Start Time: 10:00
End Time: 11:21
Wells Fargo & Co. (WFC)
Q3 2013 Earnings Conference Call
October 11, 2013, 10:00 AM ET
Jim Rowe - Director, Investor Relations
John G. Stumpf - Chairman, President and CEO
Timothy J. Sloan - Senior EVP, CFO
Erika Najarian - Bank of America Merrill Lynch
John McDonald - Sanford Bernstein
Joe Morford - RBC Capital Markets
Betsy Graseck - Morgan Stanley
Matt O'Connor - Deutsche Bank
Marty Mosby - Guggenheim
Mike Mayo - CLSA
R. Scott Siefers - Sandler O'Neill
Ken Usdin - Jefferies & Company
Good morning. My name is Brent, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Wells Fargo Third 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 would now like to turn the call over to Jim Rowe, Director of Investor Relations. Mr. Rowe, you may begin your conference.
Thank you, Brent. Good morning, everyone. Thank you for joining our call today during which our Chairman and CEO, John Stumpf; and our CFO, Tim Sloan will discuss third quarter results and answer your questions.
Before we get started, I would like to remind you that our third 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 our call over to Chairman and CEO, John Stumpf.
John G. Stumpf
Thank you, Jim. Thanks everyone for joining us today. Wells Fargo continued to demonstrate the benefit of our diversified business model generating record earnings in the third quarter and achieving our 15th consecutive quarter of earnings per share growth. While the drivers of our earnings growth over this period have differed, reflecting the changing economic and interest rate environment, our focus on meeting our customers' financial needs has remained the same.
There are currently some new economic challenges with the U.S. government shutdown and a possibility of the government defaulting on its debt, but prior to these recent events the economy had continued its pace of moderate growth with gains in consumer spending, business investment and employment. While the recovery remains uneven, there are many positive signs including increased small business optimism and a dramatic improvement in household net worth, with household leverage now lower than any time since 2002 which provides capacity for consumer spending and borrowing going forward.
The housing market also continues to demonstrate strong momentum. While as expected higher rates reduced mortgage refinancing activity this quarter, home price appreciation remains strong and affordability remains excellent. This improvement has benefited our customers and contributed to our overall credit performance. Let me take a moment to comment on the current situation in Washington and how we think about the implications for Wells Fargo.
A prolonged government shutdown and potential debt ceiling breach is unnecessary and troublesome that will likely create new needs for our customers and their families. I have asked our business leaders to identify ways we can help our customers directly affected by the shutdown. Whether its furlough, government workers or our customer distressed by agency closures and we stand ready to assist our customers during this period.
More importantly for our country I feel it is important for our leaders in Washington to set aside partisan differences, break the logjam and find workable solutions that are in the best interest of our nation and our economy. I'm encouraged by the news coming all over the nation's capital yesterday. We've managed through changing environments in the past and our experience and vision will guide us through this period of transition as well.
Our results this quarter reflected the dynamic environment we are in and the benefit of our diversity. Let me share some highlights. Our record earnings of $5.6 billion and record earnings per share of $0.99 were up 13% from a year ago. Our core loan portfolio grew by $44.2 billion, up 6%. This strong performance was broad based with growth in our commercial and consumer portfolios reflecting organic growth and the acquisition of two commercial real estate portfolios.
Our credit performance was exceptional as we continue to benefit from our conservative underwriting and improving economic conditions especially in housing with the net charge-offs down to 48 basis points annualized and our total net charge-off dollars down 59% from a year ago. Our outstanding deposit franchise continued to generate strong deposit growth with average deposits up $79.1 billion from the year ago while reduced deposit costs by 6 basis points to just 12 basis points for the entire portfolio.
We deepened relationships across our company achieving record retail banking cross-sell of 6.15 products per household. Wholesale Banking grew their cross-sell to 7 products and Wealth Brokerage Retirement cross-sell increased to 10.41 products. We had very strong returns, growing return assets by 8 basis points to 1.53% and return on equity increased by 69 basis points to 14.07%.
Our capital levels continued to grow and our estimated Tier 1 common equity under Basel III increased to 9.54% surpassing our stated 9% target. We look forward to the upcoming CCAR process where we expect to request a higher dividend and an increase to our share repurchases.
Tim will now provide more details on our third quarter results. Tim?
Timothy J. Sloan
Thanks, John. Good morning, everyone. My comments will follow the presentation included in the quarterly supplement starting on Page 2. John and I will then take your questions.
Our financial results this quarter demonstrated the benefit of our diversity and our risk discipline as we continue to produce strong results. Wells Fargo earned a record $5.6 billion and grew earnings per share to $0.99 both up 13% from a year ago. We've now achieved 15 consecutive quarters of earnings per share growth and 10 consecutive quarters of record EPS.
As John highlighted and as you can see on Page 3, our year-over-year results reflected loan growth that was well diversified as well as strong deposit growth. Lower mortgage banking revenue resulted in the decline in pre-tax pre-provision profit compared with the year ago. The higher rate environment which has reduced mortgage refinancing volume has resulted in a transitional period for our mortgage business.
We had expected and planned for lower mortgage volumes and have managed through these periods in the past. I'll provide more detail on mortgage trends later in the call. However, we're still able to grow earnings and increase returns driven by strong net interest income, fee growth across many of our businesses and significantly improve credit.
Our revenue diversification is highlighted on Page 4. Different businesses naturally contribute more or less to our revenue depending upon the economic and interest rate environment but our revenue remained almost evenly split between net interest and non-interest income and our sources of fee income were very well diversified. This is a benefit of our business model. We don't rely on any one business to generate growth.
Let me start by highlighting some of the key drivers of our third quarter results from a balance sheet and income statement perspective, starting on Page 5. Our balance sheet has never been stronger. We increased earning assets by growing loans and purchasing securities. We continue to strengthen our capital levels even as we return more capital to our shareholders.
Let me take a moment to highlight our improved liquidity position. While we believe our liquidity position was already strong, with heightened regulatory expectations we've been adding to our position over the past few months. We increased long-term debt and term deposits at very low rates and most of the proceeds went into cash and short-term investments. While building our liquidity puts some pressure on our net interest margin, it did not impact our bottom line.
Turning to the income statement on Page 6. Net interest income remains strong driven by a $23.3 billion increase in average earning assets. Mortgage revenue declined as expected but we had growth in other fee categories. Our expenses declined driven by lower personnel expense and lower operating losses.
Our effective tax rate in the third quarter was 31.9%. During the quarter we finalized settlements with tax authorities regarding prior period tax issues primarily associated with certain cross border transactions. Primarily due to these settlements we recorded a net reduction in our reserve for uncertain tax positions which resulted in a tax benefit in the third quarter of $166 million.
Let me now cover our business drivers in more detail. As shown on Page 7, we continue to have strong loan growth with period-end loans up $29.7 billion or 4% from a year ago and up $10.3 billion from the second quarter. Excluding our liquidating portfolio, our core portfolio grew by $44.2 billion or 6% from a year ago and was up $13.8 billion from the second quarter.
Commercial loans grew $8.5 billion in the quarter with broad based organic growth and $5.2 billion from acquisitions. Consumer loans grew $1.8 billion with growth in nonconforming first mortgage loans, auto, credit card and private student lending partially offset by the expected run-off from the liquidating portfolio and core home equity loans.
Even during a period with tepid industry loan growth, we've been able to grow our loans on a year-over-year basis for nine consecutive quarters and for the past six quarters, year-over-year growth has been at least 3% despite run-off from our liquidating portfolio. Our growth is a result of remaining committed to meeting the financing needs of our customers and benefiting from opportunities to grow through acquisitions.
On Slide 8 we highlight the drivers of our loan growth from a year ago. Real estate one through four family first mortgage loans grew $14.4 billion or 6% even with the run-off from our liquidating portfolio and included growth in high quality nonconforming mortgages and the retention of conforming mortgages.
C&I loans were up $13.5 billion or 8%. We have broad based growth in asset backed finance, government banking, corporate banking and commercial banking. Foreign loans grew $6.9 billion or 17% which included $4 billion from the U.K. CRE acquisition we completed in the quarter as well as trade finance growth.
Auto loans were up $3.6 billion or 8% reflecting continued strong originations. Credit card balances were up $1.8 billion or 7% with strong new account growth reflecting increased card penetration as well as marketing efforts.
Deposit growth remained strong with average deposits up $15.8 billion in the second quarter and up $79.1 billion or 8% from a year ago. We grew our primary consumer checking customers by a net 3.9% from a year ago, up from 3.5% last quarter. The growth in these relationship-based customers should benefit our future results as we remain focused on meeting more of our customers' needs.
We continue to reduce deposit costs which were down 6 basis points from a year ago and 2 basis points from the second quarter. We've successfully grown deposits while reducing our deposit costs for 10 consecutive quarters with average deposit costs declining to 12 basis points in the third quarter. Our strong deposit performance over an extended period of time is a fundamental strength of our franchise.
As shown on Page 10, tax-equivalent net interest income remained strong. Our ability to grow net interest income over the past year while the net interest margin has declined 28 basis points reflected the benefit of our loan growth and our disciplined approach to investing. Net interest income was essentially unchanged from the second quarter benefiting from one additional day in the quarter, higher securities balances, loan growth and lower funding costs. These benefits were offset by an expected decline in mortgages held for sale and lower variable income.
Average earning assets grew $23.3 billion from the second quarter reflecting increases in short-term investments, AFS securities and loans. We purchased $19.8 billion of AFS securities primarily in the form of agency MBS during the third quarter prior to the decline in rates late in the quarter. While our net interest income remains stable, our net interest margin declined by 8 basis points from the second quarter to 3.38%. This decline was driven by four primary factors.
First, our continued deposit growth which has little impact on net interest income but is dilutive to the NIM reduced the margin by 3 basis points. The liquidity-related actions that we took in the quarter reduced the margin by 3 basis points also. The net impact of balance sheet repricing and growth reduced the margin by 1 basis point. And then finally, variable income which includes PCI loan resolutions and periodic dividends was lower this quarter and reduced the margin by 1 basis point. We currently expect continued net interest margin pressure.
Non-interest income was down $898 million in the second quarter, driven primarily by lower mortgage refinanced volume and reduced gain on sale margins which I'll highlight shortly. Because of the reduction in mortgage revenue and the impact from seasonality on a linked quarter basis can make it difficult to demonstrate the underlying momentum we have in many of our businesses. It's helpful to look at our year-over-year trends excluding mortgage.
On Page 11 we show noninterest income excluding mortgage banking and you can see that we grew 5% compared with the year ago. Let me highlight some of the momentum we have across a number of our businesses. Deposit service charges were up $68 million from a year ago benefiting from strong account growth. Trust and investment fees were up $322 million with strong growth in brokerage, asset base fees and investment banking.
Card fees were up $69 million benefiting from strong account growth and increased usage in both our credit and debit card business. Commercial real estate brokerage commissions grew $35 million from strong private and public market activity. Equity gains were up $338 million reflecting gains from several transitions in the quarter. Equity gains are naturally volatile on a quarterly basis but on a year-to-date basis, gains are only up $48 million compared with 2012.
We're in a transitional period in our mortgage business. As expected with the increase in mortgage rates, our mortgage origination volume declined this quarter, particularly refinance activity as highlighted on Page 12. We've managed through many refi cycles in the past. We remain committed to the mortgage business which is an important product for our customers and benefits from our cross sell focus.
We originated $80 billion of mortgages in the third quarter and with the rise in rates, refi volume declined to 41% of originations down from 56% in the second quarter and down from 71% in the first quarter of 2012. Purchase volume remained relatively strong in the third quarter, down 4% from the second quarter benefiting from the continued strong housing market.
Our unclosed pipeline declined to $35 billion at the end of the quarter reflecting lower application volume and shorter processing times to close mortgage loans as capacities increased. If rates remain where they are today we would expect lower origination volume in the fourth quarter reflecting lower refi volume and normal fourth quarter seasonality in the purchase market.
Our gain on sale margin declined from the historically high levels we experienced for the past year to 1.42%. As rates seemed to have stabilized and competition has remained rational, we currently expect the margin to remain relatively steady in the fourth quarter. Reflecting lower origination volume, we had lower incentive compensation expenses related to mortgage production in the quarter.
We announced reductions of 5,300 mortgage FTEs in the third quarter which increased our severance costs. Most of the expense reduction from the lower FTEs was not reflected in our expense numbers for the third quarter because of the notice period we provided to our team members. But you should begin to see reduction expenses more significantly during the fourth quarter and we will continue to manage our capacity based on demand.
While higher mortgage rates reduced our mortgage refi volume, they benefit our servicing business. Our servicing revenue was up $111 million from the second quarter benefiting from a slowdown in the economic amortization of mortgage servicing rates. As we announced last week, we've reached an agreement with Freddie Mac that resolves substantially all repurchase liabilities for loans sold prior to 2009.
The cost of this agreement was fully approved for in prior periods. As a result our outstanding repurchase demands were down 25% from the second quarter and for the first time in over five years, we did not add to our repurchase reserves in the third quarter other than reserves established for current period loan sales.
Expenses declined $153 million in the second quarter as shown on Page 13. Salary expense was up $142 million which included $63 million in mortgage-related severance expense. Incentive compensation expense was down $225 million driven by lower mortgage revenue and lower capital markets and retail brokerage activity. Expenses also reflected lower operating losses, down $93 million primarily from lower litigation accruals.
The environmentally elevated costs primarily related to our residential mortgage business that we've highlighted over the last few quarters have been significantly reduced. However, over time we do expect to recognize additional benefits from a continued improvement in the housing market including additional reductions to these costs. We had higher expenses related to the regulatory environment and our compliance activities.
We've had a long history of strong risk management practices and in response to the heightened regulatory environment, our expenses increased by approximately $200 million annually. Our efficiency ratio rose to 59.1% in the quarter reflecting the immediate impact of the reduction in mortgage origination volume. We expect our efficiency ratio to improve in the fourth quarter and we continue to target an efficiency ratio between 55% and 59%.
Turning to our business segments starting on Page 14, Community Banking earned $3.3 billion in the third quarter, up 3% from the second quarter and up 22% from a year ago. Retail Banking continued to consistently grow cross sell achieving a record of 6.15 products per household, up from 6.04 a year ago. We continued to benefit from momentum in the credit card business by growing accounts, purchase volumes and balances. We had record new accounts, up 9% from a year ago and household penetration increased to 36%, up from 32% a year ago and 28% just two years ago as we continued to increase marketing and enhance our product line.
The 14% increase in purchase volume from a year ago reflects this account growth and an increase in active accounts. Credit card balances were up 3% from the second quarter and up 7% from a year ago. We also had strong loan growth in our auto business with balances up 2% from the second quarter and up 8% from a year ago. Originations were down 3% from the second quarter due to seasonality but up 9% from a year ago.
By remaining focused on serving the needs of all our small business customers, we were once again America's #1 small business lender in dollars for the 11th consecutive year. We extended $14.2 billion of new loan commitments to small business customers during the first nine months of 2013, up 24% from a year ago.
Wholesale Banking earned $2 billion in the second quarter, down 2% from the second quarter with lower sales and trading, investment banking and seasonally lower crop insurance fees. Earnings were down 1% from a year ago as lower sales and trading income offset growth in other commercial businesses and strong loan and deposit growth. While revenue was down from a year ago, we had strong momentum across a number of our commercial businesses including a 10% increase in treasury management revenue. This growth was driven by strong sales growth including continued penetration of existing customers as well as new customer growth and pricing increases.
In addition, commercial card treasury management spend volume increased 22% compared with the year ago. Wholesale Banking also benefited from growth in assets under management with AUM up 6% from a year ago driven by strong net inflows and market performance. Wholesale Banking's cross sell grew to 7 products per relationship, up from 6.7 a year ago.
Wholesale Banking results continued to benefit from consistent loan growth with loans having grown for 12 consecutive quarters. The average loans grew 5% compared with the year ago and was broad based with growth coming from nearly all our portfolios including asset backed finance, capital finance, commercial banking, commercial real estate, corporate banking, equipment finance and government and institutional banking. As I mentioned earlier loan growth also benefited from U.K. and U.S. commercial real estate acquisitions.
Wealth, Brokerage and Retirement earned $450 million in the third quarter, up 4% from the second quarter driven by higher net interest income and improved credit quality, partially offset by seasonally lower brokerage transaction revenues. Earnings were up 33% from a year ago driven by strong growth in asset based fees, higher net interest income and improved credit quality.
Revenue grew 9% from a year ago reflecting strong growth in asset based fees and higher net interest income. Retail brokerage managed account assets grew to a record $350 billion, up 18% from a year ago driven by strong market performance and net flows.
WBR has strong balance sheet growth with average loans and deposits up 10% from a year ago. Loan balances were up 3% from the second quarter, the fourth consecutive quarter of linked quarter growth. The benefit of meeting all the financial needs of our customers was also reflected in WBR settling and increasing cross sell, growing to 10.41 products per household in the third quarter up from 10.27 a year ago.
Turning to credit quality on Page 17. Our strong performance reflected our long-term risk focus and the benefit from the improving housing market. Third quarter net charge-offs declined to historically low levels, only 48 basis points of average loans. Losses in our commercial portfolio were only $19 million or 2 basis points of average loans. Consumer losses declined to 86 basis points.
We continue to have especially strong improvement in our commercial and residential real estate portfolios. Our commercial real estate portfolios were once again in a net recovery position and our consumer real estate portfolios reduced their losses by $1.2 billion from a year ago, down 70%.
Reflecting these improvements, our provision expense declined $577 million from the second quarter to $75 million and included a $900 million reserve release compared with the release of $500 million in the second quarter. Given current favorable conditions, we continue to expect future reserve releases absent a significant deterioration in the economy.
In addition to lower charge-offs in provision expense, non-performing assets also improved, NPAs down $360 million from the second quarter. Nonaccrual loans declined $1 billion, while foreclosed assets increased $662 million driven by an increase in government and shared foreclosed assets. The increase was primarily driven by enhancements for loan modification programs, slowing foreclosures in prior quarters.
Loans 90 days or more past due decreased $104 million from the second quarter and was down 30% from a year ago with improvement in both commercial and consumer loans. Early stage consumer loan delinquency balances and rates also declined from the second quarter and from a year ago.
Our estimated Tier 1 common equity ratio under Basel III increased to 9.54%, exceeding our target of 9% for the first time which includes a 100 basis point internal capital buffer. The growth in the Basel III ratio demonstrated our strong underlying earnings performance and a reduction in risk-weighted assets, reflecting an improved company credit profile and model refinements for commercial portfolios.
In addition, after the Basel rules were finalized, we took a number of actions to reduce RWA. We disposed of an asset that had a punitive risk weighting and generated and evaluated more granular data on underlying investments of our BOLI assets.
We've reduced our common share count by $28.4 million from the second quarter. We purchased 50.9 million shares and we executed a $400 million forward contract that is expected to settle in the fourth quarter for approximately 9.8 million shares. We are focused on returning more capital to our shareholders through dividends and share repurchases.
In summary, we had another solid quarter by focusing on our vision of meeting our customers' financial needs, resulting in strong loan growth and deposit growth. We benefited from a continued improvement in credit quality with losses down significantly, reflecting our conservative underwriting and an improvement in the economy, especially the rebound in housing. Our ROA and ROE continued to grow and we had strong capital generation which will benefit us as we enter the upcoming CCAR process.
We'll now open up the call for questions.
Earnings Call Part 2: