Business context and reporting period
Wells Fargo & Company filed this Form 10-Q for the quarter ended March 31, 2012. The diversified financial services company reported $1.33 trillion in period-end assets and operates through Community Banking, Wholesale Banking, and Wealth, Brokerage and Retirement.
Financial performance and condition
| Metric | Q1 2012 | Comparison |
|---|---|---|
| Revenue | $21.64 billion | Up 6% year over year |
| Net interest income | $10.89 billion | Up from $10.65 billion |
| Net interest margin | 3.91% | Down 14 basis points year over year |
| Noninterest income | $10.75 billion | Up 11%; mortgage banking was a key driver |
| Noninterest expense | $12.99 billion | Up 2% |
| Provision for credit losses | $2.00 billion | Down $215 million |
| Net income | $4.25 billion | Up 13% |
| Net income applicable to common stock | $4.02 billion | Up 13% |
| Diluted EPS | $0.75 | Up 12% |
| Efficiency ratio | 60.1% | Improved from 62.6% |
| Operating cash flow | $15.91 billion provided | Versus $17.21 billion provided |
| Investing / financing cash flow | $32.96 billion used / $14.62 billion provided | Investing cash flow was a $1.23 billion source in Q1 2011 |
At quarter-end, assets were $1.334 trillion; loans were $766.5 billion, down $3.1 billion from year-end; and deposits were $930.3 billion, up $10.2 billion. Core deposits were $888.7 billion and funded 116% of loans. Long-term debt was $129.8 billion, compared with $125.4 billion at December 31, 2011; short-term borrowings were $51.0 billion. Cash and due from banks ended at $17.0 billion, down $2.4 billion during the quarter.
Capital strengthened: Tier 1 capital ratio was 11.78%, total capital ratio 15.13%, Tier 1 leverage ratio 9.35%, and Basel I Tier 1 common equity ratio 9.98%. Management estimated the Basel III Tier 1 common equity ratio at 7.84%, subject to proposed-rule assumptions. Return on assets was 1.31% and return on equity was 12.14%. The common dividend was raised to $0.22 per share from $0.12.
Material changes versus comparable periods
- Year-over-year earnings rose primarily on higher mortgage banking and other fee income, higher net interest income, and a lower credit-loss provision; these more than offset higher expenses and taxes.
- Mortgage banking income rose to $2.87 billion from $2.02 billion, including $2.62 billion in mortgage origination/sales gains. Originations increased to $129 billion from $84 billion.
- Card fees fell 32% to $654 million, principally reflecting lower debit-card interchange rates under rules effective in late 2011.
- Average core deposits increased 9% year over year to $870.5 billion. The net interest margin nonetheless declined as higher-yielding assets continued to run off and low interest rates pressured asset yields.
- Net charge-offs fell to $2.40 billion, or 1.25% of average loans, from $3.21 billion, or 1.73%, a year earlier. The allowance for credit losses declined to $19.13 billion from $22.38 billion a year earlier.
- Nonperforming assets rose $678 million from year-end to $26.64 billion, primarily because new supervisory guidance moved $1.7 billion of junior-lien mortgages to nonaccrual. Excluding that change, nonaccrual loans declined $948 million from year-end.
Outlook, commentary, risks and unusual items
- Management targeted fourth-quarter 2012 noninterest expense of approximately $11.25 billion, revising its prior $11 billion target to reflect higher-than-expected revenue-related costs. It expected expenses to decline $500–$700 million in Q2 and continue falling through the year as integration, personnel, mortgage-volume and legal costs eased.
- Absent significant economic deterioration, management expected further allowance releases during 2012. The filing provides no broader numerical earnings or revenue guidance.
- Management cited ongoing pressure on net interest margin from low rates and runoff of higher-yielding assets. Its interest-rate simulation estimated earnings-at-risk below 1% of its plan over the next 12 months under modeled rate scenarios; outcomes remain dependent on balance-sheet composition and mortgage-servicing effects.
- A federal-state mortgage servicing and foreclosure settlement became effective April 5, 2012, after quarter-end. Wells Fargo committed $5.3 billion across consumer relief ($3.4 billion), refinancing ($900 million), and foreclosure assistance ($1.0 billion). Management expected to meet the commitments; failure to satisfy specified targets could increase amounts due. The filing estimated about $100 million in annual foregone interest from the refinance program if executed as expected.
- The mortgage repurchase liability was $1.44 billion, after $430 million of Q1 additions. The high end of reasonably possible losses above the recorded liability was $2.3 billion. The filing also reported up to $927 million of reasonably possible litigation losses in excess of the liability for probable and estimable matters; some matters had no estimable loss range.
- Other notable items: Q1 repurchases of about 8 million common shares; redemption in April of $875 million of trust preferred securities; and an April acquisition of BNP Paribas’s North American energy lending business, including approximately $3.5 billion in loans.
- Key risks include housing and economic conditions, mortgage repurchase claims and servicing obligations, regulatory changes including Basel III and the Volcker Rule, interest-rate and market movements, litigation, and execution of expense and settlement commitments.
Most important facts for investors to verify
- Whether mortgage origination gains and elevated mortgage volumes persist, and how mortgage servicing valuation changes affect earnings.
- Progress on the expense-reduction plan and delivery of the $11.25 billion Q4 2012 expense target.
- Credit trends, allowance releases, nonperforming assets, and the effect of the junior-lien nonaccrual reporting change.
- Mortgage repurchase liability assumptions, future claims, recoveries from correspondent lenders, and the possible $2.3 billion excess-loss exposure.
- Costs and execution of the $5.3 billion servicing settlement, including refinancing-related interest-income effects.
- Capital ratios under final Basel III rules, capital distributions, and the effect of trust preferred redemptions.