Wells Fargo & Company (NYSE:WFC) Q2 2023 Earnings Call Transcript

Wells Fargo & Company (NYSE:WFC) Q2 2023 Earnings Call Transcript July 14, 2023

Wells Fargo & Company beats earnings expectations. Reported EPS is $1.25, expectations were $1.17.

Operator: Welcome, and thank you for joining the Wells Fargo Second Quarter 2023 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] Please note that today’s call is being recorded. I would now like to turn the call over to John Campbell, Director of Investor Relations. Sir, you may begin the conference.

John Campbell: Good morning. Thank you, everyone, for joining our call today where our CEO, Charlie Scharf, and our CFO, Mike Santomassimo, will discuss second quarter results and answer your questions. This call is being recorded. Before we get started, I would like to remind you that our second quarter earnings materials, including the release, financial supplement and presentation deck 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 materials.

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 and the earnings materials available on our website. I will now turn the call over to Charlie.

Charlie Scharf: Thank you, John. And good morning, everyone. As usual, I’ll make some brief comments about our second quarter results and then update you on our priorities. I’ll then turn the call over to Mike to review second quarter results in more detail before we take your questions. Let me start with some second quarter highlights. We had solid results in the quarter with revenue, pre-tax pre-provision profit, diluted earnings per share, and ROTCE, all higher than a year ago. The revenue growth reflected strong net interest income growth as well as higher non-interest income. While our efficiency ratio improved and we continued to make progress on our efficiency initiatives, we had modest expense growth from a year ago.

Net charge-offs have continued to increase from historical low levels, but overall credit quality was strong and consumer and business balance sheets remain healthy. We increased our allowance for credit losses by $949 million, primarily driven by our office portfolio as well as growth in our credit card portfolio. While we haven’t seen significant losses in our office portfolio today, our detailed loan by loan review of the portfolio has given us a sense how the next several quarters could play out. We’ve also considered a number of stressed scenarios, all of which informed our actions this quarter. Mike will discuss this in more detail, but I want to make the point that it is very hard to look at any one statistic and determine the risk in the portfolio.

Loss content will be driven by a combination of factors, including but not limited to, property type, location, lease rates, lease renewal notice dates, loan structure and borrower behavior. Most importantly, our CRE teams remain focused on working with our clients’ portfolio surveillance and de-risking to minimize loss content. Both commercial and consumer average loans were up from a year ago, but were down from the first quarter as the economy has slowed and we’ve taken some credit tightening actions. Credit card spending remained strong, but the rate of growth has slowed from the outsized growth rates we saw throughout 2022. Debit card spending was flat from a year ago with growth in discretionary spend offset by declines in non-discretionary spend.

Average deposits were down from the first quarter, driven by lower consumer deposits, while the decline in commercial deposits slowed. Now let me update you on progress we’ve made on our strategic priorities, starting with our risk and control work. Regulatory pressure on banks with long-standing issues such as ours continues to grow and as such our continued intensive effort to complete the build-out of an appropriate risk and control framework for a company of our size and complexity is critical. I’ve continued to emphasize that this is our top priority and will remain so and that while we have implemented substantial portions of the work required, we have more implementation to do as well as work to make sure the changes operate effectively over time.

As I’ve said before, we remain at risk of further regulatory actions until the work is complete. While we’re devoting all necessary resources to our risk and control work, we’re also continuing to invest in our business to better serve our customers and help drive growth. Our consumer customers have continued to increase their use of our mobile app. We added over 1 million mobile active customers over the past year and mobile logins increased 9% from a year ago. Fargo, our new AI-powered virtual assistant, is now live on our mobile app for all consumer customers. Since launching at the end of April, our customers have interacted with Fargo over 4 million times. We’ve continued to make important hires, bringing new expertise to Wells Fargo in businesses we are looking to grow.

We named Barry Simmons as the new Head of National Sales in Wealth & Investment Management. He’ll be critical in our efforts to better serve clients and help advisors grow their business. We also continued to attract veteran bankers in Corporate and Investment Banking, hiring new managing directors in our banking division in priority growth areas, including a Co-Head of Global Mergers and Acquisitions, Co-Head of Financial Institutions and new heads of financial sponsors, equity capital markets, healthcare and technology, media and telecom. We also continue to focus on better serving our communities. We announced a 10-year strategic partnership with T.D. Jakes Group that could result in up to $1 billion in capital and financing for Wells Fargo to drive economic vitality and inclusivity in communities across America.

The Wells Fargo Foundation awarded $7.5 million to Habitat for Humanity to build and repair more than 360 homes nationwide. We’ve worked with Habitat for Humanity for nearly three decades and donated more than $129 million since 2010. Wells Fargo signed on as the first anchor funder of UnidosUS HOME initiative to create 4 million new Latino homeowners by 2030. We provided the initial grant to start a fund launched by FinTech Hello Alice to improve access to credit and capital for small business owners who are members of underserved groups, including women. We continue to open HOPE Inside centers in Wells Fargo branches, including six during the first half of 2023 with plans to reach 20 markets by the end of this year. The centers help empower community members to achieve their financial goals through financial education workshops and free one-on-one coaching.

We published our 2023 diversity, equity and inclusion report which highlights the progress we’ve made in our DE&I strategy and initiatives, both inside our company and the communities where we live and work. However, we have more work to do to achieve enduring results that will require long-term commitments. Looking ahead, the US economy continues to perform better than many expected and although there will likely be continued economic slowing and uncertainty remains, it is quite possible the range of scenarios will narrow over the next few quarters. This year’s Federal Reserve stress test affirmed that we remain in a strong capital position, reflecting the value of our franchise and benefits of our operating model. This capital strength allows us to serve our customers’ financial needs while continuing to prudently return excess capital to our shareholders.

As we previously announced, we expect to increase our third quarter comp stock dividend by 17% to $0.35 per share, subject to approval by the company’s Board of Directors at its regularly scheduled meeting later this month. We’ve repurchased $8 billion of common stock during the first half of this year and the stress test results demonstrated that we have the capacity to continue to repurchase common stock. Regulators have signaled that the Basel III Endgame proposal, which could be out as soon as this summer, will include higher capital requirements that will be skewed to the country’s largest banks. While there’s some speculation that capital requirements could increase by 20%, we don’t know what the impact will be to Wells Fargo. However, we do expect our capital requirements will increase.

While any changes to regulatory capital requirements are expected to be phased in gradually over several years, we are considering the potential impacts in contemplating the amounts of our future repurchases. Our balance sheet is strong. We’ve increased and remained focused on increasing our earnings capacity and continue to like our competitive position. We remain prepared for a variety of scenarios and our steadfast commitment to our risk and control build-out, coupled with our continued focus on financial and credit risk management, allows us to support our customers throughout economic cycles. I will now turn the call over to Mike.

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Mike Santomassimo: Thank you, Charlie. And good morning everyone. Net income for the second quarter was $4.9 billion or $1.25 per diluted common share, both up from a year ago, reflecting the progress we are making on improving our performance, which I’ll highlight throughout the call. Starting with capital and liquidity on Slide 3. Our CET1 ratio was 10.7%, down approximately 10 basis points from the first quarter. During the second quarter, we repurchased $4 billion in common stock and as Charlie highlighted, subject to Board approval, we expect to increase our common stock dividend in the third quarter. Our CET1 ratio was 1.5 percentage points above our current regulatory minimum plus buffers and was 1.8 percentage points above our expected new regulatory minimum plus buffers starting in the fourth quarter of this year.

While we expect to repurchase more common stock this year, we believe continuing to maintain significant excess capital is appropriate until there’s more clarity on the new capital requirements that Charlie highlighted. Our liquidity position remained strong in the second quarter with our liquidity coverage ratio approximately 23 percentage points above the regulatory minimum. Turning to credit quality on Slide 5. Overall credit quality remained strong, but as expected, net loan charge-offs continued to increase from historically low levels and were 32 basis points of average loans in the second quarter. Commercial net loan charge offs increased $137 million from the first quarter to 15 basis points of average loans. Approximately half of the increase was in commercial banking where the losses were borrower-specific with little signs of systematic weakness across the portfolio.

The rest of the increase was driven by higher losses in commercial real estate, primarily in the office portfolio. I’ll share some more details on the CRE office exposure on the next slide. Consumer net loan charge-offs increased modestly, up $23 million from the first quarter to 58 basis points of average loans. The increase primarily came from the credit card portfolio as residential mortgage loans continue to have net recoveries and auto losses declined. While consumer credit performance remained solid overall, and we’ve continued to take incremental credit tightening actions across the portfolios, we expect consumer net loan charge-offs will continue to gradually increase. Non-performing assets increased 14% from the first quarter as lower non-accrual loans across the consumer portfolios were more than offset by higher commercial non-accrual loans, primarily in the commercial real estate portfolio.

Our allowance for credit losses increased $949 million in the second quarter, primarily from — for commercial real estate office loans as well as for higher credit card balances. We’ve updated Slide 6, which highlights our commercial real estate portfolio. We had $154.3 billion of commercial real estate loans outstanding at the end of the second quarter with $33.1 billion of office loans, which were down modestly from the first quarter and represented 3% of our total loans outstanding. The office market continues to be weak and the composition of our office portfolio was relatively consistent with what we shared with you in the first quarter. As Charlie mentioned, our CRE teams are focused on surveillance and de-risking which includes reducing exposures and closely monitoring at-risk loans.

This quarter, we added a table to this slide that breaks down our CRE office disclosure in the context of our broader CRE portfolio. As the slide shows, our office loans at the end of the second quarter were primarily in corporate investment banking and that is also where we had the most non-accrual loans and the highest level of allowance for credit losses. Last quarter, we disclosed for the first time the allowance for credit losses coverage ratio for the office portfolio in the corporate investment bank, which increased from 5.7% at the end of the first quarter to 8.8% at the end of the second quarter. This quarter, we are also providing our allowance for credit losses for our total CRE office portfolio which was 6.6% at the end of the second quarter, up from 4.4% at the end of the first quarter.

As we highlighted last quarter, we’re providing this data to give you more insight into the portfolio, but each property situation is different and there are many variables that can determine performance, which is why we regularly review this portfolio on a loan-by-loan basis. For example, we have properties that are experiencing increased vacancies where borrowers have decided to inject equity and make investments to improve the property even in cities with more difficult fundamentals. We also have properties that are well leased and performing, but borrowers need help refinancing. In those situations, we are working with borrowers to restructure, which in many cases includes some paydown in balance. There are also situations that result in a sale or workout of the asset.

We will continue to closely monitor this portfolio, but as has been the case in prior cycles, this will likely play out over an extended period of time as we actively work with borrowers to help resolve issues that they may be facing. On Slide 7, we highlight loans and deposits. Average loans were relatively stable from the first quarter and were up 2% from a year ago, driven by higher commercial and industrial loans in commercial banking and credit card loans. I’ll highlight specific drivers when discussing our operating segment results. Average loan yields increased 247 basis points from a year ago and 30 basis points from the first quarter due to the higher interest rate environment. Average deposits declined 7% from a year ago, predominantly driven by deposit outflows in our consumer and wealth businesses reflecting continued consumer spending and customers reallocating cash into higher yielding alternatives.

While down from a year ago, average commercial deposits were relatively stable in the first quarter and average deposits grew in corporate and investment banking. As expected, our average deposit costs continued to increase, up 30 basis points from the first quarter to 113 basis points with higher deposit costs across all operating segments in response to the rising interest rates. Our mix of non-interest bearing deposits declined from 32% in the first quarter to 30% in the second quarter but remained above pre-pandemic levels. Turning to net interest income on Slide 8. Second quarter net interest income was $13.2 billion, up 29% from a year ago, as we continue to benefit from the impact of higher rates. The $173 million decline from the first quarter was primarily due to lower deposit balances, partially offset by one additional day in the quarter.

At the beginning of the year, we expected full year net interest income to grow by approximately 10% compared with 2022. We currently expect full year 2023 net interest income to increase approximately 14% compared with 2022. There are a variety of factors that we’ve considered in our expectation for the rest of the year. We are assuming modest growth in loans, some additional deposit outflows and migration from non-interest bearing to interest bearing deposits, as well as continued deposit repricing including competitive pricing on commercial deposits. Additionally, we are using the recent rate curve which is shown on the slide. As a reminder, many of the factors driving net interest income are uncertain and we will need to see how each of these assumptions plays out during the remainder of the year.

Turning to expenses on Slide 9. Non-interest expense grew $125 million or 1% from a year ago. At the beginning of the year, we expected our full year 2023 non-interest expense, excluding operational losses, to be approximately $50.2 billion. We currently expect our full year 2023 non-interest expense, excluding operating losses, to be approximately $51 billion. The increase includes higher severance expense due to actions we have taken and plan to take in 2023 as attrition has been slower than expected. Of note, we’ve reduced headcount each quarter since the third quarter of 2020 and headcount declined 1% from the first quarter and 4% from a year ago. As a reminder, we have outstanding litigation, regulatory and customer remediation matters that could impact operating losses.

Turning to our operating segments, starting with Consumer Banking and Lending on Slide 10. Consumer small business banking revenue increased 19% from a year ago as higher net interest income, driven by the impact of higher interest rates was partially offset by lower deposit related fees, driven by the overdraft policy changes we rolled out last year. We continue to reduce the underlying costs around the business as customers migrate to digital, including mobile. We’ve reduced our number of branches by 4% and branch staffing by 10% from a year ago. Home lending revenue declined 13% from a year ago, driven by lower net interest income due to loan spread compression and lower mortgage originations. We continued to reduce headcount in the second quarter, down 37% from a year ago and we expect staffing levels will further decline during the second half of the year.

Credit card revenue increased 1% from a year ago due to the higher loan balances. Payment rates were down from a year ago, but have been stable over the last three quarters, remained above pre-pandemic levels. New account growth remained strong, up 17% from a year ago and importantly, the quality of the new accounts continue to be better than what we were booking historically. Auto revenue declined 13% from a year ago, driven by continued loan spread compression and lower loan balances. Personal lending revenue was up 17% from a year ago due to higher loan balances. Turning to some key business drivers on Slide 11. Mortgage originations declined 77% from a year ago and increased 18% from the first quarter, reflecting seasonality. We funded our last corresponding loan in the second quarter with our current focus being serving our bank customers as well as borrowers in minority communities.

The size of our auto portfolio has declined for five consecutive quarters and balances were down 7% at the end of the second quarter compared to a year ago. Origination volume declined 11% from a year ago reflecting credit tightening actions as well as continued price competition. As Charlie highlighted, debit card spend was flat in the second quarter compared to a year ago, spending on fuel due to the lower gas prices, home improvement and travel are the largest declines compared to last year. Credit card spending continued to be strong and was up 13% from a year ago. Growth rates were stable throughout the second quarter with fuel the only category down year-over-year. Turning to Commercial Banking results on Slide 12. Middle Market Banking revenue increased 51% from a year ago due to the impact of higher interest rates and higher loan balances.

Asset-based lending and leasing revenue increased 13% year-over-year, primarily due to higher loan balances. Average loan balances were up 12% in second quarter compared to a year ago, driven by new customer growth and higher line utilization. Average loan balances have grown for eight consecutive quarters thought the pace of growth has slowed. Average loans were up 1% from the first quarter with loan growth in asset-based lending and leasing driven by seasonally higher inventory levels while middle market banking loans were flat. Turning to Corporate Investment Banking on Slide 13. Banking revenue increased 37% from a year ago, driven by stronger treasury management results, reflecting the impact of higher interest rates and higher lending revenue.

The growth in investment banking fees from a year ago reflected write-downs taken in the second quarter of 2022 on unfunded leveraged finance commitments. Commercial real estate revenue grew 26% from a year ago, driven by the impact of higher interest rates and higher loan balances. Markets revenue increased 29% from a year ago, driven by the higher trading results across most asset classes. Our strong trading results during the first half of the year were driven by underlying market conditions and also reflected the benefit of our investments in technology and talent, which have allowed us to broaden our franchise and generate more trading flows. Average loans were down 2% from a year ago and 1% from the first quarter. The decline from the quarter was driven by banking, reflecting the combination of slow demand and modestly lower loan utilization.

On Slide 14, Wealth and Investment Management revenue was down 2% compared to a year ago, driven by a decline in asset-based fees due to lower market valuations. Growth in net interest income from a year ago was driven by the impact of higher rates, partially offset by lower deposit balances as customers continue to reallocate cash into higher yielding alternatives. However, outflows into cash alternatives slowed in the second quarter. As a reminder, the majority of WIM advisory assets are priced at the beginning of the quarter. So second quarter results reflected the market valuations as of April 1, which were down from a year ago. Asset-based fees in the third quarter will reflect higher market valuations as of July 1. Average loans were down 3% from a year ago, primarily due to decline in securities-based lending.

Slide 15 highlights our Corporate results. Revenue increased $751 million from a year ago, driven by the impact of higher interest rates and lower impairments of equity securities in our affiliated venture capital and private equity businesses. In summary, our results in the second quarter reflect a continued improvement in our earnings capacity. We grew revenue and had strong growth in pre-tax provision profit. As expected, our net charge-offs continue to slowly increase from historical lows and our allowance for credit losses increased. We are closely monitoring our portfolios and taking credit-tightening actions where we believe appropriate. Our capital levels remain strong and we continue to repurchase common stock. We will now take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question will come from Ken Usdin of Jefferies. Your line is open, sir. Mr. Usdin, please check the mute button on your phone.

Charlie Scharf: Why don’t we take another one and then we’ll come back to Ken.

Operator: Certainly. The next question will come from Scott Siefers of Piper Sandler. Your line is open.

Scott Siefers: Good morning, everyone. Thank you for taking the question. It was great to see the higher NII guide and performance this quarter. That said it seems likely that dollars of NII will come down from here. I guess just broadly speaking, are you able to chat about what factors might be most important in sort of your ability to arrest a downward move in NII. In other words, kind of, when and why would it end up flattening out if we’re ideally getting close to the end of a Fed tightening cycle?

Mike Santomassimo: Yeah, thanks, Scott. It’s Mike. I’ll take that and Charlie can jump in if you want. When you look at the assumptions that underpin that, and I highlighted some of this in my script, but I’ll kind of go back through them. We’ve got a little bit of modest loan growth in there. So that’s not a big driver of sort of what we’re seeing. And I think you’re probably seeing that from others where we’re just not seeing that same demand that we saw a year or so ago on loans. We’re also assuming that we’ll see some additional outflows, particularly in the consumer space as people continue to spend money. And then we’ll see some more migration from non-interest bearing to interest bearing deposits. And then deposit pricing will — betas will evolve over time.

I think it’s still very competitive on the commercial side and I think that will continue on the consumer side and then evolve. So I think you got to look at those combination of factors and make some assumptions around when you think they start to stabilize. But I think we’re assuming that those trends that we’ve been seeing now for the last of quarters will continue, at least through the year end.

Scott Siefers: Okay. Perfect. And maybe if we could drill down into one of those in particular, just the migration from non-interest bearing to interest bearing. They’ve come down but are still above pre-pandemic levels, I believe. Do you have a sense for where and why those would start to settle out?

Mike Santomassimo: Yeah, I mean there’s a few factors underneath that. As you pointed out, we’re about 30% at the end of the quarter, down from about 32%, I think the prior quarter. And if you go back pre-COVID, they were in kind of the mid-20s, mid to upper-20s depending on when — exactly when you look at it. And we’ve been trending downward. Part of that is excess deposits on the commercial side. As people use up their earnings credits for the fees they’re paying, you’re seeing some migration there. That stabilizes. And then you’ve seen again on the consumer side, people spending from their primary checking accounts. So those are the factors that I’d look at on when that starts to slow down and stabilize, but it’s been pretty consistent at least for the last quarter or two.

Scott Siefers: Yeah. Okay. All right. Thank you very much, Mike.

Operator: Thank you. The next question will come from Ebrahim Poonawala of Bank of America. Your line is open, sir.

Ebrahim Poonawala: Hey, good morning. So, Mike, thanks for the details on the CRE book. I think Charlie mentioned that you’ve gone through loan by loan in identifying and I appreciate the idiosyncratic nature of every sort of CRE loan. But given the reserve you’ve taken this quarter, give us a sense of your visibility around how well reserved the bank is today, knowing what we know in terms of the macro-outlook? And also if you can comment on just the rest of the CRE book, particularly as it relates to San Francisco or California and your level of comfort around just apartments et cetera within that market? Thank you.