Wells Fargo & Company (WFC) reported a still strong quarter with earnings growth for 15 quarters in a row, despite a significant drop in mortgage revenues. Offsetting the expected decline in refinancing activities, provision expenses dropped to just $75 million, helping to support a still strong return on average assets (ROA) of 1.53%.
As expected, mortgage banking revenues declined during the quarter given the recent rise in long-term interest rates. Revenues were impacted by both lower refinance volumes and reduced gain on sale margins. WFC's first mortgage unclosed pipeline fell to just $35 billion, well below the level last quarter and a year ago. As such, Fitch expects that mortgage revenues will likely continue to decline over the near term.
Revenues fell 4% sequentially driven by the previously mentioned decline in mortgage revenues, though excluding mortgage from both quarters, noninterest income improved 4% on a sequential basis. WFC also reported lower trust and investment fees, offset by a significant increase in gains from equity investments, which tend to be a lumpy item for the company. Equity gains during the first nine months of 2013 are up just $48 million as compared to the same period last year. Spread income was flat, though the net interest margin once again declined on a sequential basis due to the continued growth in deposits which is dilutive to the margin. Expenses fell 1% sequentially due to lower incentive compensation, somewhat offset by higher mortgage-related severance expenses.
Provision expenses totaled just 4bps of loans on an annualized basis, as compared to quarterly NCOs at 48bps of average loans. As a result of the reserve release for the quarter, reserves for loan losses declined to 1.87% of loans. The improved housing market and improving asset quality performance drove the higher sequential reserve release. WFC expects future reserve releases, absent a significant deterioration in economic conditions. Fitch notes that NCOs at this level are also likely not sustainable, with historical losses more around the 100bps range.
As previously disclosed, WFC had reached an agreement with Freddie Mac to resolve substantially all repurchase liabilities related to loans sold to Freddie Mac prior to Jan. 1, 2009. The one-time cash payment of approximately $780m was covered by existing reserves, and as such was neutral to earnings. Fitch views the agreement favorably as it resolves the majority of mortgage-related repurchase risk for WFC, in Fitch's view. The ending balance of reserves totaled $1.42 billion or 109% of the original loan balance of unresolved repurchase demands.
Tier 1 common under Basel III improved approximately 100bps to an estimated 9.54% at Sept. 30, 2013, and exceeded the company's internal target of 9%. WFC attributed the improvement to improved risk weightings on BOLI assets, the disposition of an asset with punitive risk-weighting, and model refinements for commercial portfolios. Unlike last quarter, the movement in unrealized securities gains did not materially impact capital ratios with unrealized gains actually improving to $5.8 billion at Sept. 30, 2013 from $5.1 billion at June 30, 2013, but still well below the $11.2 billion at March 31, 2013, prior to recent rise in long-term interest rates. As an Advanced Approach bank, WFC will be subject to fluctuations in AOCI under Basel III once it comes into effect Jan. 1, 2014.
WFC's ratings were affirmed on October 8, 2013 reflecting the company's superior earning profile, strong franchise, solid capital and liquidity profiles, and improving asset quality. WFC's financial performance over the past several years has been very solid despite a challenging economic and interest rate environment. WFC continues to post very strong net income each quarter, with return on assets (ROAs) well in excess of the large regional average.
Additional information is available at 'www.fitchratings.com'.
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