Edited Transcript of Wells Fargo (WFC) Q2 2014 earnings conference call
Company: Wells Fargo & Co. (WFC)
Event Name: Q2 2014 Earnings Conference Call
Event Date & Time: July 11, 2014 10:00 AM ET
WFC Q2 2014 webcast audio
Good morning. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the Wells Fargo second quarter earnings conference call. (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.
Jim Rowe – Director, Investor Relations
Thank you, Regina and good morning everyone. Thank you for joining our call today where our Chairman and CEO, John Stumpf and our CFO, John Shrewsberry will discuss second quarter results and answer your questions.
Before we get started, I would like to remind you that our second quarter earnings release and quarterly supplement are available on our website at wellsfargo.com. I would 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 a 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 will now turn our call over to our Chairman and CEO, John Stumpf.
John Stumpf – Chairman & Chief Executive Officer
Thank you, Jim, and good morning to everyone. Thank you for joining us today. The second quarter was another strong quarter for Wells Fargo. We earned $5.7 billion in the quarter by our continued focused on creating long-term shareholder value to meeting our customers’ financial needs, including growing loans and deposits and deepening our relationships with our customers.
Let me highlight our growth during the second quarter compared with a year ago. We generated earnings of $5.7 billion, up 4% from a year ago, and earnings per share of $1.01 per share, up 3% from a year ago.
We had strong and broad based loan growth and our core loan portfolio was up $51.3 billion or 7%. Our credit performance continued to improve with total net charge-offs down $435 million or 38% from a year ago, and our net charge-off ratio was only 35 basis points annualized on average loans.
Our outstanding deposit franchise continued to generate strong growth with total deposit up $97 billion or 9%. We’ve grown deposits by an average of $265 million everyday over the past year.
We deepened relationships across our company. Retail Banking cross-sell was 6.17 products per household. Wholesale Banking cross-sell was 7.2 products and wealth, brokerage and retirement cross-sell was 10.44 products. We reduced expenses from a year ago while we continued to invest in our businesses, including strengthening our risk management infrastructure.
We also followed through our commitment to maintain strong capital ratios while returning more capital to shareholders. In the second quarter, we increased our common stock dividend by 17% and continued to reduce our share count. We returned a net $3.6 billion to shareholders in the second quarter, up significantly from $1.6 billion a year ago.
I am also proud that during the second quarter, Wells Fargo was ranked the most respected bank in the world and the 11th most respected company overall according to Barron’s Magazine 2014 ranking of the world’s most respected companies. This recognition is a result of our dedicated team members remaining focused on our consistent vision and their commitment to meeting our customers’ financial needs.
While the economic recovery remains uneven, there are many indicators that economic growth is accelerating and we remain optimistic about the opportunities the recovery provides to Wells Fargo and for our customers. The strong improvement employment in June demonstrated the strength in the labor market with unemployment at the lowest levels since September 2008.
The housing market rebound remained on track with home prices up 8% from a year ago and up 25% from the low in June 2011. Despite these increases, home affordability continued to remain attractive due to historically low mortgage rates and rising household incomes.
In June, the Conference Board’s measure of consumer confidence reached a six year high and vehicle sales reached an eight year high. The economy is also benefiting from strong energy production with domestic crude oil production running at the highest level in 26 years and our reliance on foreign energy sources has been falling for nearly a decade.
I am confident that the economic recovery and our diversified business model will continue to provide opportunities for future growth as we remain focused on helping our customers meet their financial needs.
Now John Shrewsberry, our CFO will provide more details on our second quarter results. John?
John Shrewsberry – Chief Financial Officer
Thanks, John. And good morning everyone. My comments will follow the presentation included in the quarterly supplement starting on Page 2. John and I will then answer your questions.
Wells Fargo had a very strong quarter as demonstrated by fundamental drivers of long-term growth. We earned $5.7 billion in the second quarter, down $167 million from the first quarter but keep in mind our results last quarter included a $423 million discrete tax benefit and $0.08 per share impact.
Our pre-tax income grew $303 million from the first quarter. Revenue grew from first quarter, including both net interest income and non-interest income. Core loans grew 8% annualized and average deposits grew 9% annualized. We grew pre-tax, pre-provision profit for the third consecutive quarter and credit quality continued to improve. Capital remains strong and we returned more capital to shareholders.
I will highlight the drivers of this growth throughout the call today.
As John highlighted and as you can see on Page 3, we had strong year-over-year growth in loans and deposits. Our growth in EPS and net income reflected this benefit along with the reduction in expenses and an improvement in credit quality. Our results were driven by momentum across many of our businesses. One way to demonstrate this business momentum is through noninterest income growth. Mortgage fees while up from first quarter were down $1.1 billion from a year ago due to lower refinancing volume. Excluding mortgage fees, fee income was up 9% from a year ago reflecting broad based growth in retail brokerage, deposit service charges, card fees, commercial real estate brokerage commissions, trust and investment management, merchant processing and market sensitive revenue. That’s the benefit of our diversification. We have over 90 businesses focused on meeting our customers’ financial needs.
We also grew net interest income from a year ago. And as you know growing net interest income measured in dollars has been our focus as deposits and other sources of liquidity have grown more rapidly than loan demand or other attractive investment opportunities.
Page 4 highlights our revenue diversification. While our balance between net interest income and noninterest income has been consistent, the drivers of noninterest income can vary each quarter. For example, equity investments were 9% of our fee income in the first quarter but declined to 4% in the second quarter. Other businesses such as deposits, investment banking and mortgage contributed more to fee income this quarter resulting in overall fee income growth demonstrating the benefit of our diversified business model.
Let me highlight some of the key drivers of our second quarter results from a balance sheet and income statement perspective starting on Page 5.
Our balance sheet is never been stronger; capital liquidity, asset quality, funding mix are all exceedingly strong. We increased average earnings assets by 3% from the first quarter by growing loans, increasing short-term investment in trading assets and purchasing securities. In addition, our credit quality continued to improve.
Investment securities increased $8.7 billion from first quarter reflecting $17 billion of purchases primarily U.S. Treasuries and federal agency debt, partially offset by run off. We also improved our liquidity position in response to continued heightened regulatory expectations. We issued $7.8 billion of liquidity related long-term debt and increased liquidity related short-term funding by $5.9 billion. Total short-term investments grew to $238.7 billion which helps us meet our regulatory obligations and provides dry powder to grow loans and invest in securities.
Turning to the income statement on Page 6. Revenue grew $441 million with growth in both net interest income and noninterest income. The $246 million growth in noninterest expense was primarily due to higher revenue based incentive compensation and deferred compensation expense and an increase in operating losses primarily from litigation accruals related to various legal matters. I’ll explain the drivers of our expenses in more detail later on the call.
Income tax expense increased from the first quarter which included a $423 million discrete tax benefit. As shown on Page 7, we continued to have strong, broad based loan growth in the second quarter – our 12th consecutive quarter of year-over-year growth even with the continued reduction in our liquidating portfolio of $56.5 billion over the same time period.
Our core portfolio, which excludes our liquidating portfolio, grew by $51.3 billion or 7% from a year ago and was up $15.2 billion or 8% annualized from the first quarter. Period end loans were up $29 billion or 4% from a year ago and up $2.5 billion from the first quarter. This growth was impacted by the transfer of $9.7 billion of government guaranteed student loans to held-for-sale which removes them from total loans. These student loans have been included within our liquidating portfolio since we stopped originating them in 2010. We transferred this portfolio to held-for-sale at the end of the second quarter reflecting our intent to sell our entire government guaranteed portfolio.
However, we remain committed to the private student lending business. Excluding this transfer, total loans would have increased to $12.2 billion or 6% annualized linked quarter.
On Page 8, we highlight how broad -based our loan growth continues to be at Wells Fargo. C&I loans were up $19.4 billion or 10% from a year ago as we successfully grew loans across our commercial businesses including asset backed, corporate, government, commercial and asset based.
Real-estate 1 to 4 family first mortgage loans grew $7.3 billion or 3% with growth in high quality nonconforming mortgage primarily jumbo loans. Foreign loans grew $6.2 billion or 15% from a year ago reflecting growth in trade finance and the UK Commercial Real Estate acquisition we completed in the third quarter of last year.
Auto loans were up $5.5 billion or 11% reflecting strong originations as we remained the number one auto lender in the country while maintaining our focus on pricing for risk. Commercial real estate loans were up $4.4 billion or 4% reflecting new originations and an acquisition in the third quarter of last year.
Credit card balances were up $2.4 billion or 10% with new accounts up 4%. Our growth rate has been above the industry average reflecting new account growth, product enhancements and increased usage among our existing customers.
Deposit growth also remained strong in the second quarter with average deposits growing $91.7 billion or 9% from a year ago and up $24.2 billion from the first quarter, up 9% annualized. Average deposits totaled $1.1 trillion and we benefited from strong growth in both commercial and consumer balances. Our average deposit costs declined to 10 basis points in the second quarter, down 1 basis point from the first quarter and down 4 basis points from a year ago. Our ability to generate strong deposit growth while reducing deposit costs demonstrated the fundamental strength of our outstanding deposit franchise. We have been able to grow deposits by offering best in class products and excellent customer experience and robust multi channel options.
Our primary consumer checking customers were up 4.6% from a year ago. Our ability to grow primary customers is important to our results because these customers have more interaction with us, have higher cross-sell and are more than twice as profitable as non-primary customers.
As shown on Page 10, tax equivalent net interest income increased $184 million from first quarter benefiting from an additional day in the quarter organic loan growth in higher mortgages held for sale in trading assets. Our NIM declined from the first quarter to 3.15% driven by customer deposit growth which was essentially neutral to net interest income but reduced the margin by approximately five basis points.
Liquidity related actions we took in the second quarter to meet increased regulatory liquidity expectations reduced the margin by one basis point, however, higher income from variable sources, including higher PCI resolutions and periodic dividends offset this decline.
Balance sheet repricing and growth once again did not impact the NIM this quarter as the majority of the repricing from the higher rate environment to the current rate environment is behind us.
Noninterest income increased $265 million from the first quarter with growth across our diversified businesses, including mortgage banking, investment banking, deposit service charges, card fees, retail brokerage, commercial real estate brokerage and insurance, offsetting the $460 million decline in market sensitive revenue. Market sensitive revenue declined 34% from first quarter while all other noninterest income grew 8%.
Trust and investment fees increased $197 million or 6% from first quarter on higher investment banking and retail brokerage asset based fees. Mortgage banking grew $213 million from first quarter, up 14% with growth in both originations and servicing. The second quarter benefited from a seasonally stronger purchase market with 74% of our originations coming from home purchases, up from 66% last quarter.
Total originations increased to $47 billion, up 31%. Our unclosed pipeline increased to $30 billion at the end of the quarter, up 11%. We also continued to see improvements in our net servicing results from servicing revenue up $97 million from the first quarter reflecting higher MSR hedge performance and an increase in net servicing fees reflecting the benefit of lower servicing and foreclosure costs.
As shown on Page 12, expenses were up $246 million from the first quarter while our efficiency ratio remained at 57.9% reflecting our revenue growth. The key drivers of our expenses included personnel expenses declined $106 million from the first quarter which included: seasonally elevated incentive compensation and benefit costs; salary increased as expected due to annual merit increases and one extra day in the quarter.
Personnel expense included $130 million of higher revenue based incentive compensation in the second quarter which is a type of expense increase we like to see because we are growing the top line. Additionally, personnel expenses were impacted by $84 million in higher deferred compensation expense which is offset in trading revenue.
Outside professional services and advertising expenses increased from the first quarter levels which tend to be seasonally lower. And operating losses increased $205 million from the first quarter largely due to litigation accruals for various legal matters. We remain focused on managing expenses and we expect our efficiency ratio will remain within our target range of 55% to 59% for the third quarter.
Turning to our business segment, starting on Page 13, community banking earned $3.4 billion in the second quarter, up 6% from a year ago and down 11% from first quarter primarily from higher taxes. Retail banking cross-sell was 6.17 products per household, up from 6.14 a year ago.
Our debit and credit card businesses continued to grow benefiting from account growth and higher usage. Debit card purchase volume was up 8% from a year ago driven primarily — driven by primarily checking customer growth. Credit card purchase volume was 16% from a year ago with new account growth and more active accounts. Active accounts were up 14% as the Wells Fargo credit card is becoming more top- of-wallet for our customers. Credit card household penetration increased to 39%, up from 35% a year ago.
We remain committed to serving our small business customers at an increased primary business checking account customers 5.2% from a year ago. During the second quarter, we launched Wells Fargo Works for Small Business, an initiative that provides guidance and services to small business owners. This new initiative has resulted in strong engagement with small businesses across the country including millions of views of our online video series and increased traffic to wellsfargoworks.com.
Wholesale banking earned $2 billion in the second quarter, down 3% from a year ago and up 12% from the first quarter. Loan growth remained strong and broad based across businesses, up 8% from a year ago and up 2% from first quarter.
Capital finance increased $2 billion from first quarter driven by higher utilization rates, new customer growth and growth in factoring assets. Commercial banking grew $1.8 billion from the first quarter with widespread growth across geographies and industries.
Commercial real estate grew $1.4 billion driven by new loan originations, including customer M&A activity. In addition, corporate banking, government and institutional banking, asset backed finance and equipment finance portfolios all grew from the first quarter.
Revenue increased 7% from the first quarter reflecting diversified growth across a number of wholesale banking businesses. Investment banking revenue growth was broad based across product categories. Eastdil Secured, our commercial real estate brokerage business increased revenue with strong performance in public and private markets. Asset management fees grew — from increased market valuation and inflows.
Total assets under management increased $35 billion from a year ago. Long-term assets, including equity and fixed income strategies, were up 12% while money market funds have declined by 4% from a year ago. This shift out of money market funds moderated growth in total assets under management but revenue benefited from the shift to higher fee generating long-term assets. Wholesale banking revenue also benefited from the sale of 40 insurance offices in the quarter.
Wealth brokerage and retirement earned $544 million in the second quarter, up 25% from a year ago and up 15% from the first quarter. The strong year-over-year results reflected 9% revenue growth driven by recurring revenue. Net interest income was up 11% from a year ago and asset based fees were up 14% benefiting from market performance and continued client demand for plan based advisory solutions.
Our brokerage advisory assets have grown to $409 billion, up $78 billion or 24% from a year ago. Loan growth remained strong with average loans up 12% from a year ago driven by growth in high quality nonconforming mortgages and security based lending. We also benefited from the partnership involving WBR and community banking to better meet our customers’ saving retirement planning and investment needs and we increased the number of private bankers in our banking stores by 22% from a year ago.
Turning to Page 16, credit quality continued to improve with second quarter credit losses down $108 million from first quarter and the net charge-off ratio declining to 35 basis points of average loans. Losses in our commercial portfolio were only 3 basis points of average loans and consumer losses continued to decline to 62 basis points.
Nonperforming assets have declined for seven consecutive quarters and were down $686 million from first quarter, although the pace of improvement has slowed. We had a $500 million reserve release, the same as in first quarter. We continue to expect future reserve releases, absent a significant deterioration in the economy but expect a lower level of future releases as the rate of credit improvement slows and the loan portfolio continues to grow.
Our estimated common equity Tier 1 ratio under Basel III using the advanced approach fully phased-in increased to 10.09% in the second quarter. Our share count declined in the quarter reflecting the repurchase of 39.4 million common shares and we executed a $1 billion forward repurchase contract which expected to settle in the third quarter for approximately 19.4 million shares. We expect our share count to continue to decline throughout 2014 as a result of anticipated net share repurchases.