Wells Fargo & Company — Q1 2016 Form 10-Q
Reporting period: Quarter ended March 31, 2016. Wells Fargo is a diversified financial-services company with $1.85 trillion in assets, operating through Community Banking, Wholesale Banking, and Wealth and Investment Management.
Key financial metrics
| Metric | Q1 2016 | Comparable period / change |
|---|---|---|
| Wells Fargo net income | $5.46 billion | $5.80 billion in Q1 2015, down 6% |
| Diluted EPS | $0.99 | $1.04 in Q1 2015, down 5% |
| Total revenue | $22.20 billion | $21.28 billion in Q1 2015, up 4% |
| Net interest income / net interest margin | $11.67 billion / 2.90% | $10.99 billion / 2.95% in Q1 2015 |
| Provision for credit losses | $1.09 billion | $608 million in Q1 2015 |
| Noninterest expense / efficiency ratio | $13.03 billion / 58.7% | $12.51 billion / 58.8% in Q1 2015 |
| Net charge-offs | $886 million; 0.38% annualized | $708 million; 0.33% in Q1 2015 |
| Loans / deposits at period end | $947.3 billion / $1.241 trillion | Loans up 10% and deposits up 4% year over year |
| Total equity / fully phased-in CET1 | $198.5 billion / 10.61% (Standardized Approach) | Total equity up 4% year over year; CET1 was 10.77% at year-end 2015 |
First-quarter cash flows were $5.3 billion provided by operating activities, $50.4 billion used in investing activities, and $45.0 billion provided by financing activities. Investing cash use included $28.9 billion net cash paid for acquisitions. These cash-flow categories reflect bank balance-sheet and transaction activity and are not equivalent to industrial-company free cash flow.
At March 31, primary liquidity sources totaled $447.0 billion, including $382.1 billion unencumbered. Deposits were 131% of loans. Short-term borrowings were $107.7 billion and long-term debt was $227.9 billion, versus $97.5 billion and $199.5 billion, respectively, at December 31, 2015. The increase in long-term debt primarily funded the GE Capital transactions.
Material changes and drivers
- Revenue rose 4% year over year, led by higher net interest income from loan growth, higher trading income, and acquired GE Capital assets. Average loans increased 7%; the net interest margin declined 5 basis points to 2.90%.
- Net income fell 6%, despite revenue growth, as the prior-year quarter included a $359 million discrete tax benefit and a $100 million allowance release. Q1 2016 also had higher credit-loss provision and noninterest expense.
- Loans increased $30.7 billion from year-end, including $24.9 billion from GE Capital acquisitions. Deposits increased $18.2 billion from year-end. Investment securities declined $12.7 billion in the quarter.
- Credit costs increased notably: commercial net charge-offs rose to $237 million from $44 million a year earlier, largely reflecting oil-and-gas deterioration. Consumer net charge-offs declined to 0.57% from 0.60% of average consumer loans.
- Nonaccrual loans rose to $12.2 billion from $11.4 billion at year-end; commercial nonaccruals increased to $4.0 billion, while consumer nonaccruals declined to $8.3 billion. Total nonperforming assets increased $706 million during the quarter to $13.5 billion.
- Segment net income was $3.30 billion in Community Banking, $1.92 billion in Wholesale Banking, and $512 million in Wealth and Investment Management. Each declined year over year, with prior-year tax benefits affecting Community Banking comparisons and oil-and-gas credit deterioration weighing on Wholesale Banking.
Outlook, commentary, risks and unusual items
- Management expected the full-year 2016 efficiency ratio to be at the higher end of its 55%–59% target range. It expected to continue share repurchases through the remainder of 2016, subject to regulatory, legal, capital, and market conditions.
- The remaining international portion of the GE Capital assets was expected to close in the second half of 2016. The completed acquisitions included rail assets and North American commercial lending and vendor-finance businesses.
- Wells Fargo sold its crop-insurance business on March 31, recognizing a $381 million pretax gain. Q1 revenue also included elevated mortgage-servicing-rights hedge-related gains; mortgage banking income was affected by lower mortgage originations and production margins. These items make underlying revenue trends important to assess.
- Oil-and-gas exposure was $17.8 billion in loans, with $22.9 billion of unfunded commitments. Oil-and-gas nonaccrual loans rose to $1.9 billion from $844 million at year-end. The allowance for credit losses was $12.7 billion, including approximately $1.7 billion allocated to oil and gas.
- On April 12, 2016, regulators determined Wells Fargo’s 2015 resolution plan was not credible or would not facilitate orderly resolution. The company was required to address deficiencies by October 1, 2016; potential consequences for an inadequate response include restrictions on growth or activities, higher requirements, or divestitures.
- On April 8, 2016, a court entered a $1.2 billion settlement resolving FHA lending allegations and certain related potential civil claims. The filing stated that the high end of reasonably possible litigation losses in excess of recorded probable liabilities was approximately $1.1 billion at quarter-end; unfavorable developments could materially affect results in a particular period.
- Management described the balance sheet, capital, and liquidity as strong. The fully phased-in supplementary leverage ratio was 7.6%; the company’s fully phased-in CET1 ratio was 10.61%. The filing also noted a new FDIC assessment surcharge expected to increase deposit-insurance expense by approximately $100 million per quarter once effective.
- Other risks include low interest rates and margin pressure, mortgage-servicing and repurchase exposures, regulatory and compliance costs, litigation, cybersecurity threats, and possible weakening in economic or market conditions. Management reported disclosure controls were effective as of March 31, 2016.
Most important facts for investors to verify
- Whether oil-and-gas credit deterioration continues, and how nonaccruals, charge-offs, and allowance levels evolve.
- How much of revenue and earnings growth is recurring versus acquisition-related, the crop-insurance gain, and mortgage-servicing hedge effects.
- Completion and integration of the remaining GE Capital acquisition assets, including resulting funding costs and loan performance.
- Progress in remedying the resolution-plan deficiencies by October 1, 2016, and any regulatory consequences.
- The financial and timing effects of the FHA settlement, other litigation matters, and potential mortgage repurchase or servicing claims.
- Capital and liquidity trends as assets and funding needs grow, including the effect of distributions, debt issuance, and regulatory requirements.