Wells Fargo & Company — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Wells Fargo was a diversified financial-services company with $1.226 trillion in assets. The filing reflects the continuing integration of Wachovia, acquired in December 2008. Dollar amounts below are U.S. dollars; financial figures are generally in billions unless stated otherwise.
Financial performance and condition
| Metric | Q2 2010 | Comparable period |
|---|---|---|
| Total revenue | $21.394 | $22.507 in Q2 2009; down 5% |
| Net interest income | $11.449 GAAP; $11.610 taxable-equivalent | $11.764 GAAP; $11.940 taxable-equivalent in Q2 2009 |
| Net income | $3.062 | $3.172 in Q2 2009 |
| Net income applicable to common stock | $2.878 | $2.575 in Q2 2009 |
| Diluted earnings per common share | $0.55 | $0.57 in Q2 2009 |
| Provision for credit losses | $3.989 | $5.086 in Q2 2009 |
| Noninterest expense | $12.746 | $12.697 in Q2 2009 |
| Net interest margin | 4.38% | 4.30% in Q2 2009 |
| Efficiency ratio | 59.6% | 56.4% in Q2 2009 |
| Pre-tax, pre-provision profit | $8.648 | $9.810 in Q2 2009 |
For the first half of 2010, net income was $5.609 billion versus $6.217 billion a year earlier; diluted EPS was $1.00 versus $1.13. Revenue was $42.842 billion, down 2%, and pre-tax, pre-provision profit was $17.979 billion, down 5%. The six-month effective tax rate was 34.2%, compared with 32.8%.
- Credit: Q2 net charge-offs were $4.489 billion, or 2.33% of average loans annualized, down 16% from Q1 but above Q2 2009’s $4.386 billion. The $3.989 billion provision included a $500 million reserve release. The allowance for credit losses was $25.085 billion, 3.27% of loans.
- Asset quality: Nonaccrual loans were $27.811 billion, up from $27.301 billion at March 31. Nonperforming assets totaled $32.936 billion, or 4.30% of loans. Management reported slower nonaccrual growth and lower new inflows, while real-estate-related nonaccruals continued to rise.
- Balance sheet and funding: At June 30, total assets were $1,225.9 billion, loans $766.3 billion, deposits $815.6 billion, and core deposits $758.7 billion. Core deposits funded 99% of loans. Long-term debt was $185.1 billion and short-term borrowings $45.2 billion. Total equity was $121.4 billion.
- Capital: Tier 1 capital ratio was 10.51%, total capital ratio 14.53%, Tier 1 leverage ratio 8.66%, and Tier 1 common equity ratio 7.61%. The company and subsidiary banks were reported as well-capitalized.
- Cash flows: For the first half, operating activities provided $16.854 billion and investing activities provided $11.720 billion; financing activities used $38.083 billion. Cash and due from banks decreased $9.509 billion to $17.571 billion. These bank cash-flow figures should be considered alongside balance-sheet funding and liquidity disclosures.
Material changes and business drivers
- Revenue declined 5% year over year, largely reflecting weaker mortgage banking and trading results. Mortgage banking revenue fell 34% to $2.011 billion; mortgage originations were $81 billion, down 37% from a year earlier. Trust and investment fees rose 14% to $2.743 billion.
- Q2 mortgage banking results included $382 million of additions to the mortgage repurchase reserve. The reserve reached $1.375 billion, versus $1.033 billion at year-end 2009; repurchase demands and losses remained elevated.
- Noninterest expense was nearly flat year over year, but included $498 million of Wachovia integration costs, $137 million of severance costs for Wells Fargo Financial restructuring, and $627 million of operating losses, predominantly additional litigation accruals. The efficiency ratio worsened to 59.6%.
- Average loans declined 7% year over year to $772.5 billion, reflecting soft demand and runoff of liquidating portfolios. Average core deposits were nearly flat at $761.8 billion, with growth in low-cost transaction and savings accounts offset by maturing higher-cost certificates of deposit.
- By segment, Q2 net income was $1.766 billion in Community Banking, $1.412 billion in Wholesale Banking, and $270 million in Wealth, Brokerage and Retirement. Wholesale results benefited from commercial purchased credit-impaired loan resolutions; Community Banking earnings fell year over year.
Outlook, management commentary, risks and unusual items
- Management said credit quality had improved earlier and more than expected, with quarterly losses believed to have peaked in Q4 2009 and provision expense in Q3 2009. Absent significant economic deterioration, it expected positive charge-off trends to continue and further allowance reductions to be possible. These are management expectations, not guarantees.
- Wachovia integration costs were estimated at approximately $5.7 billion in total, with $3.0 billion recorded through June 30. Management projected $600–$650 million of costs in each of Q3 and Q4 2010, declining in 2011; it continued to target $5.0 billion in annual cost savings. Approximately 80% of run-rate savings had been achieved, with 90% expected by year-end.
- In July 2010, Wells Fargo announced it would restructure Wells Fargo Financial, close its U.S. store network, and exit originating non-prime portfolio mortgage loans. The filing recorded $137 million of related Q2 severance expense.
- Management estimated overdraft-practice changes would reduce 2010 fee revenue after tax by approximately $225 million in Q3 and $275 million in Q4. Card Act changes were expected to have a $30 million after-tax impact in Q3. Actual effects could differ.
- The Dodd-Frank Act became law on July 21, 2010. The company said its ultimate effects were uncertain and could include lower revenue, higher costs or capital requirements, and changes to business practices.
- Credit and housing risks remained substantial: real-estate-secured exposures, foreclosures, mortgage repurchase claims, modifications, and economic conditions could generate further losses. Management stated the allowance was adequate, while acknowledging that unanticipated economic deterioration could require additional provisions.
- The filing reported ongoing litigation and potential losses beyond established reserves that could not be estimated with confidence. A June 2010 settlement of Data Treasury claims had no material adverse effect on Q2 results. Management believed the eventual outcomes of the discussed matters would not have a material adverse effect, but noted an unfavorable resolution could be material in a particular period.
Most important facts for investors to verify
- Whether charge-offs, nonaccrual loans, and foreclosed assets continue to improve, particularly in residential and commercial real estate.
- Whether the $25.1 billion credit-loss allowance and $1.375 billion mortgage repurchase reserve remain sufficient as claims, defaults, and housing conditions evolve.
- Whether mortgage banking revenue and mortgage servicing rights remain exposed to origination volumes, interest-rate movements, hedging outcomes, and repurchase demands.
- Whether integration costs stay within management’s projections and the targeted $5.0 billion of annual savings is realized.
- The actual earnings and cost effects of overdraft and card regulation and implementation of the Dodd-Frank Act.
- Progress and potential financial impact of significant litigation and other contingencies, including losses beyond recorded reserves.
- How the first-half cash-flow movements, debt repayments, deposit trends, and capital ratios affect ongoing liquidity and funding flexibility.