Wells Fargo & Company — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Wells Fargo is a diversified financial-services company with $1.97 trillion in assets. The period was heavily affected by COVID-19, lower interest rates, and elevated expected credit losses.
Key financial metrics
| Metric | Q2 2020 | Comparable period / change |
|---|---|---|
| Net income (loss) | $(2.4) billion | $6.2 billion profit in Q2 2019 |
| Diluted EPS | $(0.66) | $1.30 in Q2 2019 |
| Total revenue | $17.8 billion | Down 17% year over year |
| Net interest income | $9.9 billion | Down 18% year over year |
| Net interest margin | 2.25% | Down 57 basis points year over year |
| Provision for credit losses | $9.5 billion | $503 million in Q2 2019 |
| Noninterest expense | $14.6 billion | Up 8% year over year |
| Efficiency ratio | 81.6% | 62.3% in Q2 2019 |
| Net loan charge-offs | $1.1 billion; 0.46% annualized | $653 million; 0.28% in Q2 2019 |
For the first half, Wells Fargo reported a net loss of $1.7 billion versus net income of $12.1 billion in the first half of 2019. Revenue was $35.6 billion, down 18%; provision for credit losses was $13.5 billion versus $1.3 billion; and diluted EPS was $(0.65) versus $2.50.
Balance sheet, capital and liquidity
- At June 30, total assets were $1.969 trillion, deposits $1.411 trillion, loans $935.2 billion, long-term debt $230.9 billion and short-term borrowings $60.5 billion.
- Loans decreased $27.1 billion from year-end 2019; deposits increased $88.1 billion. Average Q2 deposits rose 9% year over year to $1.39 trillion, reflecting customers’ preference for liquidity.
- Cash, cash equivalents and restricted cash were $262.5 billion, up $121.3 billion from year-end. Unencumbered primary liquidity sources were $511.3 billion; the quarterly average liquidity coverage ratio was 129%, above the 100% requirement.
- Total equity was $180.1 billion. The fully phased-in CET1 ratio was 10.97%, above the Company’s 10% internal target; supplementary leverage ratio was 7.52%. Eligible external TLAC was 25.33% of risk-weighted assets versus a 22% minimum.
- Loan allowance for credit losses was $18.9 billion; total allowance for loans, including unfunded commitments, was $20.4 billion, or 2.19% of loans. Nonaccrual loans were $7.6 billion and nonperforming assets were $7.8 billion.
- First-half cash flow statement reported $33.4 billion provided by operating activities, $59.4 billion provided by investing activities and $28.5 billion provided by financing activities. Cash and equivalents increased $121.3 billion. These bank cash-flow figures reflect substantial balance-sheet and securities movements.
Material changes and drivers
- Lower market rates and asset/funding mix reduced net interest income and margin. Interest-bearing deposit costs fell, but asset yields also repriced lower.
- COVID-19 economic forecasts drove a major increase in credit provisioning and reserves. Commercial losses rose particularly in oil and gas and commercial real estate; consumer charge-offs also increased in auto and residential real estate, while payment deferrals may delay recognition of delinquencies and losses.
- Noninterest income fell 16% in Q2. Lower deposit and card fees reflected reduced activity and customer fee waivers; mortgage servicing recorded a $689 million net loss, including mortgage-servicing-right valuation pressure. Trading gains and mortgage origination gains partly offset declines.
- Noninterest expense increased 8%, principally due to higher operating losses, including litigation and customer-remediation accruals, and COVID-related occupancy costs. Operating losses were $1.2 billion in Q2 versus $247 million a year earlier.
- Average loans grew year over year, partly reflecting commercial customers drawing revolving credit lines; period-end loans declined from year-end as paydowns exceeded originations and $10.4 billion of first-mortgage loans were transferred to held for sale.
- Mortgage servicing rights measured at fair value fell to $6.8 billion from $11.5 billion at year-end 2019, reflecting valuation changes and cash-flow realization.
Outlook, risks and unusual items
- Outlook: The filing gives no specific earnings or revenue guidance. Management emphasized that the duration and severity of the downturn and resulting credit losses were uncertain. Its allowance forecast weighted 80% to a base case and 20% to a downside case; a separate sensitivity using equal weights would have increased the loan allowance by about $5 billion, and management stated this was not its expected-loss view.
- COVID-19 accommodations: At June 30, modified loans totaled $38.2 billion commercial (7% of that portfolio) and $52.8 billion consumer (13%). Deferrals, fee waivers and suspended foreclosure and collection actions may delay observable deterioration. The Company also committed $175 million in charitable donations and pledged to donate PPP processing fees.
- Regulatory constraints: The Federal Reserve’s asset cap remained in effect under the 2018 consent order, with PPP and Main Street program exposures excluded under an April 2020 amendment. The Company continued work on governance, compliance and operational-risk improvements. The filing describes multiple other consent orders and customer-remediation programs.
- Capital distributions: Share repurchases were suspended, and Federal Reserve restrictions limited capital distributions. On July 28, 2020, after quarter-end, the Company reduced its Q3 common dividend to $0.10 per share from $0.51 in Q2.
- Legal and contingent exposures: Q2 disclosures include the February 2020 $3.0 billion DOJ and SEC retail-sales-practices resolutions. The high end of reasonably possible legal losses above accrued probable losses was approximately $2.3 billion at June 30; actual outcomes may be higher or lower. Other significant litigation and investigations remain pending.
- Other notable developments: Wells Fargo adopted CECL on January 1, 2020, reducing the opening loan allowance by about $1.3 billion before subsequent pandemic-related increases. The FRB’s consent order asset cap and regulatory remediation remain important constraints. S&P lowered the Company’s long-term rating to BBB+ on July 22, after quarter-end; Fitch and DBRS had revised outlooks or trends to negative earlier in 2020.
Most important facts for investors to verify
- Whether further deterioration in the economy translates into additional provisions, charge-offs, nonaccrual loans or reserve increases, particularly in oil and gas, commercial real estate and consumer portfolios.
- How many COVID-related loan modifications remain in deferral, whether extensions increase, and how payment accommodations affect later delinquency and loss recognition.
- Whether the $20.4 billion loan-related allowance adequately covers expected losses; review management’s economic assumptions and the disclosed approximately $5 billion sensitivity.
- Whether the asset cap, consent orders and other remediation requirements affect growth, costs, operations or the timing of regulatory relief.
- How capital ratios, rating changes and Federal Reserve distribution limits affect the reduced dividend, future capital returns and funding costs.
- How mortgage-servicing valuations, servicing advances and GNMA repurchases evolve; the filing reported $14.1 billion of such repurchases in July and expected a further $5.6 billion in August.