Wells Fargo & Co. (WFC) Q2 2013 Earnings Conference Call July 12, 2013 10:00 AM ET
Jim Rowe - Director, Investor Relations
Timothy J. Sloan - Senior EVP, CFO
John G. Stumpf - Chairman, President and CEO
John McDonald - Sanford Bernstein
Erika Penala - Bank of America Merrill Lynch
Matt O'Connor - Deutsche Bank
R. Scott Siefers - Sandler O'Neill
Ken Usdin - Jefferies & Company
Paul Miller - FBR Capital Markets
Joe Morford - RBC Capital Markets
Michael Mayo - CLSA
Nancy Bush - NAB Research
Andrew Marquardt - Evercore Partners
Betsy Graseck - Morgan Stanley
Chris Mutascio - Keefe, Bruyette & Woods
Chris Kotowski - Oppenheimer
Good morning. My name is Regina, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the Wells Fargo Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)
I’d now like to turn the call over to Jim Rowe, Director of Investor Relations. Mr. Rowe, you may begin your conference.
Thank you, Regina. Good morning, everyone. Thank you for joining our call today during which our Chairman and CEO, John Stumpf; and CFO, Tim Sloan will discuss second quarter results and answer your questions.
Before we get started, I’d like to remind you that our second quarter earnings release and quarterly supplement are available on our website at wellsfargo.com. I’d also like to caution you that we may make forward-looking statements during today’s call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings including the Form 8-K filed today containing our earnings release and quarterly supplement.
Information about any non-GAAP financial measures referenced, including the reconciliation of those measures to GAAP measures, can also be found in our SEC filings, in the earnings release, and in the quarterly supplement available on our website.
I’ll now turn the call over to our Chairman and CEO, John Stumpf.
John G. Stumpf
Thank you, Jim. Thanks to everyone for joining us today. Wells Fargo had a terrific quarter and has now generated 14 consecutive quarters of earnings per share growth, with record earnings in the second quarter. This consistent strong performance during our dynamic economic and interest rate environment again demonstrates the benefit of our diversified business model.
We are not dependent on any one business to generate growth. We have over 90 businesses that are all focused on just one thing, meeting our customer’s financial needs. Our results this quarter demonstrate the momentum we have throughout for all of our businesses.
Our strong performance is broad based compared to a year-ago we earned a record $5.5 billion, up 19% and grew earnings per share of 20%. We grew pre-tax pre-provision profit by 3%. We reduced our expenses and improved our efficiency ratio by 90 basis points to 57.3%. Our core loan portfolio grew by $42.3 billion, up 6%. Our credit performance was outstanding, benefiting from our conservative underwriting in improving economic conditions, especially of housing with net charge-offs down to 58 basis points and our total net charge-off down 48% from just a year-ago.
Our strong deposit franchise, which becomes even more valuable in a rising great environment continue to grow, with total deposits up 10% from a year-ago, while we reduced total deposit cost by 5 basis points to 14 basis points.
We achieved record retail cross-sell of 6.14 products per household. Wholesale Banking grew their cross-sell to 6.9 products and Wealth Brokerage Retirement cross-sell increased to over 10 products – 10.35 to be exact. We grew return on assets by 14 basis points to 1.55% and return on equity increased by 116 basis points to 14.02%.
Our capital levels continue to grow with our estimated Tier 1 common equity ratio under Basel III increasing to 8.54% and based on our initial review of the leverage ratio proposed – proposal issued this week; we believe our current leverage levels would exceed the well capitalized requirements at both the bank and the holding company.
Our strong earnings growth has enabled us to grow our capital levels, while returning more capital to our shareholders. In the second quarter, we increased our dividends to $0.30 a share, up 36% from a year-ago and we continue to buyback stock.
Before turning the call over to Tim, let me conclude with some comments about my views on how the current economic and rate environment impacts Wells Fargo. We continue to be optimistic about the improvements we’re seeing throughout the economy. While commercial loan demand is still modest, jobs are been created, consumer confidence is increasing and the housing market continue to demonstrate strong momentum.
In fact, in the second quarter, the housing market improvement was stronger and more broad-based than it has been since before 2008. Sales were up and residential property prices increased in by 13% across the country. Yet, affordability still remains attractive, even with the increased prices and higher interest rates. The strength in the housing market was a positive catalyst to our results in the second quarter in a number of ways including higher originations performed purchases, lower environmental costs, reduced repurchase reserves and improved credit quality.
Assuming the housing market state remains strong, and we currently believe it will, our overall results will continue to reflect these benefits. While the economy continues it’s slow, but steady improvement, the current rate environment is obviously very different than it was just 90 days ago when we last announced our earnings.
We knew rates would eventually rise as we’ve been planning for a rising rate environment for sometime. The benefit of our diversified business models is that it provides opportunities to generate earnings growth over a variety of rate environment. Some of our businesses can actually do better in a lower rate environment and others benefit from the rising rates.
Tim will highlight the growth we’ve achieved across a number of our businesses on our call today. We do not manage Wells Fargo based on a specific rate environment. We manage Wells Fargo as we have for decades to satisfy our customer’s financial needs. Rates rising for the right reason and improving economy is beneficial for our customers, which then in turn benefits Wells Fargo.
Tim will now provide more details on our second quarter results. Tim?
Timothy J. Sloan
Thanks, John, and good morning, everyone. My comments would follow the presentation included in the first half of our quarterly supplement starting on Page 2. John and I will then take your questions.
As John mentioned, Wells Fargo had another outstanding quarter with record earnings of $5.5 billion, up 19% from a year-ago and up 7% from the first quarter. Earnings per share grew to $0.98, up 20% from last year and up 7% from the first quarter. We’ve now achieved 14 consecutive quarters of EPS and nine consecutive quarters of record earnings per share.
As John just mentioned, the rate environment this quarter was very different from last quarter. In fact, the economic housing rate environment has differed significantly over the past 14 quarters of our earnings growth. While the drivers of our growth have varied, our consistent risk discipline and diversified business model have remained the same.
Our results this quarter compared to the first quarter, clearly show the advantage of our diversity with our bottom line results benefiting from strong broad based trends including net interest income growth as we drew loans and invested in securities, fee growth across a variety of our businesses, reduced expenses generating positive operating leverage and improved credit and capital levels.
As you can see on page 3, our year-over-year results were also strong with growth in pre-tax, pre-provision profit, net income, EPS, both total and core loans, core deposits, ROA and ROE.
Our revenue diversification is highlighted on slide 4. A 50-50 split between spread revenue and fee revenue from our diversified businesses and cross-sell activities. Trust and investment fees were once again our largest fee category and it has been for the past five quarters. We achieved positive momentum across many of our businesses which I'll highlight throughout the call.
Let me start by highlighting some of the key drivers of our second quarter results from the balance sheet and income statement perspective. On page 5, you can see we had good balance sheet growth this quarter growing loans, deposits and securities. I'll provide more detail on the securities we purchased later on the call. The decline in our provision expense this quarter reflected improvement in home prices and our overall credit performance.
Turning to the income statement on page 6, mortgage revenue was stable in the quarter and revenue growth was driven by stronger trust and investment fees and higher net interest income. Our expenses declined as we expected primarily reflecting seasonally lower employee benefit costs.
Let me now cover our business drivers in more detail. As shown on page 7, we continued to have solid loan growth with period end loans up $26.8 billion or 3% from the year ago and up $2 billion from the first quarter. Loans grew even after the continued run off of our liquidating portfolio. This portfolio has declined by over 50% since 2008 and the headwind to overall loan growth caused by this run-off has continued to slow.
In the second quarter, the liquidating portfolio declined $15.5 billion from a year ago and $3.2 billion from the first quarter. Excluding these liquidating loans, our core loan portfolio grew by $42.3 billion or 6% from a year ago and was up $5.2 billion from the first quarter.
Commercial loans grew $1.8 billion in the quarter with board-based growth in C&I and foreign loans. Consumer loans grew $250 million with growth in nonconforming first mortgage loans, auto and credit card, partially offset by the expected run-off from liquidating and core home equity portfolios.
Deposit growth remained strong with period end deposits up $10.9 billion from the first quarter. Average deposits were up $23.6 billion from the first quarter and up $85.8 billion or 9% from the year ago. Average core checking and savings deposits were up 8% from a year ago. We grew our primary consumer checking customers by a net 3.5% from a year ago, up 2.1% from last quarter. These are active checking account customers who transact with Wells Fargo regularly.
The growth we've achieved with these relationship-based customers demonstrate the strength of our deposit franchise and should generate future growth as we focus on remaining their primary bank and meeting more of their financial needs. We continued to lower our deposit costs with average deposit costs of 14 basis points in the second quarter, down 1 basis point from the first quarter and down 5 basis points from the year ago. We've successfully grown deposits while reducing our deposit costs for 10 consecutive quarters.
As shown on page 9, we grew tax-equivalent net interest income by 3% from the first quarter. The growth in NII was driven by securities purchases, lower funding costs, loan growth, higher variable income as well as the benefit from an extra day in the quarter. Average earning assets grew $31.1 billion from the first quarter, reflecting increases in short-term investments, loans and AFS securities. We purchased $21 billion of AFS securities during the second quarter, primarily agency MBS, and we purchased an additional $6 billion of securities in the first two weeks of the third quarter.
We remained disciplined during periods of lower rates and we were prepared to deploy liquidity as rates rose. We benefitted from this disciplined approach in the second quarter by investing in higher yield and securities. While higher rates driven by an improving economy will be positive to our results over the long term, including higher yielding earning asset growth and improving credit quality, there are also some short-term effects such as lower mortgage refi volume and reduced OCI that I'll highlight throughout the call.
Higher rates impact our businesses in different ways and in different times, which reinforces the benefit of our diversified model. Our net interest margin declined by 2 basis points from the first quarter to 3.46%. This decline was driven by three primary factors. First, our continued deposit growth caused cash and short-term investments to increase reducing the margin by 6 basis points.
As I've highlighted in the past our deposit growth has little impact on net interest income but it is dilutive to the net interest margin. Offsetting this decline by 2 basis points was higher variable income including higher PCI loan resolutions and periodic dividends. This variable income is obviously lumpy and can increase or decrease in any quarter.
Finally, the net impact of re-pricing and balance sheet growth improved the margin by 2 basis points largely due to the benefit of the growth in the AFS portfolio and reduced funding costs. While margin was relatively stable this quarter, it is still reasonable to expect continued net interest margin pressure.
Despite a decline in total fee income in the quarter, many of our businesses demonstrated strong momentum including deposit service charges up $34 million from the first quarter benefitting from seasonality and account growth. Trust and investment fees up $292 million on strong investment banking fees and higher retail brokerage asset based fees. Card fees grew 75 million on credit and debit card account growth and higher purchase volume. Commercial real estate brokerage commissions grew $28 million with strong activity for both private and public deals.
Overall, noninterest income was down slightly from the first quarter on lower gains from deferred compensation plan investment income which is P&L neutral, weaker customer accommodation trading and lower fees including the lower gain on the sale of the PCI loans.
Our mortgage business continued to generate strong results in the second quarter with revenue up modestly from the first quarter as highlighted on page 11. Mortgage originations were $112 billion, our seventh consecutive quarter of more than a $100 billion in originations reflecting the benefit of the housing market improvement and low interest rates. As rates rose late in the quarter, applications for home purchases remained strong but refi application volumes declined as expected.
We still had a relatively large unclosed pipeline at the end of the quarter but refi volume is obviously very sensitive to rates. Refis were 56% of originations in the second quarter, down from 69% in the first quarter. We managed through many refi cycles in the past and we will adjust the size of our business based on production volumes through this cycle. Gain on sales margins declined to 2.21% and with the increase in mortgage rates, we would expect further declines in our margins and originations.
Expenses declined from seasonally high first quarter levels as shown on page 12. This decline was driven by a 4% reduction in personnel expenses reflecting lower employee benefit expenses due to the first quarter seasonally high payroll taxes and 401(k) matching. These declines were partially offset by higher salaries reflecting annual merit increases and higher revenue-based incentive compensation expense from strong results in capital markets, WBR and mortgage.
We also had increases in other expense categories primarily driven by our continued investment in our business to drive future growth, including project spending for product improvement and system enhancements, higher advertising and promotion expense driven by seasonality and a new campaign launched in the second quarter.
Operating losses increased $131 million in the second quarter, primarily from litigation accruals related to various legal matters and we also experienced increased costs associated with regulatory and compliance requirements. Our focus on reducing expenses while investing in our businesses to generate revenue growth is reflected in our efficiency ratio declining to 57.3% in the second quarter. We expect our efficiency ratio to remain within our target range of 55% to 59%.
As John mentioned at the start of the call, the recovery in the housing market is driving significant improvement in a number of areas, including some of our environmentally elevated costs. As highlighted on page 13, in the second quarter, most of these costs were significantly below what they had been over the past few years.
We got a nominal amount of cost associated with the independent foreclosure review this quarter of customer call volumes following the distribution of remediation checks. The improvement in real estate values helped to reduce foreclosed asset expenses by $49 million compared to the first quarter and by $143 million from a year ago. Mortgage revenue this quarter was reduced by $25 million for additions to our repurchase reserve not related to card originations which is the lowest build we’ve had since prior to 2008.
Outstanding and purchase demands were relatively stable compared with the first quarter and new demands emerged consistent with our expectations. However not all elevated costs are behind us. Mortgage revenue is reduced by $82 million to reflect higher servicing and foreclosure costs as foreclosure timelines continue to extend especially in judicial foreclosure states.
Turning to our segment results starting at page 14, community banking earned $3.2 billion in the second quarter up 28% from a year ago and up 11% from the first quarter. Retail banking achieved a record cross-sell of 6.14 products per household up from 6 products a year ago. To support sales and household growth we grew platform bank or FTE by approximately 1,900 from a year ago.
Our credit card business continued to have strong account growth with the record 594,000 new accounts in the second quarter, up 16% from a year ago. Our household penetration increased to 35%, up from 31% a year ago. Credit card balances were up 3% from the first quarter and up 9% from a year ago due to strong transaction volumes and account growth.
We also had momentum in our auto business with record originations in the second quarter of $7.1 billion up 4% from the first quarter and up 9% from a year ago. Our continued focus on serving our small business customers generated a 2.7% growth in business checking accounts from a year ago and we extended $9.3 billion of new loan commitments to small business customers during the first half of the year up 25% from a year ago.
Wholesale banking earned $2 billion in the second quarter up 7% from a year ago and down $41 million from the first quarter. Wholesale banking generated record revenue of $6.1 billion. Investment banking fee growth was strong driven by higher equity underwriting, credit originations and loan syndication fees. Investment banking results included a 34% increase in the year-to-date revenue from commercial and corporate customers. This relationship focus also benefited treasury management as revenue grew 12% from a year ago benefiting from better penetration of our existing customers.
Wholesale banking’s cross-sell reached 6.9 products per relationship up from 6.8 a year ago. Wholesale banking results continue to benefit from steady loan growth with loans having grown for a 11 consecutive quarters. The average loans increased 6% from a year ago with growth nearly all portfolios including asset back finance, capital finance, commercial banking, commercial real estate, corporate banking and government and institutional banking. Credit quality remained strong with net recoveries in the second quarter reflecting the improvement in our economy and our risk in underwriting discipline.
Wealth, Brokerage and Retirement earned a record $434 million, up 27% from a year ago and up 29% from the first quarter reflecting the success of our core business strategy of growing asset based relationships and the benefit from the improvement in the markets. Revenue grew 10% from a year ago reflecting strong growth in asset based fees and higher brokerage transaction revenue.
Retail, brokerage, managed account assets reached the record $331 billion, up 19% from a year ago driven by strong net flows and market performance. WBR had strong loan growth with average loans up 4% from the first quarter driven by non-conforming mortgages. WBR continued to effectively partner with retail banking to meet the financial needs of our customers, increasing cross-sell to 10.3 products per household. Assets referred from community banking to WBR grew over 25% from a year ago based on first quarter results. This partnership is a great example of how our businesses work together to meet the financial needs of our customers.
Turning to credit quality on Page 17, we had continued improvement across our commercial and consumer portfolios. Second quarter net charge-offs declined to 58 basis points of average loans. Losses in our commercial portfolio were only $44 million or 5 basis points of average loans. Consumer losses declined to 101 basis points. We had especially strong improvement in our commercial and residential real estate portfolios. These portfolios are now providing a tailwind for our credit performance compared to the headwind they provided when the real estate market was weaker.
Reflecting these improvements our provision expense declined $567 million from the first quarter and included $500 million in reserve releases, compared with the release of $200 million in the first quarter and $400 million from a year ago. We continue to expect further reserve releases absent a significant deterioration in the economic environment and while we don’t know what our release will be in the third quarter the favorable condition to grow this release for this quarter have not dissipated.
The recovery in the housing market also benefited our expected losses in the PCI portfolio. This quarter the accretable yield balance increased by a net $2.1 billion which included $1.6 billion increase in expected cash flows and $876 million reclassification primarily from our pick-pay portfolio. This re-class did not impact second quarter results but will be accreted into income over the remaining life of these loans.
In addition to lower charge-offs and provision expense non-performing asset also improved with MPAs down $1.8 million from the first quarter and down $3.8 billion or 15% from a year ago. Loans 90 days or more passed due decreased $206 million from the first quarter and were down 15% from a year ago with improvement in both commercial and consumer loans. Early stage consumer loan delinquency balances and rates also declined from the first quarter and from a year ago.
Earnings are the primary driver of capital growth for Wells Fargo. As shown on Page 19, our Tier 1 common equity ratio included 10.73%, up 34 basis points from last quarter. Our estimated Tier 1 common equity ratio under Basel 3 which reflects our interpretation over Basel 3 capital rules adopted July 2, increased to 8.54% in the second quarter. OCI negatively impacted the ratio by 24 basis points in the quarter due to the increase in interest rates. Because of our strong earnings growth we grew capital even with the impact on the increasing rates. We expect reductions to unrealized securities gains when rates rise and this is one reason why as we discussed over a year-ago we're targeting a capital buffer of approximately 100 basis points.
And just this week, as John mentioned the U.S. regulatory agencies issued a supplemental leverage ratio of proposal. Based on our initial review we believe our current levels -- leverage levels would exceed the well capitalized requirements at both the bank and holding company. We increased our second quarter dividend to $0.30 per share a 20% increase over the first quarter dividend and purchased 26.7 million shares in the second quarter and executed a $500 million forward contract that is expected to settle in the third quarter for approximately 13 million shares.
Including the shares under the forward contract, our share count would have been relatively flat for the quarter offsetting 40 million shares issued during the quarter primarily related to profit sharing and match contributions to 401(K) plans and team members exercising option. With many opportunities to generate growth at Wells Fargo on Slide 20 we summarized the demonstrative momentum we have throughout our businesses that I’ve highlighted on the call. In each of our businesses we have opportunities for growth reflecting the expanding needs of our customers. This customer account and balance growth along with increased cross-sell with help drive our future results and reflects the benefits of our diversified model.
In summary we had a very good quarter with strong broad based improvement and demonstrative momentum across many of our businesses. This included growth in loans, deposits, net interest income and fee growth across many of our businesses. We reduced expenses and benefited from a continued improvement in credit quality that reflected our conservative underwriting and the strengthening economy especially the rebound in housing. Our ROA and ROE continue to grow and we grew capital levels while returning more capital to shareholders.
We will now open up the call for your questions.
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