Wells Fargo & Company — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Wells Fargo is a diversified financial services company. Figures below are in U.S. dollars; financial amounts are rounded to billions unless otherwise stated.
Financial performance and condition
- Quarterly earnings: Net income was $5.73 billion, up 3% from Q3 2013; diluted EPS was $1.02, versus $0.99. Net income applicable to common stock was $5.41 billion.
- Revenue and expenses: Revenue was $21.21 billion, up 4% year over year. Noninterest income rose 6% to $10.27 billion; noninterest expense increased 1% to $12.25 billion. The efficiency ratio improved to 57.7% from 59.1%.
- Net interest: Net interest income on a taxable-equivalent basis was $11.2 billion, up from $10.9 billion. Net interest margin fell to 3.06% from 3.39%, reflecting asset-yield pressure and growth in liquidity-related funding and lower-yielding short-term assets.
- Credit costs and quality: Provision for credit losses was $368 million, compared with $75 million a year earlier, as the allowance release was smaller. Net charge-offs declined 31% to $668 million, or 0.32% of average loans. Nonperforming assets were $17.67 billion, down $406 million from June 30; nonaccrual loans were $13.37 billion. The allowance for credit losses was $13.48 billion, or 1.61% of loans.
- Nine-month results: Net income was $17.35 billion, up 7%; diluted EPS was $3.08, up 7%. Revenue was $62.90 billion, down slightly from $63.12 billion, primarily reflecting lower mortgage banking revenue. Noninterest expense declined 1% to $36.39 billion.
- Balance sheet and lending: Total assets were $1.64 trillion, up 7% from year-end 2013. Loans totaled $838.9 billion, up $16.6 billion; excluding a $9.7 billion student-loan transfer to held-for-sale, loans rose $26.3 billion. Core loans increased $34.4 billion. Deposits were $1.13 trillion, up $51.4 billion; core deposits were $1.02 trillion.
- Liquidity and debt: Primary liquidity sources totaled $387.1 billion, including $319.0 billion unencumbered. Long-term debt was $184.6 billion, versus $153.0 billion at year-end 2013; short-term borrowings were $62.9 billion. The company issued $16.3 billion of liquidity-related long-term debt in Q3.
- Capital and shareholder returns: Total equity was $183.0 billion. Basel III General Approach ratios were 11.11% CET1, 12.55% Tier 1 risk-based capital, 15.58% total capital and 9.64% Tier 1 leverage. Estimated fully phased-in Advanced Approach CET1 was 10.47%. The common dividend was $0.35 per share; the quarterly net payout ratio was 66%. The company repurchased 48.7 million shares in Q3.
- Cash flows: For the first nine months, operating cash flow was $14.7 billion, investing cash flow was negative $95.3 billion and financing cash flow was positive $78.7 billion. Cash and due from banks ended at $18.0 billion. These cash-flow measures reflect substantial banking balance-sheet activity.
Material changes versus comparable periods
- Q3 earnings and revenue improved year over year, while nine-month revenue edged lower. Mortgage origination and sale gains fell to $2.2 billion for the first nine months from $6.0 billion, partly offset by higher trust and investment fees and equity investment gains.
- Mortgage originations were $48 billion in Q3 versus $80 billion a year earlier, and $131 billion for nine months versus $301 billion. Mortgage banking revenue was broadly flat year over year in Q3 but fell 32% for nine months.
- Credit performance continued to improve: annualized net charge-offs declined, nonaccrual loans fell from $15.7 billion at year-end 2013, and the allowance for credit losses decreased from $15.0 billion.
- Average loans rose 4% year over year and average core deposits rose 8%. Investment securities increased 11% year over year at quarter-end. The Q3 net interest margin nevertheless declined 33 basis points year over year.
- Operating losses rose to $417 million in Q3 from $195 million, primarily due to litigation accruals. For nine months they increased to $940 million from $640 million.
Outlook, commentary, risks and unusual items
- Management outlook: The company expected to operate within a 55%–59% efficiency-ratio target in Q4 2014. It expected further allowance releases absent significant economic deterioration, but at a lower pace as credit improvement slows and loans grow. Management described the company as positioned to benefit from higher interest rates; modeled 24-month earnings sensitivity was positive in higher-rate scenarios and negative in lower-rate scenarios.
- Mortgage servicing and valuation: Q3 mortgage servicing income included a $270 million net MSR valuation gain, compared with $26 million a year earlier. Nine-month net MSR valuation gains were $1.15 billion, versus $223 million. MSR fair values and related hedges are sensitive to interest rates, prepayments and servicing costs.
- Mortgage repurchase exposure: The recorded repurchase liability was $669 million, down from $899 million at year-end 2013. The high end of reasonably possible losses in excess of the recorded liability was $984 million. The company released $81 million of provision in Q3, citing updated estimates and observed trends.
- Litigation and servicing: The high end of reasonably possible litigation losses above the recorded liability was approximately $950 million. The filing states that an unfavorable resolution could materially affect results for a particular period, although management did not expect the matters to materially affect consolidated financial position. A federal FHA-insurance lawsuit remained in discussions with the U.S. government. Separately, a California debit-card posting judgment of approximately $203 million was affirmed by the Ninth Circuit on October 29, 2014; Wells Fargo was considering its options.
- Other risks: Risks include low interest rates, housing and economic conditions, regulatory and capital requirements, litigation and mortgage servicing obligations, cybersecurity and operational disruption, and market or funding stress. The company reported no material losses from cyberattacks. S&P lowered hybrid capital ratings one notch under revised criteria; the company and its bank remained highly rated.
- Regulatory developments: The U.S. liquidity coverage ratio rule phases in from January 2015, with full minimum compliance required by January 2017. The Volcker Rule compliance deadline was July 2015; management did not anticipate a material financial impact. New OCC risk-governance guidelines were to take effect in November 2014.
- Accounting revision: Wells Fargo revised certain prior-period commercial loan balances after determining that some factoring arrangements did not qualify as loans. The revision reduced loans and other liabilities but did not affect net income or total cash flows.
Most important facts for investors to verify
- Whether loan growth, core deposit growth and the declining net interest margin continue, particularly as interest rates and funding balances change.
- Whether credit quality and allowance releases remain consistent with management’s expectations; assess the $13.48 billion allowance against portfolio growth and economic conditions.
- How mortgage originations, MSR valuations and repurchase claims develop, including the $984 million possible loss above the recorded repurchase liability.
- The resolution and financial impact of litigation, including the FHA-insurance case, the affirmed approximately $203 million posting judgment and the approximately $950 million excess reasonably possible litigation-loss estimate.
- Capital and liquidity under evolving Basel III, LCR and other regulatory requirements; note that the fully phased-in Advanced Approach CET1 estimate differs from the reported General Approach ratio.
- The drivers of nine-month operating cash flow of $14.7 billion and the $31.6 billion increase in long-term debt from year-end 2013.