Wells Fargo & Company — 2014 Q2 Form 10-Q
Reporting period: Quarter ended June 30, 2014; comparative results are principally against Q2 2013, with first-half comparisons against the six months ended June 30, 2013. Balance-sheet comparisons are against December 31, 2013. Wells Fargo is a diversified U.S. financial-services company with approximately $1.6 trillion in assets.
Key financial metrics
| Metric | Q2 2014 / June 30, 2014 | Comparable period |
|---|---|---|
| Net income | $5.73 billion; diluted EPS $1.01 | Q2 2013: $5.52 billion; diluted EPS $0.98 |
| Net income applicable to common stock | $5.42 billion | Q2 2013: $5.27 billion |
| Total revenue | $21.07 billion | Q2 2013: $21.38 billion |
| Net interest income and margin | $10.79 billion GAAP; 3.15% margin | Q2 2013: $10.75 billion; 3.47% margin |
| Noninterest income | $10.28 billion | Q2 2013: $10.63 billion |
| Noninterest expense / efficiency ratio | $12.19 billion / 57.9% | Q2 2013: $12.26 billion / 57.3% |
| Provision for credit losses | $217 million | Q2 2013: $652 million |
| Loans / deposits | $828.9 billion / $1.119 trillion | At year-end 2013: $822.3 billion / $1.079 trillion |
| Long-term debt / short-term borrowings | $167.9 billion / $61.8 billion | At year-end 2013: $153.0 billion / $53.9 billion |
| Total equity | $181.5 billion | At year-end 2013: $171.0 billion |
For the first half of 2014, net income was $11.62 billion, up 9% year over year, and diluted EPS was $2.06, up 8%. Revenue was $41.69 billion, down 2%; noninterest expense was $24.14 billion, down 2%.
- Credit: Q2 net charge-offs were $717 million, or 0.35% of average loans annualized, down 38% from Q2 2013. Nonperforming assets were $18.08 billion, down $686 million from March 31. The allowance for credit losses was $13.8 billion, versus $15.0 billion at year-end 2013.
- Cash flow: In the first half, operating activities used $398 million, investing activities used $52.7 billion, and financing activities provided $53.9 billion. Cash and due from banks ended at $20.6 billion, compared with $17.9 billion a year earlier. Bank cash flows reflect substantial movements in loans, securities, deposits, and mortgage activity.
- Liquidity: The company reported $292.6 billion of unencumbered primary liquidity at June 30, including cash and high-quality securities. Core deposits were $1.007 trillion, or 122% of total loans.
- Capital: Basel III General Approach ratios were 11.31% Common Equity Tier 1, 12.72% Tier 1 risk-based, 15.89% total risk-based, and 9.86% Tier 1 leverage. The estimated fully phased-in Advanced Approach CET1 ratio was 10.14%.
Material changes versus comparable periods
- Q2 net income rose 4% year over year, while revenue fell about 1%; first-half net income increased 9% despite a 2% revenue decline.
- Mortgage banking revenue fell 39% in Q2, to $1.72 billion, as lower origination volume and margins reduced mortgage-sale gains. Originations were $47 billion versus $112 billion a year earlier; 74% were purchase loans versus 44%.
- Lower mortgage revenue was partly offset by higher deposit service charges, trust and investment fees, and equity investment gains. Q2 brokerage advisory, commissions and other fees rose 7%; net gains from equity investments were $449 million versus $203 million.
- Net interest income increased slightly, but net interest margin contracted 32 basis points year over year. Management cited growth in lower-yielding liquidity assets and funding balances, alongside low rates and replacement of maturing higher-yielding assets.
- Credit performance improved: Q2 net charge-offs declined from $1.15 billion to $717 million, and provision expense fell from $652 million to $217 million. The quarter’s provision included a $500 million allowance release, as did Q2 2013.
- Loans grew 4% year over year and deposits 9%. Core loans increased as non-strategic portfolios continued to run off. A $9.7 billion government-guaranteed student loan portfolio was transferred to loans held for sale at quarter-end.
Outlook, management commentary, risks and unusual items
- Management expects to remain within its 55%–59% efficiency-ratio target in Q3 2014. It expects future allowance releases absent significant economic deterioration, but at a lower rate as credit improvement slows and loans grow.
- Management described the company as positioned to benefit from higher interest rates through asset repricing, while warning that mortgage activity and MSR values may move in the opposite direction. Simulations showed positive earnings sensitivity under higher-rate scenarios and negative sensitivity under lower-rate scenarios over a 24-month horizon.
- Capital distributions continued: the quarterly common dividend increased 17% to $0.35 per share; the company repurchased 39.4 million shares in Q2 and reported a 66% net payout ratio. Further repurchases depended on capital needs, market conditions, and regulatory considerations.
- A $423 million discrete tax benefit was recognized in Q1 2014, primarily from resolution of prior-period state tax matters. Q2 servicing income included a $475 million net MSR valuation gain, reflecting hedge gains that more than offset lower MSR fair value.
- The mortgage repurchase liability was $766 million at June 30. The filing estimated reasonably possible losses up to $975 million in excess of that liability. Litigation losses reasonably possible in excess of recorded liabilities had a high-end estimate of $1.2 billion; some matters’ possible losses could not be estimated.
- Mortgage-servicing and foreclosure obligations remain significant. The company said it believed it had reported sufficient foreclosure-prevention actions to meet a $1.2 billion commitment, pending monitor approval. It reported fulfilling its consumer-relief and refinance commitments under a separate federal-state settlement.
- Other risks include interest-rate and market movements, mortgage servicing and repurchase claims, credit deterioration, litigation and regulatory costs, cybersecurity and operational failures, and evolving capital and liquidity rules. Wells Fargo reported no material losses from cyber attacks to date.
- The filing revised certain 2012–2013 commercial loan balances after determining that some factoring arrangements did not qualify as loans. The revision reduced commercial loans and other liabilities, but did not affect net income or total cash flows.
Most important facts for investors to verify
- Whether core revenue and earnings can offset the continued mortgage origination decline and pressure on net interest margin.
- The sustainability of credit improvement and allowance releases, including whether the $13.8 billion allowance remains appropriate as loan balances grow.
- Mortgage servicing valuation assumptions, hedge effectiveness, repurchase claims, and the stated potential losses above recorded liabilities.
- Capital and liquidity after dividends, repurchases, debt issuance, and implementation of Basel III and other regulatory requirements.
- Legal and regulatory developments, including litigation reserves, servicing commitments, and the pending approval of foreclosure-prevention actions.
- Reported first-half operating cash use and the large investing cash outflow, interpreted in the context of banking and mortgage-related balance-sheet movements.