Wells Fargo & Company — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Comparisons below are generally with the corresponding 2016 period unless noted. Amounts are in U.S. dollars.
Business context and financial performance
Wells Fargo is a diversified financial services company with three reportable segments: Community Banking, Wholesale Banking, and Wealth and Investment Management. It reported $1.93 trillion in assets at quarter-end.
| Metric | Q2 2017 | Comparable period / change |
|---|---|---|
| Total revenue | $22.17 billion | Essentially flat year over year |
| Net income | $5.81 billion | $5.56 billion; up 5% |
| Net income applicable to common stock | $5.40 billion | $5.17 billion |
| Diluted EPS | $1.07 | $1.01 |
| Net interest income | $12.48 billion GAAP; $12.81 billion taxable-equivalent | GAAP up 6%; taxable-equivalent up 6% |
| Net interest margin | 2.90% | 2.86% |
| Noninterest income | $9.69 billion | $10.43 billion; down 7% |
| Noninterest expense | $13.54 billion | $12.87 billion; up 5% |
| Provision for credit losses | $555 million | $1.07 billion |
| Efficiency ratio | 61.1% | 58.1% |
| Pre-tax, pre-provision profit | $8.63 billion | $9.30 billion |
For the first half, net income was $11.27 billion, up 2%, and diluted EPS was $2.07, up 4%. Revenue was $44.17 billion, approximately flat. Net interest income increased $1.4 billion, while noninterest income declined $1.6 billion and noninterest expense increased $1.4 billion. The effective tax rate was 27.7% for Q2 and 27.5% for the first half, benefiting from discrete tax items, including stock-compensation accounting and the agreement to sell insurance businesses.
Balance sheet, credit, cash flow and capital
- Loans and deposits: Period-end loans were $957.4 billion, essentially unchanged from June 2016 but down $10.2 billion from year-end 2016. Deposits were $1.306 trillion, up 5% year over year and approximately flat from year-end; average Q2 deposits were a record $1.301 trillion.
- Funding costs and securities: Average deposit cost was 21 basis points, up 10 basis points year over year. Investment securities were $409.6 billion, up 16% from June 2016. Average net interest margin improved modestly as higher asset yields more than offset funding-cost increases.
- Credit quality: Q2 net charge-offs were $655 million, or 0.27% annualized of average loans, versus $924 million and 0.39% a year earlier. The allowance for credit losses was $12.15 billion, or 1.27% of loans, versus $12.75 billion and 1.33% a year earlier. Nonperforming assets were $9.84 billion, or 1.03% of loans, the lowest ratio since the Wachovia merger. Oil-and-gas credit improved; consumer credit-card and auto loss rates increased year over year.
- Liquidity and debt: Average quarterly liquidity coverage ratio was 124%, above the 100% minimum, with $389 billion of high-quality liquid assets and $75 billion above projected net outflows. Long-term debt was $238.9 billion at quarter-end, down from $255.1 billion at year-end; short-term borrowings were $95.4 billion. Deposits equaled 136% of loans.
- Cash flow, first half: Operating cash flow was positive $9.0 billion, compared with negative $1.4 billion in 2016; investing cash flow was positive $12.6 billion, compared with negative $69.5 billion; financing cash flow was negative $22.0 billion, compared with positive $72.2 billion. Cash and due from banks ended at $20.2 billion. The prior-year investing and financing comparisons were materially affected by acquisitions and funding activity.
- Capital and shareholder returns: Total equity was $206.1 billion. The reported Common Equity Tier 1 ratio was 11.87% under transition rules; fully phased-in Standardized Approach CET1 was 11.59%. The fully phased-in supplementary leverage ratio was 7.9%. The company returned $3.4 billion to shareholders in Q2 through dividends and net repurchases, repurchased 43.0 million shares, and declared a $0.38 common dividend per share. On July 25, the Board raised the quarterly dividend to $0.39 per share and approved the 2017 capital plan without Federal Reserve objection.
Material changes, outlook and risks
- Revenue was flat in Q2, but the mix shifted toward net interest income. Lower mortgage banking, debt-security gains and trading income weighed on noninterest income. Mortgage originations were $56 billion, down from $63 billion; the residential held-for-sale production margin fell to 1.24% from 1.66%.
- Expense growth reflected higher salaries, technology and risk staffing, FDIC assessments, and outside professional and contract services for regulatory, compliance, legal and project work. The temporary FDIC surcharge was expected to continue for about two years.
- Management described the balance sheet as strong and focused on customer needs, risk management, and rebuilding trust. It gave no specific consolidated earnings or revenue forecast in the provided filing text. It expected share repurchases to continue through the remainder of 2017.
- Sales-practices and conduct matters: The company’s expanded review of retail accounts from 2009 through September 2016 was ongoing, with completion expected by the end of Q3 2017. Wells Fargo said the review could significantly increase the identified number of potentially unauthorized accounts, but did not expect incremental remediation costs from that work to have a significant financial impact. The filing describes a $142 million proposed class settlement, preliminarily approved in July, as well as ongoing regulatory inquiries and other litigation.
- Other customer remediation: The company announced auto collateral-protection-insurance remediation estimated at approximately $64 million in cash and $16 million in account adjustments. It also identified other auto-loan, mortgage rate-lock, add-on-product and deposit-account concerns that could lead to remediation or further inquiries.
- Legal contingencies: The high end of reasonably possible legal losses in excess of accrued probable losses was approximately $3.3 billion at June 30, 2017. The company said outcomes are uncertain; ultimate resolution of mortgage-related regulatory investigations or sales-practices matters could not be assessed for material adverse effect on consolidated financial condition, and an unfavorable matter could materially affect results for a particular period. The filing also reports a $108 million settlement reached in August in a VA loan-guaranty case.
- Interest-rate and other risks: Management’s simulations indicated modest net-interest-income benefit from higher rates and a decline under lower-rate scenarios, subject to assumptions and excluding rate-sensitive noninterest income and expense. Other cited risks include mortgage servicing rights valuation, credit and economic conditions, regulatory requirements, litigation, cybersecurity, funding costs, and reputation. The 2017 resolution plan had been submitted, but regulatory feedback was pending; deficiencies could result in restrictions or additional requirements.
Most important facts for investors to verify
- Progress, findings and remediation costs from the expanded sales-practices review, including final approval and claims under the class settlement.
- Whether identified auto, mortgage, add-on-product and deposit-account issues produce additional customer remediation, investigations or litigation expense.
- The composition and sustainability of earnings: net interest income and margin gains versus weaker mortgage banking, other noninterest income, and higher operating expenses.
- Credit trends, especially auto and credit-card losses, oil-and-gas exposure, allowance adequacy, and the direction of nonperforming assets.
- Actual capital distributions, including the increased dividend, planned repurchases and settlement of the $1 billion forward repurchase contract.
- Developments in the $3.3 billion excess legal-loss range, resolution-plan feedback, liquidity requirements and future regulatory capital or funding rules.