Wells Fargo & Company — Q3 2017 Form 10-Q
Reporting period: Quarter ended September 30, 2017; comparisons are primarily with Q3 2016. Wells Fargo is a diversified U.S. financial services company with $1.93 trillion in assets and three reported segments: Community Banking, Wholesale Banking, and Wealth and Investment Management.
Key financial results
| Metric | Q3 2017 | Comparable period / change |
|---|---|---|
| Revenue | $21.9 billion | Down 2% year over year |
| Net income | $4.6 billion | $5.6 billion in Q3 2016; down 19% |
| Diluted EPS | $0.84 | $1.03 in Q3 2016 |
| Net interest income (GAAP) | $12.5 billion | Up 4% year over year |
| Net interest margin | 2.87% | 2.82% in Q3 2016 |
| Noninterest income | $9.5 billion | Down 9% year over year |
| Noninterest expense | $14.4 billion | Up 8% year over year |
| Efficiency ratio | 65.5% | 59.4% in Q3 2016 |
| Pre-tax, pre-provision profit | $7.6 billion | $9.1 billion in Q3 2016 |
Results included a $1.0 billion non-tax-deductible litigation accrual, reducing diluted EPS by approximately $0.20. The accrual materially increased expense and affected the efficiency ratio. For the first nine months of 2017, net income was $15.9 billion, down 5%, and diluted EPS was $2.91, down 4%, year over year.
Balance sheet, liquidity, capital and cash flow
- At September 30, assets were $1.935 trillion, loans $951.9 billion, deposits $1.307 trillion, and total equity $206.8 billion. Loans declined $15.7 billion from year-end 2016; deposits were nearly unchanged at period-end, while average Q3 deposits rose 4% year over year.
- Investment securities reached $415.0 billion, up $7.5 billion from year-end 2016. Long-term debt was $238.9 billion, down $16.2 billion from year-end; short-term borrowings were $93.8 billion.
- Average deposit cost rose to 26 basis points, up 15 basis points year over year. Average deposits were 137% of average loans.
- Quarterly average liquidity coverage ratio was 128%, with $398.4 billion of high-quality liquid assets and $86.8 billion above projected net cash outflows. Management described liquidity and capital as strong.
- Regulatory CET1 was 12.10% under the applicable transition-based reporting measure; fully phased-in CET1 under the Standardized Approach was 11.82%, above management’s 10% target. Fully phased-in supplementary leverage ratio was 7.9%.
- For the first nine months, operating cash flow was $18.5 billion, investing cash flow $9.3 billion, and financing cash flow negative $29.3 billion; cash and due from banks ended at $19.2 billion. Investing cash flow was substantially less negative than in 2016, which included significant acquisition-related cash outflows.
Material changes and segment performance
- Lower noninterest income—especially mortgage banking, trading, and deposit service-charge income—offset growth in net interest income. Q3 mortgage banking income fell 37% year over year, and mortgage originations declined to $59 billion from $70 billion.
- Expense growth reflected the litigation accrual, higher operating losses, personnel costs, and spending on legal, regulatory, compliance, technology, and project work. Operating losses rose to $1.3 billion from $577 million.
- Community Banking Q3 net income fell 31% to $2.2 billion, including the $1.0 billion litigation accrual. Wholesale Banking net income was approximately unchanged at $2.0 billion. Wealth and Investment Management net income rose 5% to $710 million; its client assets reached a record $1.9 trillion.
- Shareholder returns were $4.0 billion in Q3 through common dividends and net repurchases. Wells Fargo repurchased 49.0 million shares for $2.6 billion; the declared common dividend rose to $0.39 per share.
Credit, legal matters, outlook and risks
- Credit quality improved overall: Q3 net charge-offs were $717 million, or 0.30% of average loans, versus $805 million and 0.33% a year earlier. Nonperforming assets fell to $9.3 billion, or 0.98% of loans. The allowance for credit losses was $12.1 billion, or 1.27% of loans, including $450 million for preliminary hurricane-loss estimates.
- Consumer credit remained mixed. Automobile net charge-offs rose to 1.41% from 0.87% a year earlier; management cited higher loss severities, industry trends, and temporary repossession restrictions related to collateral protection insurance issues. Credit-card net charge-offs also increased. California wildfire impacts were still being evaluated.
- Sales-practices review identified approximately 3.5 million potentially unauthorized consumer and small-business accounts and 528,000 potentially unauthorized online bill-pay enrollments. These are review findings, not a determination that every account or enrollment lacked customer authorization. Approximately 190,000 accounts incurred fees or charges. The company reported additional refunds and credits and continued work under regulatory consent orders.
- Other remediation and conduct issues include automobile collateral protection insurance, for which the company estimated about $100 million in cash remediation and $30 million in account adjustments; possible refunds related to unused automobile GAP products; and mortgage rate-lock extension fees. About $98 million in rate-lock fees were assessed to approximately 110,000 borrowers, but the company expected refunds to be lower.
- Legal proceedings remain a material uncertainty. The company recorded the $1.0 billion Q3 mortgage-related regulatory-investigation accrual. The high end of reasonably possible losses beyond accrued probable losses was approximately $3.3 billion at quarter-end. Wells Fargo said ultimate outcomes of mortgage investigations and sales-practices matters could not be determined and actual losses could exceed estimates.
- Management’s rate simulations indicated modest net-interest-income benefit from higher rates, but lower-rate scenarios would reduce projected NII. The filing provides no specific consolidated earnings or revenue guidance. Management expected to continue share repurchases through the remainder of 2017, subject to regulatory, legal, capital, market, and other conditions; a $1 billion forward repurchase entered in October was expected to settle in Q1 2018 for about 19 million shares.
- Other risks include regulatory and compliance demands, reputational and conduct risk, hurricane and wildfire-related credit losses, auto-loan performance, mortgage servicing and repurchase exposures, interest-rate and market volatility, and potential funding or collateral effects of credit-rating changes. The filing also notes that a proposed stable-funding rule and future capital requirements could affect the company.
Most important facts for investors to verify
- Whether additional sales-practices, auto-insurance, mortgage-fee, or other customer remediation will be required, and its total cost.
- How the $1.0 billion litigation accrual and the estimated $3.3 billion range of possible losses beyond accruals evolve as investigations and lawsuits proceed.
- Whether revenue and expense trends improve after excluding litigation and other unusual items, particularly mortgage banking and Community Banking results.
- Whether rising deposit costs, loan trends, and interest rates sustain or erode net interest margin and earnings.
- Whether hurricane and wildfire estimates, automobile charge-offs, and the allowance for credit losses remain adequate as more information becomes available.
- Whether capital distributions and repurchases remain consistent with regulatory approvals, capital requirements, and the company’s stated capital targets.