Wells Fargo & Company — 2010 Q3 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Wells Fargo is a diversified U.S. financial-services company with approximately $1.2 trillion in assets. The filing was signed November 5, 2010.
Key financial metrics
| Metric | Q3 2010 | Comparable period |
|---|---|---|
| Total revenue | $20.9 billion | $22.5 billion in Q3 2009; down 7% |
| Wells Fargo net income | $3.34 billion | $3.24 billion in Q3 2009; up 3% |
| Net income applicable to common stock | $3.15 billion | $2.64 billion in Q3 2009; up 19% |
| Diluted EPS | $0.60 | $0.56 in Q3 2009 |
| Net interest income | $11.10 billion GAAP; $11.25 billion taxable-equivalent | GAAP $11.68 billion; taxable-equivalent $11.86 billion in Q3 2009 |
| Net interest margin | 4.25% | 4.36% in Q3 2009 |
| Noninterest income / expense | $9.78 billion / $12.25 billion | Income down 9%; expense up 5% year over year |
| Provision for credit losses | $3.45 billion | $6.11 billion in Q3 2009 |
| Efficiency ratio / PTPP | 58.7% / $8.62 billion | Efficiency ratio 52.0%; PTPP $10.78 billion in Q3 2009 |
| Net charge-offs | $4.10 billion; 2.14% annualized | $5.11 billion; 2.50% annualized in Q3 2009 |
- Nine-month results: Revenue was $63.72 billion, down 3% from $65.99 billion. Net income was $8.95 billion, down 5% from $9.45 billion; diluted EPS was $1.60 versus $1.69.
- Balance sheet at September 30: Assets were $1.221 trillion; loans $753.7 billion; deposits $814.5 billion; allowance for loan losses $23.9 billion; and total equity $125.2 billion. Assets, loans and deposits were lower than at year-end 2009.
- Debt and liquidity: Short-term borrowings were $50.7 billion and long-term debt $163.1 billion, versus $39.0 billion and $203.9 billion, respectively, at year-end 2009. Core deposits of $771.8 billion funded 102% of average loans in Q3. Cash and due from banks was $16.0 billion at quarter-end.
- Cash flows, first nine months: Operating activities provided $22.8 billion, investing activities provided $25.5 billion and financing activities used $59.4 billion; cash and due from banks declined $11.1 billion to $16.0 billion. The filing does not present a separate Q3-only cash-flow statement.
- Capital: Tier 1 capital ratio was 10.90%, total capital 14.88%, Tier 1 leverage 9.01% and Tier 1 common equity 8.01%. The company and subsidiary banks were reported as well capitalized under applicable requirements.
Material changes and operating performance
- Q3 net income was described by management as a quarterly record. Earnings improved despite lower revenue, as the provision for credit losses fell and common earnings benefited from lower preferred-stock charges.
- Revenue weakness reflected lower net interest income, reduced deposit service charges following Regulation E and overdraft-policy changes, and lower mortgage servicing results. Mortgage loan origination/sales gains rose $835 million year over year, but servicing income fell $1.4 billion, largely because of lower mortgage-servicing hedge carry income.
- Average loans fell 6% year over year to $759.5 billion, partly due to planned runoff of non-strategic portfolios. Average core deposits increased 2% to $772.0 billion. The net interest margin declined 11 basis points year over year.
- Credit quality improved for a third consecutive quarter: net charge-offs declined 9% from Q2 and 24% from the Q4 2009 peak. The $3.45 billion provision was $650 million below net charge-offs, producing a reserve release. However, nonaccrual loans rose 2% from Q2 to $28.3 billion, and total nonperforming assets were $34.6 billion.
- Community Banking net income decreased 27% year over year to $2.0 billion; Wholesale Banking rose to $1.4 billion from $594 million; Wealth, Brokerage and Retirement increased to $256 million from $111 million.
- Wachovia integration was reported as meeting or exceeding expectations. Wells Fargo had achieved about 85% of its targeted $5.0 billion annual run-rate savings by quarter-end and expected to reach the full target upon completing integration in 2011. Q3 integration expenses were $476 million.
Outlook, risks and unusual items
- Management expected further allowance reductions absent significant economic deterioration. It also expected to exceed a 7% Tier 1 common equity ratio under proposed Basel III rules within the next few quarters; both statements are forward-looking and dependent on assumptions and final rules.
- Management estimated Regulation E and related overdraft changes would reduce Q4 2010 fee revenue by approximately $440 million. Card-related legislative and regulatory changes were estimated to have a further $47 million Q4 impact; actual effects could vary.
- The Dodd-Frank Act became law in July 2010; its ultimate impact was undetermined pending implementation and rulemaking. Other risks cited include housing and unemployment conditions, loan losses, interest rates, mortgage servicing and repurchase exposure, regulatory changes, and Wachovia integration.
- The mortgage repurchase liability was $1.33 billion, up from $1.03 billion at year-end 2009. Q3 repurchases and investor reimbursements involved $768 million of loan balances; related net losses were $414 million. Management said future demands and loss severity could exceed estimates.
- Foreclosure practices were under regulatory and legal scrutiny. Wells Fargo identified instances where final affidavit execution or notarization steps were not strictly followed and announced supplemental affidavits for about 55,000 pending foreclosures in 23 judicial-foreclosure states. It said it did not believe the issues affected loan-data quality or caused improper foreclosures, and did not plan a foreclosure moratorium.
- A California court entered a judgment directing a different debit-card transaction posting method and approximately $203 million in remediation in the Gutierrez case; Wells Fargo said it would appeal. Mortgage-related litigation and investigations included claims for which the company said it could not estimate possible losses. The filing noted that unfavorable outcomes could be material in a particular period, notwithstanding management’s belief that aggregate outcomes would not materially adversely affect consolidated statements.
- Other notable items: $639 million of PCI-loan nonaccretable difference was transferred to accretable yield in Q3, expected to be recognized as income over the loans’ remaining lives; and the company incurred a $16 million loss on termination of a conduit subordinated note earlier in 2010.
Most important facts for investors to verify
- Whether credit improvement continues and whether declining provisions and reserve releases remain appropriate as nonaccrual loans and foreclosed assets rise.
- The adequacy of the $1.33 billion mortgage repurchase liability, subsequent investor demands, and any losses or legal exposure tied to servicing and foreclosure procedures.
- Delivery of the remaining Wachovia cost savings and integration completion in 2011, including the effect of ongoing integration and credit-workout costs.
- The actual Q4 and future revenue effects of Regulation E, overdraft-policy changes and card regulation, compared with management’s estimates.
- Final Basel III and Dodd-Frank requirements and their effects on capital, liquidity, earnings and business practices.
- Mortgage servicing income and MSR valuation sensitivity: residential MSRs were $12.5 billion at quarter-end, down from $16.0 billion at year-end 2009.