Wells Fargo & Company — Q1 2018 Form 10-Q
Reporting period: Quarter ended March 31, 2018. Wells Fargo is a diversified U.S. financial services company reporting across Community Banking, Wholesale Banking, and Wealth and Investment Management.
Financial performance and position
| Metric | Q1 2018 | Comparison |
|---|---|---|
| Total revenue | $21.9 billion | Down 1% from Q1 2017 |
| Net interest income (GAAP) | $12.2 billion | $12.3 billion in Q1 2017 |
| Net interest margin (taxable-equivalent) | 2.84% | 2.87% in Q1 2017 |
| Noninterest income | $9.7 billion | Down 2% year over year |
| Noninterest expense | $15.0 billion | Up 9%; included an $800 million litigation accrual |
| Wells Fargo net income | $5.1 billion | Down 9% from $5.6 billion |
| Diluted EPS | $0.96 | Down from $1.03 |
| ROA / ROE | 1.09% / 10.58% | 1.18% / 11.96% in Q1 2017 |
| Cash flows | $15.2 billion operating; $10.2 billion investing; $(38.9) billion financing | Cash, cash equivalents and restricted cash declined $13.6 billion |
| Period-end assets / loans / deposits | $1.915 trillion / $947.3 billion / $1.304 trillion | Assets down $36.4 billion and deposits down $32.3 billion from Dec. 31, 2017 |
| Allowance for credit losses | $11.3 billion; 1.19% of loans | Down from $12.0 billion and 1.25% at year-end |
| Long-term debt / short-term borrowings | $227.3 billion / $97.2 billion | Long-term debt up $2.3 billion from year-end |
| Capital and liquidity | CET1 11.92%; LCR 123%; total equity $205.9 billion | CET1 down from 12.28% at year-end; LCR exceeded the 100% minimum |
Average loans were $951.0 billion, down 1% year over year; average deposits were $1.297 trillion, essentially unchanged. Average deposit cost rose 17 basis points to 34 basis points. Net charge-offs were $741 million, or 0.32% of average loans, versus $805 million and 0.34% a year earlier. Nonaccrual loans were $7.7 billion, down 21% year over year.
Material changes versus comparable periods
- Net income fell 9% year over year as higher noninterest expense more than offset lower credit-loss provision and a lower tax rate. The $800 million litigation accrual was a major expense item.
- Mortgage banking income fell to $934 million from $1.2 billion, largely due to lower mortgage production margins; the residential held-for-sale production margin declined to 0.94% from 1.68%.
- Service charges on deposit accounts declined 11%, partly reflecting customer-friendly overdraft changes. Insurance income decreased following the sale of Wells Fargo Insurance Services in late 2017.
- Q1 included a $643 million pretax gain from selling $1.6 billion of Pick-a-Pay loans and a $202 million pretax gain from selling Wells Fargo Shareowner Services, partly offset by a $176 million loss related to the planned Reliable Financial Services asset sale.
- Higher interest rates reduced the fair value of available-for-sale debt securities: net unrealized gains of $1.3 billion at year-end became net unrealized losses of $1.9 billion at March 31, contributing to lower equity.
Outlook, risks, and unusual items
- Federal Reserve asset cap: A February 2018 FRB consent order limits consolidated assets to the December 31, 2017 level until required plans are implemented and accepted and third-party reviews are completed to the FRB’s satisfaction. The company said Q1 average assets were below the cap level. The order requires a third-party review by September 30, 2018; timing of removal is not assured.
- CFPB/OCC consent orders: On April 20, 2018, after quarter-end, Wells Fargo agreed to $1 billion in civil money penalties concerning its compliance risk program and past auto collateral protection insurance and mortgage rate-lock extension practices. The matter was treated as a recognizable subsequent event, with an $800 million Q1 accrual, reducing diluted EPS by $0.16. The orders also require compliance, audit, and customer-remediation plans.
- Further legal and conduct exposure: The filing reports ongoing reviews and inquiries involving sales practices, auto lending and insurance, mortgage rate-lock fees, account freezing and closures, wealth-management referrals, fiduciary fees, foreign exchange, and mortgage matters. The high end of reasonably possible legal losses in excess of accrued probable losses was approximately $2.6 billion at March 31, 2018; actual outcomes may be higher or lower.
- Capital returns: The company returned $4.0 billion through dividends and net share repurchases in Q1, repurchased 50.6 million shares, and stated it expected to continue repurchases through 2018, subject to regulatory and other conditions. An April $1 billion forward repurchase was expected to settle in Q3 for approximately 20 million shares.
- Management outlook: The filing provides no specific numerical earnings or revenue guidance. Management described credit quality, liquidity, and capital as solid, while noting the asset cap and extensive regulatory and remediation work. Its interest-rate simulations indicated modest net-interest-income benefit from higher rates and declines under lower-rate scenarios, subject to modeling assumptions.
- Moody’s affirmed ratings but changed its outlook to negative; S&P downgraded the company one notch and changed its outlook to stable during Q1.
Most important facts for investors to verify
- Progress, FRB acceptance, and independent review of governance, compliance, and operational-risk plans—and the duration and business effects of the asset cap.
- Final customer remediation costs and the full financial and operational consequences of the CFPB/OCC orders and other ongoing investigations.
- Whether expense levels and profitability improve after the litigation accrual, given Q1 expense growth and the increase in the efficiency ratio to 68.6% from 62.0% a year earlier.
- Trends in deposits, loan balances, funding costs, mortgage production margins, and consumer auto and credit-card losses.
- Capital distributions and CET1 trajectory, including the effects of share repurchases, regulatory conditions, and stress-test results.