WELLS FARGO & COMPANY quarterly report, Q1 FY2013

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Wells Fargo & Company — 2013 First-Quarter Form 10-Q

Business context and reporting period. Nationwide diversified financial-services company; report covers the quarter ended March 31, 2013. Amounts below are U.S. dollars. The company reported $1.4 trillion in period-end assets and operated through Community Banking, Wholesale Banking, and Wealth, Brokerage and Retirement.

Financial performance and condition

  • Earnings and revenue: Net income was $5.171 billion, up 22% year over year; net income applicable to common stock was $4.931 billion. Diluted EPS was $0.92, versus $0.75. Total revenue was $21.259 billion, down 2% from $21.636 billion.
  • Income and margins: Net interest income was $10.499 billion, down from $10.888 billion. Net interest margin declined to 3.48% from 3.91%, reflecting repricing and runoff of higher-yielding assets, partly offset by lower funding costs and securities purchases. Noninterest income was $10.760 billion, essentially flat year over year; noninterest expense fell 5% to $12.400 billion. The efficiency ratio improved to 58.3% from 60.1%. Pre-tax, pre-provision profit was $8.859 billion, up 2%.
  • Credit: Provision for credit losses declined to $1.219 billion from $1.995 billion. Net charge-offs were $1.419 billion, or 0.72% of average loans, versus $2.395 billion, or 1.25%. Nonperforming assets decreased to $22.876 billion from $24.509 billion at year-end 2012. The allowance for credit losses was $17.193 billion, including a $200 million allowance release during the quarter.
  • Loans, deposits and liquidity: Period-end loans were $799.966 billion, approximately flat sequentially and up 4% year over year. Average loans rose 4% year over year to $798.074 billion. Total deposits were $1.011 trillion, up $7.9 billion from year-end; period-end core deposits were $939.934 billion, down 1% sequentially. Average core deposits increased 6% year over year to $925.866 billion. Available-for-sale securities were $248.160 billion. Cash and due from banks were $16.217 billion; short-term investments and federal funds sold were $143.804 billion.
  • Debt and capital: Period-end long-term debt was $126.191 billion and short-term borrowings were $60.693 billion. Total equity was $163.395 billion. Basel I Tier 1 capital and total capital ratios were 11.80% and 14.76%; Tier 1 common equity was 10.39%. Management estimated a Basel III Tier 1 common equity ratio of 8.39% using proposed rules.
  • Cash flows: Operating activities provided $9.137 billion; investing activities used $26.157 billion; financing activities provided $11.377 billion. Cash and due from banks decreased $5.643 billion during the quarter. Cash-flow movements include substantial banking and mortgage-related activity and should be read in that context.

Material changes versus comparable periods

  • Year-over-year earnings and diluted EPS rose strongly despite lower revenue, primarily because credit costs and noninterest expenses declined.
  • Net interest margin continued to compress; management expected further pressure as assets reprice in the low-rate environment.
  • Credit indicators improved, including lower charge-offs, nonperforming assets and criticized commercial exposures. The allowance for loan losses fell to $16.711 billion from $17.060 billion at year-end.
  • Average loans and core deposits grew year over year. Core loans, excluding $3.7 billion of runoff in non-strategic and liquidating portfolios, increased $4.1 billion sequentially.
  • Available-for-sale securities increased $13.0 billion sequentially. The company purchased $17.8 billion of agency mortgage-backed securities during the quarter.
  • Noninterest expense benefited from lower operating losses, foreclosed-asset expense, contract services and completed Wachovia integration activities; personnel expense increased.

Outlook, commentary, risks and unusual items

  • Outlook: Management expected second-quarter 2013 expenses to decline from first quarter and the efficiency ratio to remain within its 55%–59% target range. It expected future allowance releases during 2013 absent significant economic deterioration. Full-year 2013 effective tax rate was expected to exceed the first-quarter rate absent further discrete tax benefits.
  • Capital returns: The Federal Reserve did not object to the 2013 capital plan. The Board approved a second-quarter common dividend of $0.30 per share, up from $0.25 in first quarter and $0.22 in 2012 quarters. The company repurchased approximately 17 million shares in first quarter.
  • Mortgage and rate exposure: Management warned that low rates could continue to pressure net interest margin. Higher rates may benefit balance-sheet repricing but can reduce mortgage refinancing activity and affect mortgage-servicing-right valuations. The residential mortgage servicing-right balance was $12.061 billion at fair value; total residential and commercial MSRs were $13.2 billion.
  • Mortgage commitments and contingencies: The mortgage repurchase liability was $2.317 billion; reasonably possible losses above the recorded liability had a stated high end of $2.2 billion. A separate litigation-loss range had a high end of $1.1 billion above accrued probable losses. These are estimates, not stated probable additional losses.
  • Settlements and litigation: The company paid its $766 million share of the amended foreclosure-review settlement in first quarter 2013 and committed to foreclosure-prevention actions on $1.2 billion of loans by January 2015. Under the National Mortgage Settlement refinance program, it reported refinancing about 31,000 borrowers; management estimated approximately $1.8 billion of future forgone interest income, or $180 million annually. A Medical Capital Corporation settlement in principle for $105 million was reached in April, subject to court approval.
  • Other risks: Key exposures include housing and economic conditions, mortgage servicing and repurchase demands, litigation and regulatory requirements, interest-rate and market movements, credit quality, cyberattacks and operational disruptions. The company reported no material cyberattack losses to date and said disclosure controls were effective as of March 31, 2013.

Most important facts for investors to verify

  • Whether margin pressure and changes in loan and deposit mix offset continued loan growth and lower funding costs.
  • Whether improving credit metrics support further allowance releases without weakening loss coverage; review the allowance, nonperforming assets and charge-offs together.
  • Whether mortgage repurchase demands, servicing costs, MSR valuations and settlement commitments remain within recorded estimates.
  • Whether the proposed-rule-based Basel III capital estimate changes as regulations are finalized, and how capital returns compare with regulatory approvals and actual repurchases.
  • How much of reported earnings growth reflects sustainable operating performance versus lower credit provisions, discrete tax benefits and other valuation or settlement-related items.