Wells Fargo & Company — 2018 Q2 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Wells Fargo is a diversified financial services company. Unless noted, financial figures are in U.S. dollars; “prior year” refers to the comparable 2017 period.
Financial performance and condition
| Metric | Q2 2018 | Comparison |
|---|---|---|
| Net income | $5.186 billion | Down 11% from $5.856 billion |
| Net income applicable to common stock | $4.792 billion | Down 12% from $5.450 billion |
| Diluted EPS | $0.98 | Down from $1.08 |
| Total revenue | $21.553 billion | Down 3% from $22.235 billion |
| Net interest margin | 2.93% | Up from 2.90% |
| Noninterest expense | $13.982 billion | Up 3% from $13.541 billion |
| Efficiency ratio | 64.9% | Up from 60.9% |
| Pre-tax, pre-provision profit | $7.571 billion | Down 13% from $8.694 billion |
- For the first half, net income was $10.322 billion, down 10%; revenue was $43.487 billion, down 2%; and diluted EPS was $1.94, down 8%. The effective tax rate was 23.6%, versus 27.6% a year earlier.
- Q2 net interest income was $12.541 billion on a GAAP basis; taxable-equivalent net interest income was $12.704 billion. Noninterest income was $9.012 billion, down 8%, mainly reflecting lower mortgage banking and insurance income and lower deposit service charges.
- Q2 results included $481 million of net discrete income tax expense, mostly related to state taxes following the Supreme Court’s South Dakota v. Wayfair decision. Management said results also benefited from the lower federal tax rate.
- Average loans were $944.1 billion, down 1% year over year; average deposits were $1.271 trillion, down 2%. Average deposit cost rose 19 basis points year over year to 0.40%.
- At June 30, total assets were $1.880 trillion, down $72.1 billion from year-end 2017; loans were $944.3 billion and deposits were $1.269 trillion. Long-term debt was $219.3 billion and short-term borrowings were $104.5 billion.
- First-half operating cash flow was $14.381 billion, investing cash flow was $10.711 billion, and financing cash flow was negative $77.590 billion. Cash, cash equivalents and restricted cash ended at $163.449 billion, down $52.498 billion from year-end, primarily reflecting deposit outflows.
- Credit indicators improved overall: Q2 net charge-offs were $602 million, or 0.26% of average loans, versus $655 million and 0.27% a year earlier. Nonaccrual loans were $7.486 billion, down 17% year over year. The allowance for credit losses was $11.110 billion, or 1.18% of loans, versus $12.146 billion and 1.27% a year earlier.
- Capital remained strong: fully phased-in CET1 was 11.98%, total equity was $206.1 billion, and the supplementary leverage ratio was 8.1%. The company reported a quarterly average liquidity coverage ratio of 123%, above the 100% minimum.
Material changes and drivers
- Lower revenue and higher expenses reduced earnings. Q2 noninterest income fell 8%, led by mortgage banking income, down 33%, and insurance income, down 64%; the latter reflected the prior sale of Wells Fargo Insurance Services. Mortgage loan origination/sales gains fell 51%.
- Q2 noninterest expense rose mainly because of higher operating losses and personnel costs. Operating losses increased 77% to $619 million in the quarter and rose to $2.087 billion for the first half, versus $632 million a year earlier, primarily due to remediation and litigation accruals.
- Q2 average deposits and loans declined year over year. Management attributed commercial deposit declines partly to actions taken in response to the Federal Reserve asset cap; customer cash movements toward higher-rate alternatives also affected deposits.
- Net interest margin improved modestly year over year, benefiting from higher rates and lower long-term debt balances, partly offset by lower loan balances and other factors. For the first half, NIM was unchanged at 2.89%.
- Community Banking Q2 net income fell 10% to $2.496 billion; Wholesale Banking fell 4% to $2.635 billion; and Wealth and Investment Management fell 37% to $445 million. WIM results included a $203 million net loss on equity securities, including impairment on the announced sale of the RockCreek ownership stake.
Outlook, risks and unusual items
- Federal Reserve asset cap: A February 2018 consent order limits consolidated assets to the December 31, 2017 level until required plans and third-party reviews are completed and accepted by the FRB. The company said it planned to operate under the cap through the first part of 2019; Q2 average assets were below the cap level.
- Consumer protection consent orders: On April 20, 2018, the company entered into CFPB and OCC consent orders requiring an aggregate $1 billion in civil money penalties and plans for compliance, audit and customer remediation. The orders concern the compliance risk program, certain auto collateral protection insurance practices and mortgage rate-lock extensions.
- Customer remediation and reviews: Reviews remain ongoing across auto lending, add-on products, deposit-account freezing or closures, wealth referrals, fiduciary and custody fees, and foreign exchange practices. Through Q2, the company had accrued $120 million for possible fiduciary and custody fee refunds and $171 million for FX remediation and rebates. It also accrued $8 million in Q2 for a mortgage modification calculation error affecting approximately 625 customers.
- Other legal exposure: The high end of reasonably possible legal losses in excess of accruals was approximately $2.2 billion at June 30. A $2.09 billion settlement to resolve a Department of Justice mortgage securities investigation had been reached and was fully accrued. The company cautioned that actual legal outcomes and losses could differ materially from estimates.
- Management outlook: Management expected an effective tax rate of approximately 19% for the remainder of 2018, excluding future discrete items. It expected share repurchases to continue through the rest of 2018. The FRB did not object to the 2018 capital plan, which included up to $24.5 billion of gross common share repurchases from Q3 2018 through Q2 2019, subject to management discretion and applicable conditions.
- On July 24, 2018, after quarter-end, the company announced an increase in the quarterly common dividend to $0.43 per share. It also announced redemption of Series J preferred stock, expected to reduce Q3 diluted EPS by about $0.03.
- Management identified sensitivity to interest rates, deposit costs and flows, mortgage volumes and servicing-rights valuations, credit conditions, regulation, litigation, customer remediation, operational and cyber risks, and the asset cap. A 200-basis-point rate increase was projected to raise net interest income by $1.3–$1.8 billion in year one and $3.1–$3.6 billion in year two relative to the base scenario; a 100-basis-point decline was projected to reduce it by $0.7–$1.2 billion and $2.0–$2.5 billion, respectively.
Most important facts for investors to verify
- Progress and timing of FRB plan approval, third-party reviews and eventual removal of the asset cap, including its effects on deposits, assets and growth.
- Whether remediation and legal costs—including the $1 billion consent-order penalties and the additional possible legal-loss range—remain within accrued amounts or require further charges.
- Whether declining mortgage originations, lower production margins and continued deposit-cost increases further pressure revenue, net interest margin and earnings.
- Credit trends and allowance adequacy, especially automobile charge-offs, commercial real estate nonaccruals, and changing economic conditions.
- Execution of the announced buyback and dividend plans, while maintaining regulatory capital and liquidity requirements.
- Effects of accounting changes adopted in 2018 on period comparisons; the filing revised certain prior-period presentations, including equity-security and revenue classifications.