Wells Fargo & Company — Q1 2010 Form 10-Q
Business context and reporting period. For the quarter ended March 31, 2010, Wells Fargo reported as a diversified financial services company with $1.2 trillion in assets. The filing compares results principally with Q1 2009 and, for balance-sheet measures, December 31, 2009. The Wachovia acquisition continued to shape results and integration activity.
Key financial metrics
- Revenue and earnings: Total revenue was $21.45 billion, up 2% year over year. Net interest income was $11.15 billion; noninterest income was $10.30 billion, up 7%. Wells Fargo net income was $2.55 billion, down 16%; income applicable to common stock was $2.37 billion versus $2.38 billion. Diluted EPS was $0.45 versus $0.56. Annualized ROA was 0.84% and ROE was 8.96%.
- Margins and expenses: Net interest margin was 4.27%, up 11 basis points year over year. Noninterest expense was $12.12 billion, up 3%; the efficiency ratio was 56.5%, compared with 56.2%. Pre-tax, pre-provision profit was $9.33 billion, down 6% from the prior quarter and up 1% year over year.
- Credit and reserves: Provision for credit losses was $5.33 billion, compared with $4.56 billion in Q1 2009, and equaled net charge-offs. Net charge-offs were $5.33 billion, or 2.71% of average loans annualized, versus $3.26 billion, or 1.54%, a year earlier; they were slightly below Q4 2009’s $5.4 billion. The allowance for loan losses was $25.12 billion, 3.22% of loans; the allowance for credit losses, including unfunded commitments, was $25.66 billion, 3.28% of loans.
- Balance sheet and liquidity: Total assets were $1.224 trillion, down 2% from year-end and 5% year over year. Loans were $781.43 billion, down 7% year over year; deposits were $804.89 billion, down 2% from year-end. Core deposits were $756.05 billion, down 3% from year-end. Cash and short-term investments totaled $70.49 billion. Average core deposits funded 95% of average loans.
- Debt and capital: Long-term debt was $199.88 billion and short-term borrowings were $46.33 billion at quarter-end. Tier 1 capital was $98.33 billion, with a 9.93% Tier 1 risk-based ratio; the Tier 1 leverage ratio was 8.34%. Tier 1 common equity was $70.2 billion, or 7.09% of risk-weighted assets. The company and subsidiary banks reported regulatory capital levels above applicable “well-capitalized” thresholds.
- Cash flow: Operating activities provided $8.88 billion, versus $15.88 billion in Q1 2009; investing activities provided $12.70 billion, versus $18.70 billion; financing activities used $32.36 billion, versus $36.16 billion. Cash and due from banks declined $10.78 billion during the quarter to $16.30 billion. Bank cash flows are affected by loan, deposit, and securities movements.
- Shareholder distributions: The declared common dividend was $0.05 per share, versus $0.34 in Q1 2009. Book value per common share was $20.76, up from $16.28 a year earlier.
Material changes versus comparable periods
- Revenue increased despite a 7% decline in average loans; higher trust and investment, insurance, processing, and other fee income, plus a higher net interest margin, offset weaker loan volumes and lower net interest income.
- Credit costs remained elevated: provision expense rose 17% year over year, while net charge-offs increased substantially from Q1 2009. Management said charge-offs had peaked in Q4 2009 and provision expense in Q3 2009, subject to economic conditions.
- Mortgage banking revenue was nearly flat at $2.47 billion. Mortgage origination and sale gains fell 31% to $1.10 billion, while servicing income benefited from net MSR hedge-related valuation gains. Residential mortgage originations were $76 billion, down from $101 billion.
- Nonperforming assets rose to $31.5 billion, or 4.03% of loans, from $27.6 billion at year-end. Nonaccrual loans increased to $27.3 billion, with the increase concentrated in consumer real estate and commercial real estate.
- Capital strengthened: Tier 1 common equity rose to $70.2 billion and its ratio increased from 6.46% at year-end to 7.09%. Total equity increased to $118.2 billion from $114.4 billion.
- Adoption of new VIE consolidation guidance added $18.6 billion of net assets at January 1, 2010, and increased beginning retained earnings by $183 million. Newly consolidated assets also contributed to reported nonaccruals and charge-offs.
Outlook, management commentary, risks, and unusual items
- Management described credit trends as improving, citing lower early-stage consumer delinquencies and reduced commercial and CRE losses. It expected nonperforming assets to continue rising gradually and peak before year-end; these expectations depend on economic conditions not deteriorating.
- Loan demand remained soft. Wells Fargo reported $128 billion of new loan commitments in Q1, including $76 billion of residential mortgage originations, and continued to reduce non-strategic and liquidating loan portfolios.
- Wachovia integration costs were $380 million in Q1, versus $205 million a year earlier. Management estimated total integration costs of about $5 billion, expected about $2 billion in 2010, and reported that more than 70% of targeted run-rate savings had been realized.
- Regulatory and legislative changes were estimated to reduce 2010 fee revenue by about $500 million after tax from overdraft-related changes, and by $75 million to $100 million after tax from credit-card changes, before potential offsets. Actual impacts could vary.
- The mortgage loan repurchase reserve rose to $1.26 billion from $1.03 billion at year-end. Q1 included a $402 million reserve addition; the company repurchased or settled loans with $600 million in balances and recorded $172 million of net losses on repurchase activity. Further investor demands or higher loss severity could require additional reserves.
- Other notable items included $197 million of securities impairment write-downs; a $53 million tax expense from the new retiree-health-care tax treatment; and a $160 million payment by Wachovia to resolve government investigations concerning pre-acquisition activity.
- Risks highlighted include persistent recession, unemployment and housing weakness; credit losses and reserve adequacy; mortgage repurchase demands; interest-rate and MSR valuation exposure; integration execution; regulatory changes and potential rating downgrades; litigation and investigations; and off-balance-sheet and counterparty exposures. Maximum exposure to loss for disclosed unconsolidated VIEs was $70.8 billion, which the filing says is a remote hypothetical measure, not expected loss.
- Management reported effective disclosure controls as of March 31, 2010, and no material first-quarter change in internal control over financial reporting.
Most important facts for investors to verify
- Whether subsequent quarters confirm management’s claim that credit losses and provisions have peaked, and whether NPAs peak as projected.
- Allowance adequacy and loss performance in residential mortgages, Pick-a-Pay, junior liens, credit cards, and commercial real estate.
- Future mortgage repurchase demands, reserve adequacy, and the outcomes of related investor and government actions.
- Progress on Wachovia integration, realized cost savings, remaining costs, and revenue synergies.
- Actual effects of overdraft and credit-card rules on fee income, including any offsets from customer behavior or other business activity.
- Capital, liquidity, debt funding, and the sensitivity of earnings and MSR values to changes in interest rates and markets.