Wells Fargo & Company — Q3 2009 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2009; financial statements are unaudited. Wells Fargo is a diversified financial services company. The December 31, 2008 Wachovia acquisition materially expanded the company: Wachovia results are included in 2009 operating results, but not in comparable 2008 results. Accordingly, year-over-year changes are not fully comparable.
Key financial metrics
| Metric | Q3 2009 | Comparable period / other date |
|---|---|---|
| Total revenue | $22.5 billion | $10.4 billion in Q3 2008; flat versus Q2 2009 |
| Wells Fargo net income | $3.24 billion | $1.64 billion in Q3 2008 |
| Net income applicable to common stock | $2.64 billion | $1.64 billion in Q3 2008 |
| Diluted EPS | $0.56 | $0.49 in Q3 2008; $1.69 for first nine months of 2009 |
| Net interest margin | 4.36% | 4.79% in Q3 2008; 4.30% in Q2 2009 |
| Efficiency ratio | 52.0% | 53.0% in Q3 2008; 56.4% in Q2 2009 |
| Net charge-offs | $5.1 billion; 2.50% annualized | $4.4 billion; 2.11% in Q2 2009 |
| Provision for credit losses | $6.1 billion | $2.5 billion in Q3 2008 |
| Allowance for credit losses | $24.5 billion; 3.07% of loans | $21.7 billion; 2.51% at Dec. 31, 2008 |
| Assets / loans / deposits | $1,228.6 billion / $800.0 billion / $796.7 billion | At Sept. 30, 2009; assets and loans were $1,309.6 billion and $864.8 billion at Dec. 31, 2008 |
| Short-term / long-term borrowings | $30.8 billion / $214.3 billion | At Sept. 30, 2009; $108.1 billion / $267.2 billion at Dec. 31, 2008 |
| Capital ratios | Tier 1 10.63%; total capital 14.66%; Tier 1 common 5.18% | At Sept. 30, 2009 |
For the first nine months of 2009, revenue was $66.0 billion and net income was $9.45 billion, versus $32.4 billion and $5.39 billion, respectively, in 2008. The increase largely reflects Wachovia’s inclusion in 2009. Q3 pre-tax, pre-provision profit was $10.8 billion.
Cash flows for the first nine months: operating activities provided $25.3 billion, investing activities provided $74.8 billion, and financing activities used $106.6 billion. Cash and due from banks declined $6.5 billion to $17.2 billion.
Material changes and notable items
- Q3 revenue was essentially unchanged from Q2; the efficiency ratio improved from 56.4% to 52.0%, partly reflecting lower FDIC assessments and merger savings.
- Credit costs rose from Q2: charge-offs increased to $5.1 billion and the allowance grew. Nonaccrual loans reached $20.9 billion, up from $15.8 billion at June 30; nonperforming assets were $23.5 billion.
- Total loans and assets declined from year-end 2008, while deposits increased to $796.7 billion. Average checking and savings deposits rose 11% annualized from Q2.
- Mortgage banking income was $3.1 billion. Q3 included a $1.5 billion net MSR/economic-hedge valuation gain: a $2.1 billion MSR fair-value decline was more than offset by $3.6 billion of hedge gains, largely attributed to hedge-carry income in a low short-term-rate environment.
- Q3 included $396 million of securities other-than-temporary impairment write-downs and $249 million of merger and integration costs. A $146 million increase to the mortgage repurchase reserve was also recorded.
Outlook, risks and contingencies
- Management expected credit losses to remain elevated. Assuming no further economic deterioration, it projected consumer losses to peak in the first half of 2010 and commercial and commercial real estate losses to peak later in 2010. Nonperforming assets were expected to continue growing near term.
- Wachovia integration was described as on schedule. Management targeted $5 billion of annual run-rate savings upon expected completion in 2011 and revised estimated cumulative integration costs to approximately $5.5 billion, from $7.9 billion.
- Wells Fargo reported generating $20 billion toward the Federal Reserve’s $13.7 billion SCAP capital buffer requirement by September 30, exceeding it by approximately $6 billion. The company remained subject to Treasury CPP preferred-stock terms, including a 5% dividend rate for the first five years followed by 9% and restrictions affecting common dividends and repurchases.
- New overdraft policies were estimated to reduce 2010 fee revenue by approximately $300 million after tax; actual impact could vary.
- New consolidation rules effective January 1, 2010 (FAS 166/167) were preliminarily expected to add about $48 billion of assets and $25 billion of risk-weighted assets. Estimates could change as interpretation and implementation progressed.
- Prudential had exercised its option to put its joint-venture interest to Wells Fargo, with closing expected around January 1, 2010. The purchase price and cash-versus-stock mix were not yet determined; stock issuance could dilute shareholders.
- Management cited housing, unemployment, credit markets, loan modifications, interest rates, MSR valuations, securities impairments, merger integration, regulation and litigation as risks. It believed pending legal matters would not have a material adverse effect overall, while acknowledging an unfavorable outcome could materially affect a particular period.
Most important facts for investors to verify
- Whether charge-offs, nonaccrual loans and reserve needs continued rising, particularly in Wachovia, commercial real estate and Pick-a-Pay portfolios; merger purchase accounting affects comparability of credit measures.
- Whether reported earnings remain supported by recurring operating revenue after separating mortgage hedge gains, securities impairments and integration expenses.
- Progress on the Wachovia integration, the $5 billion savings target and the revised $5.5 billion integration-cost estimate.
- The final balance-sheet and capital effects of FAS 166/167, and the terms and funding of the Prudential put transaction.
- Capital actions and potential dilution, including CPP repayment, preferred dividends, any common-stock issuance, and the effect of overdraft policy changes on fee income.