Wells Fargo & Company — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 31, 2014. Wells Fargo is a diversified U.S. financial services company. Unless otherwise noted, figures are in U.S. dollars; income statement comparisons are year over year, and balance-sheet comparisons are to December 31, 2013.
Key financial results
| Metric | Q1 2014 | Comparable period / change |
|---|---|---|
| Total revenue | $20.625 billion | $21.259 billion; down 3% year over year |
| Net interest income | $10.615 billion | $10.499 billion; up 1% GAAP |
| Net interest margin | 3.20% | 3.49%; down 29 basis points |
| Noninterest income | $10.010 billion | $10.760 billion; down 7% |
| Noninterest expense | $11.948 billion | $12.400 billion; down 4% |
| Provision for credit losses | $325 million | $1.219 billion; down $894 million |
| Wells Fargo net income | $5.893 billion | $5.171 billion; up 14% |
| Net income applicable to common stock | $5.607 billion | $4.931 billion; up 14% |
| Diluted EPS | $1.05 | $0.92; up 14% |
| Efficiency ratio | 57.9% | 58.3%; improved 0.4 percentage point |
| Net charge-offs | $825 million; 0.41% of average loans, annualized | $1.419 billion; 0.72% |
Balance sheet, liquidity and capital
- Total assets were $1.547 trillion, up $23.2 billion from year-end. Loans were $826.4 billion, up $4.2 billion; core loans grew $7.0 billion while non-strategic and liquidating loans ran off by $2.9 billion.
- Total deposits were $1.095 trillion, up $15.4 billion. Core deposits were $994.2 billion. Core deposits equaled 120% of total loans, compared with 119% at year-end.
- Cash on deposit and unencumbered U.S. Treasury, federal agency and agency mortgage-backed securities provided $273.1 billion in primary liquidity at quarter-end, versus $255.1 billion at year-end.
- Long-term debt was $153.4 billion, compared with $153.0 billion at year-end; short-term borrowings were $57.1 billion, compared with $53.9 billion.
- Total equity was $176.5 billion, up $5.5 billion. Basel III General Approach capital ratios were 11.36% Common Equity Tier 1, 12.63% Tier 1 risk-based capital and 15.71% total risk-based capital. The estimated fully phased-in Basel III Advanced Approach CET1 ratio was 10.07%.
- Operating cash flow was $2.841 billion, versus $9.137 billion in Q1 2013; investing cash flow was negative $18.225 billion and financing cash flow was positive $15.196 billion. These bank cash flows include substantial movements in loans, securities and deposits.
Material changes and business drivers
- Mortgage banking income fell to $1.510 billion from $2.794 billion. Mortgage origination and sale gains declined 77% to $572 million as refinancing volumes and margins dropped; originations fell to $36 billion from $109 billion. Net servicing income rose to $938 million, including a $407 million net mortgage servicing rights valuation gain.
- Trust and investment fees increased 7% to $3.412 billion, and gains from equity investments rose to $847 million from $113 million. Trading gains decreased 24% to $432 million.
- Credit performance improved: nonaccrual loans were $14.7 billion, down from $15.7 billion at year-end, and total nonperforming assets were $18.8 billion, down $840 million. The allowance for credit losses declined to $14.4 billion from $15.0 billion. The quarter included a $500 million allowance release, versus $200 million a year earlier.
- Community Banking net income rose 31% to $3.844 billion, supported by lower credit costs and expenses. Wholesale Banking net income fell 15% to $1.742 billion, reflecting lower revenue, including lower purchased-credit-impaired loan resolution income and customer-accommodation trading. Wealth, Brokerage and Retirement net income rose 41% to $475 million.
Outlook, commentary and risks
- Management described economic growth as uneven in Q1 but said activity improved later in the quarter and expressed optimism about future growth. It cited loan and deposit growth, stronger customer relationships, improved credit and expense management.
- Management expected to operate within its 55%–59% efficiency-ratio target range in Q2 2014. It expected the full-year effective tax rate to be higher than Q1’s 27.9% absent further discrete tax benefits; Q1 included a $423 million discrete benefit, primarily from resolution of state tax matters. The filing provides no clear full-year numerical earnings or revenue guidance.
- Management expected further allowance releases absent significant economic deterioration. The outlook remains sensitive to the economy, housing and collateral values, loan losses, low interest rates, deposit mix and funding costs. The company said higher rates would benefit net interest income over time, while mortgage activity and mortgage servicing rights could move adversely.
- Mortgage repurchase liability was $799 million. The high end of reasonably possible losses in excess of that recorded liability was $940 million. Separately, the high end of reasonably possible litigation losses above the liability for probable and estimable losses was $911 million. Wells Fargo said the eventual outcome of legal actions was not expected to materially affect consolidated financial position, while acknowledging an unfavorable outcome could materially affect results for a particular period.
- Servicing-related obligations include a commitment to provide foreclosure-prevention actions on $1.2 billion of loans by January 7, 2015. The company said it expected to meet the commitment. It also reported that it had fulfilled its consumer-relief and refinancing commitments under the 2012 federal/state mortgage settlement.
- Other risks include evolving cybersecurity threats, regulatory changes and compliance costs, mortgage servicing and foreclosure practices, contingent repurchase demands, and interest-rate, liquidity and market risks. The filing reports no material losses from cyberattacks and no credit-rating changes during the quarter.
- The company reported a revision to prior-period commercial loan balances because certain factoring arrangements did not qualify as loans. The revision reduced prior commercial loans and corresponding other liabilities, but did not affect net income or total cash flows. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether earnings growth can continue as mortgage origination income contracts and net interest margin remains under pressure.
- The sustainability of credit improvement and allowance releases, including the adequacy of the $14.4 billion allowance and exposure in residential real estate, home equity and commercial portfolios.
- The sensitivity of the $14.953 billion fair value of residential mortgage servicing rights to rates, prepayments and servicing costs, and the effectiveness of related hedges.
- The ultimate costs of mortgage repurchase and servicing obligations, including the $799 million reserve, $940 million possible excess loss range and remaining regulatory commitments.
- Capital-plan execution: the proposed Q2 dividend increase to $0.35 per share, planned share repurchases and the effect of evolving Basel III and liquidity requirements.
- Cash-flow interpretation: operating cash flow declined year over year, while bank cash flows are materially affected by loan, securities and deposit movements.