Wells Fargo & Co. (WFC) Management Presents at 2014 Morgan Stanley Financials Conference (Transcript)
Wells Fargo & Co. (WFC)
2014 Morgan Stanley Financials Conference
June 10, 2014 9:45 a.m. ET
Executives
John Shrewsberry - Senior EVP, Chief Financial Officer
Analysts
Betsy Graseck - Morgan Stanley
Betsy Graseck - Morgan Stanley
Okay. Maybe people could make their way in. We’re going to kick off our next session – Wells Fargo with a couple of audience poll question first before moving into the fireside chat Q&A format.
So two questions – one is what is the main catalyst that would drive you to add to your position in Wells Fargo? There are four choices. One is operating leverage of 100 basis points – that’s 100 basis points plus; B) higher buybacks; C) higher dividend yields; and then D) it’s accelerating loan growth. So A) operating leverage; B) higher buybacks; C) higher dividend yield; and D) is accelerating loan growth. And let’s see what the room is thinking. Accelerating loan growth with a slight interest in operating leverage. And no one cares about the buybacks and the dividend – there we go.
Okay. What about second question? What net payout ratio do you expect for Wells Fargo in 2015? Recently Wells did give you some guidance there. So where are you within that range? A) 55 to 65; B) 65 to 70; C) 70 to 75; D) 75 plus. What are you looking for from Wells in 2015?
Okay. Very evenly skewed. Interesting. I would have thought the lower end given the expectation for loan growth. But we can get into that in the Q&A.
Okay. So with that, we have with us today John Shrewsberry, CFO of Wells Fargo. John took on his role as CFO just last month, prior to which he was head of Wells’ securities division. Wells is the country’s largest mortgage originator and the servicer the fourth largest in the country by assets and the largest by market cap. Wells has demonstrated strong earnings momentum with 17 straight quarters of EPS growth and has been the leading performer in our group up 14% year to date versus 3% for the BKX.
So we will be using the fireside chat format. I will kick off with a few questions, and I look forward to some audience participation. If you’re interested, raise your hands and we will keep the conversation going.
So John, thanks very much for joining us this morning.
John Shrewsberry
Thanks for having me.
Betsy Graseck - Morgan Stanley
So question on rates, let’s kick off with that, because that’s been one of the key to this [ph] so far today lower forever. What if we have lower forever, notwithstanding what’s been happening in the rates market over the last day or two, but what if we have lower forever? What does that due to balance sheet, your investment style, how does the company think about that?
John Shrewsberry
Well, it depends on what else is going on in the economy while rates are lower forever in your example, if there is very modest loan growth and not a lot of other competing uses for capital, then we’d be thinking harder about how else we deploy excess liquidity into securities. We have these debates today in this rate environment about the risk of taking on incremental duration with the ever-present threat of a rate increase around the corner. And if we got the sense that this is going to go on indefinitely, then we would probably commit a little bit more. Of course, you never know what’s going to happen next. But those are the types of Algo [ph] discussions that we have today.
Betsy Graseck - Morgan Stanley
And what conditions would it be that you would need to see to extend duration a little bit?
John Shrewsberry
Well, part of it is the rhetoric that policymakers are offering in terms of what they think they're really going to react to. Part of it’s how the market reacts to the tapering that’s going on, and a lot of it is the growth environment that we’re in. If we’re going to stay in a lackluster growth environment, and there’s no catalyst for rates to go up, then I think we’d probably be more inclined to take a little bit more risk but if we feel like apparently bank stock investors feel today like higher rates are around the corner based on what’s happened recently, then at the margin that would make us less inclined to take on incremental duration.
Betsy Graseck - Morgan Stanley
We had Howard Marks up here earlier today and we were talking about what the group’s outlook is for the 10-year which ended up being in the 2.7% to 3% range, his comment was – well, really the real question is what was our expectation for rates 9 months ago?
John Shrewsberry
Is the question – what was our expectation for 10-year rates 9 months ago, or what’s our expectation for rates 9 months forward?
Betsy Graseck - Morgan Stanley
9 months forward.
John Shrewsberry
Well, it’s hard not to look at the forward curve and buy into what it's offering to you. I think people really do believe that rates are going to be somewhat higher. But the rhetoric and frankly the growth at the moment isn’t really providing support for that.
Betsy Graseck - Morgan Stanley
Right. Now having been head of the securities division, obviously you spent a lot of time in the rates market. Maybe you could help us understand how Wells Fargo thinks about managing through what has been some volatility in rates?
John Shrewsberry
Well, it’s – there are component pieces to it. In the securities division, interest-rate risks are managed like they are, I’d say, in other markets businesses on a specific mark to market DBO-1 oriented basis and because all of the instruments have ready prices, in the larger bank which is where we – there is more exposure, because most of the instruments are loans and deposits, it’s a little bit less mark to market-oriented. So we, like everyone else, use these big Algo simulations of what will happen, what would happen and in different curve scenarios, different loan growth and deposits growth, the run-off scenarios to arrive at what we think our sensitivity is to changes in rates. And then we position ourselves accordingly, sometimes using securities, sometimes using derivatives, and all the tools in the playbook.
Betsy Graseck - Morgan Stanley
And more recently in the securities portfolio, you’ve been using more held to maturities, is that right?
John Shrewsberry
Yes, we’ve begun to for the reasons that we've described. The principal reason to be concerned about a backup is because of the OCI impact and its hit to capital in this new regime. And so that accounting classification gives you protection from a capital perspective and the backup. I mean we still own underwater securities but it wouldn’t have the same GAAP impact.
Betsy Graseck - Morgan Stanley
So one of the benefits of low rates for you at Wells Fargo is that your MSR is not rising, right? I mean historically rates of MSR up and I think one of the questions I often get on Wells Fargo is how do you think the company is managing the MSR assets, what happens as rates rise, how do you think about managing – the size of that relative to the cheap?
John Shrewsberry
So well, first of all, we’re not creating MSR at the pace that we used to, because the mortgage production environment is down. We think about the inputs into the MSR valuation calculation is being, on the one hand, expense oriented, which we’ve adapted to over time as it’s become more expensive to service the average loan and that would detract from the cash flow that you’re present valuing over time, that’s been important. And then in this environment where we’re relatively out of the money for the average refi of our customer, things are slowing down, cash flows are extending out, and it’s creating more value.
So those things are model driven, we understand the inputs, easy enough to manage. If we get into a more volatile rate environment where we have a little bit more of a dynamic hedging approach, that could get a little bit more exciting but for some period of time and now I wouldn’t describe this as terribly volatile and it’s had a very nice profile throughout.
Betsy Graseck - Morgan Stanley
Could you speak a little bit to longer term strategies for the MSR in that rising rate environment? I think Wells Fargo had mentioned in the past some of the options that might be in front of you.
John Shrewsberry
Well, that discussion originated when this idea that a certain type of intangible asset would be a bad capital asset, was a hotter topic. And frankly when MSR was being created at a faster pace, and so you could imagine that we might be limited in terms of how much we could own without having an adverse capital impact. And that discussion really isn’t today's issue. So in that context, we’ve talked about selling pieces of the MSR and we actually had entered into an agreement to sell a piece of it and that may come to fruition. There are other strategies that you can imagine using third-party servicers, or thinking about the economics differently about the MSR that that we would probably spend more time focusing on, if we thought that we were going to put ourselves or find ourselves in a bad capital outcome. And we explore each of those a little bit with other servicers to see what’s economic but it’s not the first order issue for Wells Fargo today.
Betsy Graseck - Morgan Stanley
Got it. Okay, great. Well, I wanted to turn the conversation towards mortgage, and maybe we could get into a little bit discussion around how you’re thinking about the purchase market here, because clearly the MBA has taken down its forecast for purchase market from plus 4% to minus 5% year on year for this year. How is Wells Fargo thinking about mortgage volumes in 2014?
John Shrewsberry
So I think we still subscribe to the $1 trillion to $1.1 trillion total market size for the year, it’s an estimate. We see the second quarter being stronger than the first, no surprise because of the seasonality. But we’ve said over the last couple of weeks that this purchase season doesn’t seem as robust as we might have imagined it, it’s a little bit slower. And so we will see whether that changes as we go into summer. But for one reason or another, that just doesn’t seem to be -- in spite of affordability and in spite of better employment and the little bits of green shoots that we see out there, it’s not showing up from our perspective strongly in the home purchase market as we might have expected.
Betsy Graseck - Morgan Stanley
And why do you think that is?
John Shrewsberry
It’s a great question. But people just are not buying homes at the pace – it could be that where economic situations are the rosiest, home price appreciation is less affordable in the New York area, in the Bay Area, in markets like that, people are getting priced out, that’s a possibility. It’s a regional set of explanations but it’s just not quite where we imagined that it would be.
Betsy Graseck - Morgan Stanley
And what about QM, has that impacted the pull-through rate of applications?
John Shrewsberry
Yeah, well, it is the binding constraint for people who would want to buy a home, who are at the lower end of qualification. They really do have to be able to demonstrate and verify that they can afford to make the payments and carry of the other costs of owning a home and it’s a relatively high bar in a good way. I mean it encourages responsible lending and it’s meant to discourage people from being in homes that they can’t afford to pay for. But that when we talk about making more credit available and programs that are designed to do that, at the end of the day they still have to qualify for the loan on a fully underwritten basis. And that’s the bar that has to be chinned. So at that end of the market, I would say that is a constraining factor. I am not sure if that makes a giant difference from 1 trillion to 1.1 trillion to 1.2 trillion or 3 trillion [ph] because those are -- that is at the margin, and those will be probably smaller balance loans in addition. But it’s a constraint.
Betsy Graseck - Morgan Stanley
And then what about Wells Fargo’s “opening of the credit box”? We've been hearing that you – that Wells Fargo is willing to go down a little bit more FICO [ph] over the past year or so. Is that an accurate statement?
John Shrewsberry
I’d say we've been willing to reduce some of our mortgage credit overlays on top of incremental conservativeness, on top of what are agency minimums in part because there is a little bit greater clarity that in terms of what originator responsibility is in those areas. So I think we're trying to help borrowers. But it’s not making it an enormous difference in terms of the size of the market, really is the marginal activity. Separately we've also done a few things in the nonconforming space, so in the, call it, prime jumbo loans that would end up on our balance sheets where we’ve provided a little bit more flexibility for our best customers and people who want a loan that’s non-conforming but that wouldn't end up with the agencies, but that would end up on our sheets. So that’s just flexibility for our high credit quality customers.
Betsy Graseck - Morgan Stanley
And then on the other side of the spectrum, could you give us a sense as to how -- your constraints for how low you would go on FICO for underwriting, obviously Fannie, Freddie, FHA have their grids, do you do the full grid or there is a certain cut off that you have for yourself of this stage?
John Shrewsberry
I don’t have a specific answer for you. There is different circumstances, different programs, different LTV, FHA versus the two agencies that all have a slightly different set of rules, and it’s not as simple as just having a number. I would say at the margin, credit is a little bit more available today but it is not driving a big difference in the outcomes for the size of the market.
Betsy Graseck - Morgan Stanley
Got it. And then on mortgage lastly for me and if you have a mortgage question, let me know and raise your hands. On recent commentary from Mel Watt on ways to potentially make it more clear on reps and warranties, how do you think about that discussion? I know Mike Heid at your conference indicated that there could be some interest there at the end.
John Shrewsberry
Yeah, I think it’s very encouraging. Mike Heid who is the head of Wells Fargo home mortgage spoke at our investor day a few weeks ago on this topic and it was clear that this notion of some sort of a sun set date after a borrower has made 24, 36 some number of payments is encouraging and he believes will cause originators to be a little bit more accommodating to borrowers. And it’s designed to fill that policy goal I think of making credit a little bit more available. So that’s a discussion that wasn’t on the table not that long ago. It is today and it is a step in a good direction. That’s our point of view.
Betsy Graseck - Morgan Stanley
Okay, great. Anybody in the audience have a question for John on mortgage –
John Shrewsberry
Not about your own mortgage.
Betsy Graseck - Morgan Stanley
Okay. Well let’s shift into loan growth. So you indicated just while we are on the mortgage topic, you indicated that you’ve been doing some things with non-QM for your best customers. Can you speak a little bit to how you think that is impacting your loan growth both in the first and second lien resi and then we can move on to others?
John Shrewsberry
So we have a great interest in extending credit and holding loans for our best customers in the non-conforming space. And that’s contributing to loan growth. You can see in the industry – in the HA data that on the consumer side of things, including mortgage, were in the just broad stroke below 5% growth rate engine and then C&I and commercial real estate above 5% growth rate engine, I think we’re probably representative of that, second lien mortgage still a very quite slow growth business and not surprisingly, credit card, we’ve got a big emphasis, we’ve rolled out a couple of new products to attract more of our affluent customers. I would expect that to grow from a relatively small base at a faster pace than the industry while we really focus on it, and adapt our program to be different and more attractive to customers.
Auto, we’ve had a great – we’re the largest auto lender in the U.S. We had a great first quarter in auto. I think we’re having a great quarter that’s continuing into the second quarter. And then in C&I, I think we look like the industry, we’ve got – we see loan growth – that’s both new loan growth as well as existing utilization – it’s the first order of business at Wells Fargo. I am happy to see what investors have to say about that, because nothing makes us happier than a rapid loan growth as well.
Betsy Graseck - Morgan Stanley
So just looking at consumer first and then shifting to the commercial side. On overall loan growth you’ve had for the whole portfolio 5% or so, you’re reporting lower because of the run off, right? So you’re reporting about 2.5% but your underlying new loan growth is about 5%. So could you just give us a sense as to how you see that run off portfolio trajecting from here? Is it the same kind of pace that –
John Shrewsberry
Same pace.
Betsy Graseck - Morgan Stanley
Okay. And so the duration on that.
John Shrewsberry
That’s 12-year average life, I mean it’s out there for a while. The pick a pay portfolio is a big piece of it. The legacy Wells Fargo home-equity portfolio is a piece of it, and those things will be out there for a good long time running off at a – not a constant pace but probably relatively predictable pace.
Betsy Graseck - Morgan Stanley
And so there has been some articles recently reminding people that there is a payment shock with the HELOC product and anybody who had had that product offering for the past 10 years or so, could you remind folks what kind of pace you have with that, I think it’s a little bit longer duration maybe to explain, how you’re dealing with that and what kind of performance you’re seeing?
John Shrewsberry
Sure. What we've been in communication with borrowers to remind them of the -- of what they’ve signed up for what's coming with specifics, and if it’s appropriate descriptions of things they might do to adapt to that when it comes, the profile of our entering into amortization phase is shifted out further than the average originator of those loans, we still have several years before it becomes a bigger issue. So what happens between now and then with rates, what happens between now and then with home price appreciation, what happens between now and then with employment will all vary greatly on what the actual experience is with that, when it happens, when it comes. We talk about it every day, it’s built very carefully into our allowance for credit loss analysis and my sense is that we have a very good handle on where we’re going with it. But like anything else the facts and circumstances will change between now and then. Hopefully lot of those folks will be refied out completely before that day even comes.
Betsy Graseck - Morgan Stanley
Rising home equity has been helpful with that. On the cards [ph] side, you indicated some of the new products – Propel – right, that you’ve offered a couple of different products there. You’ve been growing, I think the card growth portfolio – the card loans have been growing about 6%, 7-ish percent.
John Shrewsberry
Yes, it’s hard to – these products are so new that you wouldn’t account for them in recent growth. So a couple of quarters out, it will be a better measure of what their impact is. But as we described at investor day they are behaving in the early weeks and months in terms of the national rollout exactly as we had hoped and imagined.
Betsy Graseck - Morgan Stanley
So your card growth is, as you mentioned, well above the industry and with these products, it could accelerate?
John Shrewsberry
It should be, yes.
Betsy Graseck - Morgan Stanley
And then on C&I, maybe you could give us a sense as to what your corporate customers are using the C&I loans for, we had USB up here earlier, they were indicating that for a while the vast majority of the use was M&A related, but maybe we can hear from you as to what customers are using it for and recently there has been an acceleration in C&Is, you can see in the HA data so –
John Shrewsberry
So it will be the whole gamut in terms of utilization and C&I for us is a variety of different loans – or different customer categories. We are the largest lender in the middle market, so there is a broad swath of it there, these would be the $50 million to $500 million revenue companies, often it’s privately owned that may be executing on strategic initiatives but more likely it's another plan, it’s more equipment, it's more people, it's expanded operations in more of an organic sense.
We also have a big corporate lending business where it’s more Fortune 2000 in there, it certainly could include M&A but it could be as simple as changing the debt profile on that company's balance sheet. It’s not necessarily incremental growth but it would represent all forms of utilization. We’ve got a big asset based lending business. That would include our share of financing that’s done in connection with M&A where there is receivables or inventory on the books of the target, but also just ongoing working capital growth for a variety of retailers and others that hold lots of short-term liquid assets that need to leverage. So it’s a bundle of all of those things but the good news is growth is growth, that represents more economic activity, it represents a little bit of optimism or willingness to extend themselves on the part of those clients.
Betsy Graseck - Morgan Stanley
People have talked in the past about how when corporates begin to invest or accelerate their investment spend, so they will first draw down on deposits before drawing down on that line of credit. Could you give us a sense as to –
John Shrewsberry
That is a reasonable theory. But deposits are growing even still while loan growth is growing. So it could be that the average corporate or commercial customer is interested in maintaining a lot more liquidity and flexibility in the future and they will keep cash on deposit even while borrowing or drawing to execute their -- whatever their growth goals are but it hasn't been the case as you might imagine that it’s drained down on cash before ratchetting up incremental leverage.
Betsy Graseck - Morgan Stanley
It looks like this time is different in that regard?
John Shrewsberry
It’s too early to tell but every time is different.
Betsy Graseck - Morgan Stanley
Anything on loan growth that anybody wants to raise question in the audience –
Earnings Call Part 2:
