Wells Fargo & Company — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; comparisons are primarily with the corresponding 2014 periods. Wells Fargo is a diversified U.S. financial services company with $1.7 trillion in assets and three reportable segments: Community Banking, Wholesale Banking, and Wealth, Brokerage and Retirement.
Key financial results
| Metric | Q2 2015 | Change vs. Q2 2014 |
|---|---|---|
| Wells Fargo net income | $5.719 billion | Down $7 million |
| Diluted earnings per common share | $1.03 | Up from $1.01 |
| Total revenue | $21.318 billion | Up 1% |
| Net interest income | $11.270 billion | Up 4% |
| Net interest margin | 2.97% | Down from 3.15% |
| Noninterest income | $10.048 billion | Down 2% |
| Noninterest expense | $12.469 billion | Up 2% |
| Efficiency ratio | 58.5% | Up from 57.9% |
| Provision for credit losses | $300 million | Up from $217 million |
| Net loan charge-offs | $650 million; 0.30% annualized of average loans | Down 9%; 0.35% a year earlier |
For the first half of 2015, net income was $11.523 billion, down 1%; diluted EPS was $2.07, compared with $2.06. Revenue increased 2% to $42.596 billion, while noninterest expense increased 3% to $24.976 billion. The six-month provision for credit losses was $908 million, versus $542 million.
Balance sheet, liquidity and capital
- At June 30, total assets were $1.721 trillion, loans were $888.5 billion, and total deposits were $1.186 trillion. Compared with year-end 2014, loans rose $25.9 billion and deposits rose $17.5 billion.
- Core deposits were $1.083 trillion, up $28.3 billion from year-end. Average deposit cost was 8 basis points, down 2 basis points year over year.
- Short-term borrowings were $83.0 billion and long-term debt was $179.8 billion at period-end. The filing reports $190.7 billion of total equity and an 11.08% total-equity-to-assets ratio.
- Primary liquidity sources totaled $396.4 billion, including $323.2 billion unencumbered. Cash and due from banks were $19.7 billion; interest-earning deposits, largely held at the Federal Reserve, were $188.0 billion.
- Basel III fully phased-in CET1 was 10.55% under the Standardized Approach and 10.62% under the Advanced Approach. The fully phased-in supplementary leverage ratio was 7.8%.
- The quarterly common dividend increased 7% to $0.375 per share. Wells Fargo repurchased 36.3 million shares in Q2 for $2.0 billion and had about 155.7 million shares remaining under its authorization at quarter-end.
Six-month cash flows were $864 million provided by operating activities, $28.126 billion used in investing activities, and $27.378 billion provided by financing activities. Operating cash flow improved from $398 million used in the first half of 2014; investing outflow narrowed from $52.745 billion, while financing inflow declined from $53.859 billion.
Material changes and operating drivers
- Loans reached a record $888.5 billion, up 7% year over year. Core loans grew 9% year over year; the GE Capital loan purchase and related financing contributed $11.5 billion during Q2.
- Average deposits increased $83.8 billion, or 8%, year over year. Primary consumer checking customers grew 5.6%.
- Net interest income rose on asset growth and lower funding costs, but margin declined as a larger liquidity and funding base included low-yielding short-term investments.
- Mortgage origination and sale gains increased to $1.191 billion from $688 million, reflecting higher origination volumes and margins. Net trading gains fell to $133 million from $382 million, primarily due to lower economic hedge and deferred compensation gains.
- Noninterest expense growth reflected higher personnel costs and operating losses. Q2 operating losses rose 43% to $521 million, predominantly due to litigation accruals; lower travel and entertainment expense partly offset the increase.
- Community Banking Q2 net income was $3.358 billion, down 2%; Wholesale Banking earned $2.011 billion, up 3%; Wealth, Brokerage and Retirement earned $602 million, up 11%.
Outlook, risks and unusual items
- Management expected to operate within a full-year 2015 efficiency-ratio target range of 55%–59%. It stated that the company was positioned to benefit from higher interest rates; modeled higher-rate scenarios showed 0%–5% earnings sensitivity over 24 months, while lower-rate scenarios showed 0%–1% downside relative to its most-likely plan. These are sensitivities, not earnings guidance.
- Management cited continued credit improvement, historically low losses, and declining nonperforming assets. However, commercial nonaccrual loans increased, primarily because of oil-and-gas deterioration. Oil and gas was 2% of total loans; related nonaccrual loans reached $508 million, versus $76 million at year-end 2014.
- The allowance for credit losses was $12.614 billion, or 1.42% of loans, down from $13.169 billion at year-end. Management cautioned that future allowance needs depend on loan growth, portfolio performance, and economic conditions.
- Mortgage-servicing income remained sensitive to rates, prepayments, MSR valuations, and hedging. Q2 net MSR valuation gains after hedges were $107 million, versus $475 million a year earlier.
- The recorded mortgage repurchase liability was $557 million. The high end of reasonably possible losses in excess of that liability was $934 million. Separately, the high end of reasonably possible litigation losses above recorded liabilities was approximately $1.4 billion. Management said it did not expect the matters, individually or in aggregate, to materially affect consolidated financial position, but an unfavorable resolution could materially affect results in a particular period.
- In June, Wells Fargo Bank amended its OCC consent order concerning mortgage-servicing practices. It must remediate specified activities; the OCC may take further supervisory action, including possible civil money penalties. The amendment also restricts certain new mortgage-servicing acquisitions and outsourcing.
- Other stated risks include low interest rates, regulatory and compliance costs, cybersecurity and operational threats, mortgage servicing and repurchase claims, and exposure to economic or market deterioration. The filing reported no material losses from cyberattacks to date.
Investor verification priorities
- Verify loan and deposit growth, including the contribution, pricing, and credit performance of the GE Capital transaction.
- Track net interest margin and the extent to which asset growth and deposit costs offset low-yield liquidity balances.
- Assess energy-sector credit quality, nonaccrual trends, charge-offs, and the adequacy of the allowance.
- Review litigation accruals, the mortgage repurchase liability and possible-loss range, and compliance with the amended OCC consent order.
- Monitor MSR valuation and hedge volatility, mortgage production trends, and the effect of changing rates on mortgage income.
- Confirm capital ratios, liquidity levels, regulatory requirements, and the sustainability of dividends and share repurchases.