Wells Fargo & Company — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. Wells Fargo is a diversified financial services company; the filing reports consolidated results and three operating segments: Community Banking, Wholesale Banking, and Wealth, Brokerage and Retirement. Unless stated otherwise, amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2011 | Comparable period / change |
|---|---|---|
| Net income | $3.76 billion | $2.55 billion in Q1 2010; up 48% |
| Net income applicable to common stock | $3.57 billion | $2.37 billion; up 51% |
| Diluted EPS | $0.67 | $0.45; up 49% |
| Total revenue | $20.33 billion | $21.45 billion; down 5% |
| Net interest income | $10.65 billion | $11.15 billion; down 4% |
| Net interest margin | 4.05% | 4.27%; down 22 basis points |
| Provision for credit losses | $2.21 billion | $5.33 billion; down 59% |
| Noninterest expense | $12.73 billion | $12.12 billion; up 5% |
| Efficiency ratio | 62.6% | 56.5% in Q1 2010 |
| Pre-tax pre-provision profit | $7.60 billion | $9.33 billion; down 19% |
Revenue and earnings trends diverged: record net income reflected sharply lower credit-loss provisioning, while revenue fell and expenses rose. Mortgage banking income declined 18% to $2.02 billion, and deposit service charges declined 24% to $1.01 billion. The latter reflected regulatory and overdraft-policy changes. Higher trust and investment fees, card fees, trading gains and equity-investment gains partly offset those declines.
Cash flow: Operating cash flow was $17.21 billion, versus $8.88 billion in Q1 2010; investing cash flow was $1.23 billion, versus $12.70 billion; financing cash flow was negative $17.51 billion, versus negative $32.36 billion. Cash and due from banks increased $934 million during the quarter to $16.98 billion. These banking-company cash-flow figures should be interpreted alongside the balance sheet and funding disclosures.
Balance sheet and funding at March 31, 2011: Assets were $1.245 trillion, down 1% from year-end 2010. Loans were $751.2 billion, down 1%; deposits were $837.7 billion, down 1%; and long-term debt was $148.6 billion, down from $157.0 billion. Short-term borrowings were $54.7 billion. Average core deposits were $796.8 billion, up 5% year over year, and funded 106% of average loans. Cash, short-term investments and available-for-sale securities were $93.0 billion, $93.0 billion and $167.9 billion, respectively.
Capital: Tier 1 capital ratio was 11.50%, total capital ratio 15.30%, Tier 1 leverage ratio 9.27%, and Tier 1 common equity ratio 8.93% under Basel I. Total equity was $134.9 billion. Management’s estimate of Tier 1 common equity under its interpretation of proposed Basel III was 7.2%; it estimated this was 20 basis points above the proposed fully phased-in 7.0% minimum. The estimate is subject to final rules and regulatory interpretation. The company increased its quarterly common dividend to $0.12 per share and authorized repurchases of an additional 200 million shares.
Material changes and credit quality
- Net charge-offs fell to $3.21 billion, from $5.33 billion a year earlier and $3.84 billion in Q4 2010. The annualized net charge-off rate was 1.73%, versus 2.71% a year earlier.
- Nonperforming assets declined to $30.6 billion from $32.4 billion at year-end and $31.5 billion a year earlier. Nonaccrual loans were $25.0 billion; foreclosed assets were $5.5 billion.
- The allowance for loan losses was $22.0 billion, or 2.93% of loans, versus $23.0 billion, or 3.04%, at year-end. Total allowance for credit losses was $22.4 billion. The provision was $1.0 billion below net charge-offs; management said it expected further allowance reductions absent significant economic deterioration.
- Loans 90 days or more past due and still accruing, excluding government-insured or guaranteed loans, fell to $2.4 billion from $2.6 billion at year-end and $4.9 billion a year earlier.
- Loans averaged $754.1 billion, down 5% year over year, reflecting weak consumer demand and planned run-off of non-strategic and liquidating portfolios. Those portfolios declined to $126.8 billion from $133.3 billion at year-end and $190.8 billion at year-end 2008.
- Core deposits at period-end were $795.0 billion, slightly below year-end but 5% above a year earlier. The mix continued shifting toward checking and savings accounts.
Outlook, management commentary, risks and unusual items
- Credit outlook: Management expected future allowance releases if the economy did not deteriorate significantly. It also cautioned that further housing-price declines, unemployment or other economic weakness could produce additional losses and make the allowance inadequate.
- Mortgage servicing and foreclosure: Federal Reserve and OCC consent orders require remediation of identified servicing and foreclosure deficiencies, strengthened controls and an independent review of certain foreclosures. No civil penalties were assessed under the orders at the time of filing, but regulators reserved the ability to seek them. Management expected higher mortgage-servicing costs. Other government investigations continued and could lead to penalties, remedies, litigation and significant costs.
- Mortgage repurchases: The repurchase liability was $1.21 billion. Wells Fargo added $249 million to the liability and incurred $331 million of repurchase and reimbursement losses in the quarter. Management said a reasonably possible loss range above the recorded liability could not be estimated with confidence.
- Regulation and revenue: Based on then-current Federal Reserve proposals for debit interchange fees, management estimated a potential reduction in quarterly income of about $325 million after tax, before offsets. The rule was expected to be implemented in 2011; the estimate remained subject to change.
- Expenses and one-time effects: Q1 included $440 million of Wachovia integration costs and $472 million of operating losses, substantially all related to additional foreclosure-litigation accruals. The effective tax rate was 29.5%, including a tax benefit from realizing a previously written-down investment. Management estimated a 32% full-year 2011 effective tax rate.
- Wachovia integration: Management said integration remained on schedule, with substantially all originally expected cost savings realized and revenue synergies above initial expectations. At the time of filing, 74% of banking customers were on a single deposit system.
- Other outlook: No specific earnings or revenue guidance was provided. Management cited capacity to add loans and higher-yielding mortgage-backed securities, while emphasizing that forward-looking expectations depend on economic, regulatory, market and integration conditions.
- Accounting and controls: The filing identified the allowance for credit losses, purchased credit-impaired loans, mortgage servicing rights, repurchase losses, fair-value estimates and income taxes as critical accounting policies. Management concluded disclosure controls were effective as of March 31, 2011; it reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the improvement in credit quality and lower provisioning continue, and whether future reserve releases prove supportable.
- Trends in net interest margin, loan balances, deposit mix and the earnings effect of lower-yielding cash and short-term investments.
- The final impact of debit interchange rules and other regulatory changes on fees and revenue.
- The cost, timing and potential penalties or liabilities associated with mortgage-servicing consent orders, foreclosure reviews, litigation and repurchase demands.
- The sensitivity of mortgage servicing rights, repurchase reserves and credit estimates to housing prices, interest rates, prepayments and servicing costs.
- Final Basel III requirements and their effect on capital ratios, alongside the company’s dividend, repurchase and trust-preferred redemption plans.
- Comparability of Wachovia-acquired purchased credit-impaired loan metrics with other periods and banks; the filing notes that purchase accounting affects reported credit ratios.