Wells Fargo & Company — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Wells Fargo is a diversified financial services company with $1.26 trillion in assets. Results reflect continued integration of Wachovia and improving credit conditions, alongside weaker mortgage revenue and lower net interest margin.
Financial performance and position
Unless otherwise indicated, amounts are in U.S. dollars; financial results below compare Q2 or the first half of 2011 with the corresponding 2010 period.
| Metric | Q2 2011 | Comparison / context |
|---|---|---|
| Revenue | $20.4 billion | Down 5% year over year |
| Net income | $3.95 billion | Up 29%; net income applicable to common stock was $3.73 billion |
| Diluted EPS | $0.70 | Up from $0.55 |
| Net interest income | $10.68 billion | Down from $11.45 billion; taxable-equivalent net interest margin was 4.01%, versus 4.38% |
| Provision for credit losses | $1.84 billion | Down from $3.99 billion |
| Net charge-offs | $2.84 billion | Down from $4.49 billion; 1.52% of average loans, versus 2.33% |
| Noninterest expense / efficiency ratio | $12.48 billion / 61.2% | Expense down 2%; efficiency ratio was 59.6% a year earlier |
| Pre-tax, pre-provision profit | $7.91 billion | Down 9% year over year |
- First-half results: Net income was $7.71 billion, up 37%; diluted EPS was $1.37, up 37%. Revenue was $40.72 billion, down 5%, and noninterest expense was $25.21 billion, up 1%.
- Cash flow, first half: Operating activities provided $28.56 billion; investing activities used $10.26 billion and financing activities used $10.28 billion. Cash and due from banks increased $8.02 billion to $24.06 billion.
- Balance sheet at June 30: Assets were $1.260 trillion; loans $751.9 billion; deposits $853.6 billion; long-term debt $142.9 billion; and total equity $137.9 billion. Versus December 31, 2010, loans declined $5.3 billion, deposits rose $5.7 billion, long-term debt fell $14.1 billion, and total equity rose $10.0 billion.
- Liquidity and capital: Core deposits were $809.0 billion and funded 108% of loans. Tier 1 capital ratio was 11.69%, total capital 15.41%, Tier 1 leverage 9.43%, and Tier 1 common equity 9.15% under Basel I. Management estimated Tier 1 common equity at 7.35% under its interpretation of proposed Basel III rules.
- Shareholder returns: Quarterly common dividend was $0.12 per share. The company repurchased 35.4 million shares in Q2.
Material changes and business drivers
- Year-over-year revenue declined chiefly because of lower mortgage banking income, reduced deposit service charges following regulatory and overdraft-policy changes, and lower average loans. Q2 net interest margin fell 37 basis points year over year, reflecting more low-yielding cash and short-term investments and fewer loans; lower funding costs partly offset the pressure.
- Mortgage banking income declined 19% in Q2 to $1.62 billion. Net servicing income fell 28%, while loan origination and sale gains fell 6%. Residential mortgage originations were $64 billion, down from $81 billion a year earlier.
- Deposit service charges declined 24% to $1.07 billion. Trust and investment fees rose 7%, card fees 10%, and trading gains increased to $414 million from $109 million. Equity investment gains were $724 million, versus $288 million.
- Credit quality improved: nonperforming assets fell to $27.9 billion from $30.5 billion in Q1 2011 and $32.8 billion a year earlier. The allowance for loan losses was $20.9 billion, down from $22.0 billion at March 31; the allowance for credit losses was $21.3 billion. Management said the allowance was adequate and expected future releases absent significant economic deterioration.
- Average core deposits grew 6% year over year to $807.5 billion. Average loans declined 3% to $751.3 billion, mainly as non-strategic and liquidating portfolios ran off. Those portfolios totaled $121.8 billion, down $5.1 billion in Q2 and $69.0 billion since the Wachovia acquisition.
- By segment, Q2 net income was $2.1 billion in Community Banking (up 22%), $1.9 billion in Wholesale Banking (up 32%), and $333 million in Wealth, Brokerage and Retirement (up 23%).
Outlook, risks, contingencies and unusual items
- Expense target: Management aims to reduce quarterly noninterest expense from $12.5 billion in Q2 2011 to $11 billion by Q4 2012, through expense initiatives and completion of merger-related work. Merger integration costs were $484 million in Q2.
- Regulatory revenue impact: Wells Fargo estimated final debit interchange rules would reduce quarterly income by about $250 million after tax beginning in Q4 2011, before offsets; management expected to recapture at least half over time.
- Tax outlook: Management estimated a full-year 2011 effective tax rate of approximately 32.5%.
- Mortgage and legal exposure: The mortgage repurchase liability was $1.19 billion; reasonably possible losses above that reserve were estimated at up to $1.8 billion. Separately, reasonably possible litigation losses above recorded liabilities had a high-end estimate of $1.6 billion. These are different exposures and estimates, not forecasts of losses.
- The company entered into foreclosure-related consent orders with the OCC and Federal Reserve requiring servicing and foreclosure improvements; no civil penalties were assessed under those orders at the time described. On July 20, 2011, after quarter-end, a separate Federal Reserve order imposed an $85 million penalty concerning Wells Fargo Financial mortgage lending and required borrower remediation.
- A $125 million preliminary settlement of private-label mortgage-backed securities claims was reached during Q2 and preliminarily approved July 26, 2011. A separate proposed $590 million settlement of Wachovia preferred securities and bond/note litigation was subject to court approval and had been reflected in the financial statements.
- Key risks include weak housing and employment conditions, continued mortgage repurchase claims and foreclosure costs, regulatory changes, interest-rate and mortgage-servicing-rights volatility, soft loan demand, potential capital and liquidity requirements, and the execution of Wachovia integration and expense plans. Management cautioned that its forward-looking statements are subject to material uncertainty.
Important facts for investors to verify
- Whether credit improvement persists and whether reserve releases occur without a reversal in economic or housing trends.
- How net interest margin and revenue respond to loan growth, deposit mix, interest rates, and the Q4 debit-interchange changes.
- Progress toward the $11 billion quarterly expense target, including merger costs and litigation-related expenses.
- Final outcomes and cash costs for mortgage repurchase claims, foreclosure consent orders, borrower remediation, and pending legal settlements.
- Final Basel III and other regulatory capital rules and their effect on capital ratios, dividends, and share repurchases.
- Quarterly cash-flow trends and the durability of deposit funding as debt is reduced and loans change.