 2015 |
| Net charge-offs | $924 million; 0.39% of average loans, annualized | $650 million; 0.30% in Q2 2015 |
For the first half, revenue was $44.36 billion, up 4%; net income was $11.02 billion, down 4%; and diluted EPS was $2.00, down 3%. Net interest income rose, but higher credit-loss provisions and expenses weighed on earnings. Pre-tax, pre-provision profit was $9.30 billion in Q2, up 5% year over year.
Noninterest income increased 4% in Q2 to $10.43 billion, with higher trading and lease income and gains from the health benefit services sale, partly offset by lower mortgage banking, insurance, and trust and investment fees. Noninterest expense rose 3% to $12.87 billion, mainly from personnel, GE Capital lease depreciation, and professional services. The reported Q2 effective tax rate was 32.3%.
At June 30, assets were $1.889 trillion, loans $957.2 billion, deposits $1.245 trillion, and total equity $202.7 billion. Long-term debt was $243.9 billion and short-term borrowings $120.3 billion. Primary liquidity sources totaled $452.8 billion, including $379.7 billion unencumbered. First-half operating cash flow was negative $2.1 billion, versus positive $864 million in the prior-year period; investing cash flow was negative $69.5 billion and financing cash flow positive $72.9 billion.
Capital remained strong: fully phased-in CET1 was 10.61% under the Standardized Approach, and the fully phased-in supplementary leverage ratio was 7.7%. Total equity exceeded $200 billion for the first time. The company returned $3.2 billion to shareholders in Q2, including 44.8 million common shares repurchased.
Material changes versus comparable periods
- Commercial and industrial loans and capital leases acquired from GE Capital contributed to loan growth. Total loans rose 8% year over year and 4% from December 31, 2015; average Q2 loans increased 9% year over year.
- Deposits reached a record $1.245 trillion, up 5% year over year and 2% since year-end. Average deposit cost was 11 basis points, up 3 basis points year over year.
- Net interest income increased, but margin declined amid low rates, deposit growth, lower securities yields, and higher long-term debt funding costs.
- Credit costs increased sharply, principally reflecting deterioration in oil and gas lending and loan growth. Commercial net charge-offs rose to $357 million from $62 million a year earlier; consumer net charge-offs declined to 49 basis points from 53 basis points.
- First-half results included $381 million pre-tax gain on the crop insurance sale and $290 million on the health benefit services sale. GE Capital acquisitions also increased lease income, expenses, and debt.
Outlook, commentary, risks, and unusual items
- Management said persistent low rates, market volatility, and economic uncertainty continued to pressure results; the Brexit vote added uncertainty and could keep rates lower for longer. The company expects to operate at the higher end of its 55%–59% full-year efficiency-ratio target.
- Management expected further 2016 share repurchases. A $750 million forward repurchase contract entered in July was expected to settle in Q4 for approximately 16 million shares. The Federal Reserve did not object to the company’s 2016 CCAR capital plan.
- Oil and gas remained a key credit risk: the $17.1 billion portfolio had $2.6 billion in nonaccrual loans at quarter-end, up from $844 million at year-end 2015. The allowance for credit losses, including unfunded commitments, was $12.7 billion, or 1.33% of loans.
- Nonperforming assets were $13.1 billion, down $433 million from Q1; lower consumer nonaccruals and foreclosed assets were partly offset by higher oil and gas nonaccruals. Management considered the allowance appropriate but noted it could change with loan growth, portfolio performance, and economic conditions.
- The OCC terminated its mortgage-servicing consent orders in May 2016, ending related business restrictions, and imposed a $70 million penalty that had been accrued previously and was paid in Q2. The interchange litigation settlement was vacated by an appeals court and remanded for further proceedings. The high end of reasonably possible litigation losses above recorded liabilities was approximately $1.0 billion; an unfavorable outcome could materially affect results in a particular period.
- The recorded mortgage repurchase liability was $255 million. The high end of reasonably possible losses exceeded that liability by $179 million. Other risks identified include interest-rate and mortgage-servicing-right valuation exposure, regulatory changes, cybersecurity and operational risks, and potential higher funding costs.
- The GE Capital acquisition was not fully complete at quarter-end; additional international business closings were anticipated in the second half of 2016.
Most important facts for investors to verify
- Whether oil and gas credit deterioration, provisions, and commercial charge-offs continue to rise—and whether the allowance remains adequate.
- Whether revenue and earnings can withstand further net interest margin compression and the expected higher end of the efficiency-ratio range.
- How much of first-half performance and balance-sheet growth reflects GE Capital acquisitions and one-time divestiture gains, and the results of remaining acquisition closings.
- Developments in the interchange litigation and other legal matters, including potential exposure beyond recorded reserves.
- Liquidity, funding costs, debt issuance, and capital ratios as regulatory liquidity and loss-absorption requirements evolve.
- Mortgage servicing-right valuation and mortgage repurchase exposures, including whether the recorded liability and stated range remain appropriate.