Wells Fargo & Co Earnings Call Insights: Liquidity Coverage Ratio and Mortgage Volumes Outlook
Liquidity Coverage Ratio
John McDonald – Sanford C. Bernstein: Tim, question on liquidity. Could you tell us where you are on the liquidity coverage ratio relative to your understanding of what will be required of you in the regulatory rules?
Timothy J. Sloan – SEVP and CFO: John, it’s a good question. One of the challenges is that the rules haven’t been finalized and similar to the Basel III capital rules from the point at which they were originally proposed to where they were finalized there was a very fair amount of discussion and change. I would tell you that we have adequate capital to operate Wells Fargo. Having said that we’re going to continuing to do work with the regulators in terms of those interpretations there may be some incremental amount of liquidity that we need to raise, but we certainly – it’s certainly something that we are focused on because liquidity risk is a key risk for the Company, given over $1 trillion of deposits we have and given the experience we have in terms of operating in different environments. But again we think we’ve got adequate liquidity, again we may need to raise a little bit more but it shouldn’t be material for the Company.
John McDonald – Sanford C. Bernstein: So it’s a factor and as you think about the pace at which you deploy your cash, you mentioned buying some securities here today, is that a factor in how you’re thinking about deploying your liquidity?
Timothy J. Sloan – SEVP and CFO: No it’s not a big factor at all, John. Again to me it’s much more important to think about the liquidity needs for operating the business as it relates to how much we want to invest in securities, because the first call for any of our liquidity is always got to be to our customers in terms of loan demand, but it’s not a primary driver in terms of the pace of activity. The primary driver in terms of the pace of our investment activity has been that over the last year we’ve been in this very low rate environment. If you turn the clock back a year ago, we had a lot of excess liquidity, there was a lot of concern that we’re going to be in low rates for a while and there was this view that we weren’t investing fast enough. We wanted to stay disciplined then. That was the primary drivers. Just like today one of the primary drivers for why we’re investing more in our securities portfolio is because we think given the rate back the returns are much more attractive…
John McDonald – Sanford C. Bernstein: Yeah and we did see a benefit there in the degree of net interest margin compression but you still have an expectation for some continuing margin compression. What are the drivers there, Tim? And then, in terms of NII dollars, do you still expect to grow the NII dollars from the current level?
Timothy J. Sloan – SEVP and CFO: So, on the net interest margin, I don’t think the drivers have really changed that much. As you recall, if you look at our net interest margin decline which we’ve had one over the last 14 quarters, the primary driver for the decline has been the fact that we‘ve been growing deposits with long-term for the Company. Within the quarter, we can have some variability based upon the variable income which was positive this quarter, but last quarter it was negative. The balance sheet continues to re-price a bit. So, the factors really haven’t changed, because we haven’t gotten to a point that the balance sheet has completely re-priced, so that we could continue to see some continued compression in the net interest margin. The underlying factors really haven’t changed. In terms of net interest income, our goal is to growth net interest income over time. What happens on a quarter-by-quarter basis, I just don’t know for sure, because there are a lot of factors. We had a lot of positive factors that drove our net interest income this quarter which I think was absolutely terrific. Again, I don’t know if that means we are going to grow net interest income in the third quarter, but over time, I believe that we can grow net interest income and we – in this quarter, I think we’ve demonstrated our ability to do that.
John McDonald – Sanford C. Bernstein: Switching gears over to the mortgage revenues. Did the gain on sale margin of the 221 you mentioned hold up better than expected and what were the factors there and is there any framing you can do for us of how much pressure that margin could experience as you move through the next couple of quarters?
Timothy J. Sloan – SEVP and CFO: Yeah, John, I think that’s a very fair observation, and candidly, I think the mortgage gain on sale margin has held up better, not just for the last quarter, but for the last year than I think anybody in the business or in the industry would have expected. That said, it has come down, and it came down over 30 basis points in the quarter and our best guess is that we are seeing pressure in the gain on sale margin and gain on sale margin isn’t going to be decline. Recall that last quarter, we framed the gain on sale margin variability over last few years that if you annualize it, at the low end it was 160 and at high-end, again, on an annualized basis was 220. We’ve been at the high-end. We think we’re going to start to move down from there. So, I think there is going to be pressure. I do not believe you’re going to see a 2.21% gain on sale margin. I think it’s more likely to be lower. But again, it’s really a function of the competitive environment which we think has been very rational as we’ve gone through this cycle, as well as the rate environment. Recall that our best guess in the second quarter was that originations were going to be a little bit lower in the first quarter. But in fact, originations were up in the second quarter, because rates stayed low for a longer period of time. Rates are now up and that’s going to affect originations for sure. So, there is a lot of variability. But to put it very bluntly, we think that the gain on sale margin is going to decline and it will decline somewhere in the range of what we’ve seen over the last few years. But it is going to decline…
John G. Stumpf – Chairman, President and CEO: But John, as you know and Tim’s absolutely right. It will decline and margins will be under some pressure. But we have this wonderfully balanced business within the business. In other words, when rates increase it refi’s drop, margins come in because there is more competition, but then you have a servicing portfolio and that does better. So, there is balance within this business not only — and there’s also of course balance in the broad distribution and diversity within the Company. So, as some businesses do better some do not as well when rates rise.
John McDonald – Sanford C. Bernstein: Tim one follow-up on that. Could you remind us of the mechanics by which the higher servicing income can work its way through the income statement and why didn’t – it didn’t seem like we saw any of that start this quarter with big move in the tenure. What will trigger the kind of offset being balance on the servicing side where the income net we’ll see that start to rise?
Timothy J. Sloan – SEVP and CFO: Yeah as John pointed out, over time I think that there is some balance in the business on the revenue side, because of the fact that servicing income tends to be a little bit less volatile. We should see some benefit in terms of servicing income increasing as the housing industry continues to improve. As we pointed out we did reduce the value of this servicing for some elongation of some foreclosure timelines. Over time that will dissipate and then we’ll continue to get the carry in the underlying servicing income. Our hedge ratio is pretty high. So, it’s not like we’re betting the farm on or the stagecoach on the increase in rates in the servicing portfolio. We’ll see some benefit there. But I think it’s also really important to remember that there will also be some expense trade-offs in the mortgage business itself as – if it turns out that originations are down then it’s immediately in the quarter you get a benefit from the revenue-based compensation, commission is coming down and then to the extent that volume continues then you also make adjustments that tend to be on a lag basis, on a quarterly basis in terms of some of your other expenses.
John McDonald – Sanford C. Bernstein: Are you starting to make those adjustments based on what you’re seeing in the pipeline and the outlook given rates?
Timothy J. Sloan – SEVP and CFO: John, we are making adjustments all the time. The fact of matter is, we entered the quarter with actually a pretty strong pipeline of $63 billion which was only down 10%, 15% from the end of the quarter, but there is no question that to the extent that we continue to see a decline in the pipeline that we will make adjustments and so you can assume that we will begin to make some of those adjustments this quarter.
Mortgage Volumes Outlook
Erika Penala – Bank of America Merrill Lynch: My first question is a follow-up to John’s last. We heard another mega bank today say that if loan rates stay where they are that the mortgage market could shrink 30% or 40% in the second half of the year. Do you agree with that statement for your Company given what you’re seeing in purchase trends? And additionally, could you quantify if that number is correct how much of the expenses can come up proportionate to that 30% to 40% decline?
Timothy J. Sloan – SEVP and CFO: It’s a fair question. I don’t think anybody really knows what the volumes in the mortgage business are going to be. I think one of the challenges for anybody making that estimate today is that the complexion of originations is really changing. When you look at the percentage of refi volume versus purchase money volume that we had in the first quarter of this year, for example, it was about one-third purchase money and about two-thirds refi volume. As the housing industry continues to approve and as we went into the spring selling season, you saw that that mix shift and so it was more like 55, 44, 45 or whatever, and what that means is that a larger portion of your originations are coming from the purchase portion of the business. So, I think it is a fact that refinance volume is certainly very much impacted by rates, but also – I mean we’ve seen now rates (as the long end) start to come down 10 basis points just in the last few days. And so, we don’t know for sure where volume is going to be. We believe it’s going to be lower in this quarter and one of the things that we’ve learned in the mortgage business is it’s probably not a good thing to thing six months out or nine months out because there can be so much variability. We think volumes are going to be down, but whether it’s going to be 30% to 40%, I just don’t know. As it relates to expenses, again, the timeline generally is that the revenue-based compensation declines immediately and to the extent that you have continued origination reductions and then you start to reduce some of your expenses. That tends to occur on a lagged quarter basis. But at the end of the day we still believe that we can continue to have good margins in the business and to keep the efficiency ratio where it is. Because also remember that one of the other important things that’s going on in the business is you’ve got an improvement in the underlying housing industry so that your environmental related hopefully will come down including foreclosures at the same time.
John G. Stumpf – Chairman, President and CEO: Erika, one of the things that – I know that we should not forget, now that we’ve been through this many times, but we have 6200 stores, 30,000 or 40,000 personal bankers that refer business in. So, when rates rise and it’s more of a purchase money business, we have all folks on deck helping serve customers and we still have tons of our customers who are interested in buying homes and moving and so forth who are our customers but do their mortgage business in other places. So, we have still lots of opportunities to capture purchase money business which is still not at the levels that it was a year ago, pre-crisis. So, there’s lots of activity going on there. Surely, the refinance volume is going to come down significantly if rates continue to stay high. But as Tim mentioned I don’t know what they still be. 90 days ago we wouldn’t have talked about what we’re talking about today, things change very quickly in this business…
Timothy J. Sloan – SEVP and CFO: Yeah, Erika let me just reinforce again, as you think about the third quarter and you think about the volume that we’ve seen over the last couple of years, we’ve been very fortunate to see quarters in which volume has been above $100 billion. We just don’t think that we’re going to see $100 billion in mortgage volume, given the current rates today in the third quarter.
Erika Penala – Bank of America Merrill Lynch: Speaking of how Wells benefits as housing recovers I know that you’re frustrated by the obsession on your margin but as I think about Slide 26 in your deck it seems like you have $876 million of reclassification to accretable yield and $1.6 billion of additional expected cash flows that could be helpful to your margin over time. Should we think of the Pick-A-Pay portfolio similar to how we think about reserve release for the entire company and that as housing gets better you could release some of the marks into net interest income which would benefit or alleviate some of the concerns on margin?
Timothy J. Sloan – SEVP and CFO: There’s no question that the key drivers for the improvement in the – or the reclassification were housing prices as well as the underlying credit performance within that portfolio and those are very similar to the drivers for the improvement in our home equity portfolio. In terms of the impact, I’d love to tell you that when you re-class the 876 we get and the immediate impact, that’s not the way it works, it occurs over the life of the loans. There will be some positive impact and if the current trends continued, this isn’t the last time that we’ve seen the reclassification. I can promise you that’s going to be the case, but it will provide some positive benefit over time. But again we’ve got to make sure that we put it in the right context because our best estimate is the weighted life of that portfolio is still about 14 years.
Erika Penala – Bank of America Merrill Lynch: And just if I could sneak one more and just a clarification follow-up to John’s question. On the LCR cash balances keep growing, but in other calls you’ve mentioned that you have something like $50 billion of excess cash, is that true still relative to how we should think about Basel III LCR compliance and I guess as the main message is potentially the cash balance will continue to build from here?
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