Business context and reporting period
Wells Fargo & Company’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2009. The company provides banking, mortgage, investment, insurance and related financial services. Its December 31, 2008 acquisition of Wachovia materially expanded the business: Wachovia results and average balances are included in 2009, but not in the 2008 income-statement comparisons. Accordingly, year-over-year growth is not on a like-for-like basis.
Financial results and key metrics
| Metric | Q2 2009 | Comparable period / context |
|---|---|---|
| Total revenue | $22.5 billion | $11.5 billion in Q2 2008; includes Wachovia in 2009 |
| Net income attributable to Wells Fargo | $3.2 billion | $1.8 billion in Q2 2008 |
| Net income applicable to common stock | $2.6 billion | $1.8 billion in Q2 2008 |
| Diluted earnings per common share | $0.57 | $0.53 in Q2 2008; $0.56 in Q1 2009 |
| Net interest income / margin | $11.8 billion / 4.30% | Taxable-equivalent net interest income was $11.9 billion; margin was 4.16% in Q1 2009 and 4.92% in Q2 2008 |
| Noninterest income / expense | $10.7 billion / $12.7 billion | $5.2 billion / $5.8 billion in Q2 2008 |
| Efficiency ratio | 56.4% | 56.2% in Q1 2009; 51.0% in Q2 2008 |
| Credit costs | $5.1 billion provision; $4.4 billion net charge-offs (2.11% annualized) | Q2 2008 provision was $3.0 billion; net charge-offs were $1.5 billion (1.55%) |
| Allowance for credit losses | $23.5 billion, or 2.86% of loans | $21.7 billion, or 2.51%, at Dec. 31, 2008 |
| Profitability | ROA 1.00%; common-stockholder ROE 13.70% | Q2 2008: 1.19% and 14.58%, respectively |
For the first half of 2009, Wells Fargo reported net income of $6.2 billion, diluted EPS of $1.13 and revenue of $43.5 billion. First-half operating cash flow was $17.8 billion; investing cash flow was positive $24.2 billion and financing cash flow was negative $45.1 billion. Cash and due from banks declined $3.1 billion to $20.6 billion over the period.
At June 30, 2009, total assets were $1.284 trillion, loans $821.6 billion, deposits $813.7 billion and core deposits $761.1 billion. Short-term borrowings were $55.5 billion and long-term debt was $229.4 billion. Total equity was $121.4 billion. Regulatory capital ratios were 9.80% Tier 1 risk-based capital, 13.84% total risk-based capital and 8.32% Tier 1 leverage.
Material changes versus prior periods
- Reported revenue, assets, loans and deposits rose substantially versus 2008, principally because Wachovia’s results are included for 2009 but excluded from the comparable 2008 periods.
- Compared with Q1 2009, revenue rose to $22.5 billion from $21.0 billion, net income to $3.2 billion from $3.0 billion, and net interest margin to 4.30% from 4.16%. Average loans declined to $833.9 billion from $855.6 billion, while average core deposits increased to $765.7 billion from $753.9 billion.
- Credit stress worsened: Q2 net charge-offs rose from $3.3 billion in Q1 and $1.5 billion a year earlier. Nonaccrual loans increased to $15.8 billion from $10.5 billion at March 31, and nonperforming assets rose to $18.3 billion from $12.6 billion. Wachovia purchase-accounting rules affect these comparisons: certain acquired credit-impaired loans were written down and reclassified to accrual status.
- The common dividend was reduced to $0.05 per share for Q2, from $0.34 in Q1 2009 and $0.31 in Q2 2008. The company issued approximately $9.3 billion of common stock in the first half, including an $8.6 billion offering in May.
- Net unrealized losses on available-for-sale securities fell to $0.4 billion from $9.9 billion at year-end 2008; the portfolio’s reported fair value was $206.8 billion at June 30.
Outlook, risks and unusual items
- Q2 earnings included a $700 million credit-reserve build, a $565 million FDIC special assessment and $244 million of merger-related costs. Management said the three items reduced EPS by approximately $0.10, $0.08 and $0.03, respectively.
- Management expected credit losses and nonperforming assets to increase further, with commercial and commercial real estate losses likely to remain elevated until the economy improves. It cited early signs of moderation in some consumer and small-business loss trends, but no broad stabilization was assured.
- The company said it had generated $14.2 billion toward the Federal Reserve’s $13.7 billion SCAP capital buffer requirement by June 30, exceeding the target by $500 million, and expected to generate additional qualifying capital in Q3. Tier 1 common equity was $47.1 billion, or 4.49% of risk-weighted assets.
- Management stated that Wachovia integration remained on schedule and targeted $5 billion of annual run-rate savings at completion, with further expense initiatives expected during the rest of 2009. Wachovia branch conversions to the Wells Fargo platform were scheduled to begin later in the year.
- New accounting standards effective in 2010 (FAS 166 and 167) may require consolidation of certain entities. The company’s preliminary estimate identified up to $109 billion of additional GAAP assets and $46 billion of risk-weighted assets; management cautioned that actual amounts could differ materially.
- Other significant exposures include the $111.0 billion Pick-a-Pay portfolio (carrying value $90.4 billion), mortgage repurchase claims and MSR valuation sensitivity. Mortgage origination and servicing income benefited from strong refinancing activity and a $1.0 billion net MSR valuation gain after hedge results in Q2.
- Prudential gave notice that it would exercise its option to put its interest in the brokerage joint venture to Wells Fargo, with closing expected around January 1, 2010; the final payment depends on appraisal. The company also disclosed an Illinois Attorney General lawsuit alleging discriminatory mortgage lending practices. Management did not expect legal matters to have a material adverse effect overall, but noted an unfavorable outcome could materially affect a particular period.
- Management identified recession conditions, unemployment, housing prices, capital needs, integration execution, interest rates, securities impairment, deposit competition and regulatory changes as risks. It cautioned that the credit allowance may prove inadequate if conditions deteriorate further.
Important facts for investors to verify
- Separate Wachovia’s contribution from legacy Wells Fargo results when assessing revenue growth, profitability and credit trends.
- Track charge-offs, nonaccrual loans, TDRs and allowance adequacy, taking account of SOP 03-3 purchase accounting and its effect on reported credit ratios.
- Monitor progress on the SCAP capital buffer, Tier 1 common equity, the reduced common dividend and any future capital actions.
- Test whether the $5 billion integration savings target is achieved and whether cost reductions offset FDIC assessments and merger expenses.
- Assess Pick-a-Pay and other mortgage exposures, MSR valuation assumptions, repurchase reserves, and the possible 2010 consolidation effects of FAS 166 and 167.
- Follow the Prudential joint-venture put valuation and the status and potential financial consequences of disclosed litigation.