富國銀行 (WFC) 2003 Q3 法說會逐字稿

Welcome to the Wells Fargo third quarter earnings recorded call.

At this time, I would like to turn the call over to Bob Strickland, director of Investor Relations.

Hello.

This is Bob Strickland, and thank you for calling in to the Wells Fargo third quarter 2003 earnings review pre-recorded call.

Before we talk about our third quarter results, we need to make the standard securities law disclosure.

In today's call, we will make forward-looking statements about specific income statement and balance sheet items, and other measures of future results of operations and financial condition, including -- statements about the expected benefits from certain strategic actions taken in the quarter; mortgage servicing income and the potential value of our mortgage servicing portfolio; commercial loan growth; our target capital ratios; and the impact of the adoption of FIN 46.

Forward-looking statements give our expectations about the future.

They are not guarantees, and results may differ from expectations.

Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update them to reflect changes that occur after that date.

For a discussion of some of the factors that may cause actual results to differ from expectations, refer to our SEC filings, including the 8-K filed today, which includes the press release announcing our third quarter results; our Form 10-Q for the second quarter 2003 and Form 10-K for 2002, and to information incorporated into those documents.

Now I will turn the review over to our Chief Financial Officer, Howard Atkins.

Thank you, Bob.

I'm pleased to report that Wells Fargo earned $1,561,000,000, or 92 cents per share, in the third quarter of 2003, up 10 percent from the 84 cents a share earned a year ago.

Third quarter results were negatively affected by 10 cents per share due to certain actions we took in the quarter to take advantage of interest rates and equity markets, which will benefit future earnings.

We'll discuss these strategic actions in a moment.

The 92 cents per share represents another record result, and is the 9th consecutive quarter of double-digit earnings per share growth.

We are pleased with both the strength and the consistency of these results.

As indicated in the quarterly press release, the Company's earnings per share growth was driven principally by year-over-year revenue growth of 19 percent.

Revenue growth continued to be driven by strong consumer loan growth across virtually all types of consumer lending products.

In addition, the deposit inflows remain strong, with average core deposit growth of 17 percent year-over-year, including 32 percent growth in consumer and business non-interest-bearing checking accounts.

Excluding all mortgage escrow accounts, these deposit growth rates were 12 percent and 18 percent, respectively.

With mortgage applications at record levels at the end of the second quarter, we expected and got strong mortgage results in the third quarter.

While mortgage activity has slowed since the midyear refinancing peak, applications are still running at reasonably high levels, with an application pipeline of $62 billion at the start of the fourth quarter.

Our asset management business is now growing nicely.

Trust and investment fees were up 9 percent year-over-year and 29 percent annualized, on a linked quarter basis -- in line with the recent rally in equity markets -- as well as our ongoing success building our investment management business organically and through fill-in acquisitions.

So far this year we've added over 100 private bankers and almost 400 Series 7 licensed bankers, and we are well on our way toward achieving the staffing goals in these areas.

The newly acquired Montgomery Asset Management has begun to contribute to overall investment management results, as well.

We continue to have great success cross-selling insurance into our middle market customer base.

Insurance brokerage fees at Acordia, the largest bank owned insurance holding company in the United States, were up were up 9 percent year-over-year.

Credit cards, merchant card business, capital markets, foreign exchange, real estate brokerage and asset-based lending all benefited from increased activity in each of these businesses.

Consumer finance earnings were up 32 percent year-over-year, driven by 36 percent receivable growth within our same prudent underwriting disciplines and prudent business practices.

The one soft spot in our business mix continued to be commercial loans, which remained essentially flat.

Despite recent evidence of a pickup in business activity in many of our regional markets, we have yet to see that translated into renewed commercial loan demand.

We believe our commercial loan portfolio has substantial upside potential, perhaps more so than at comparable stages in previous economic cycles.

Average commercial line utilization is about 5 percent below average usage two years ago, and during that same period we've been adding to the number of commercial relationships doing business with Wells Fargo.

Should national commercial loan demand pick up, we believe the competition of increased line usage on a higher base of accounts could be very powerful in terms of the quality commercial loan growth.

I would like to concentrate my remaining remarks on two important aspects of our third quarter results.

First, I'll describe in some detail the strategic actions we took during the quarter to take advantage of current markets, especially interest rates and equity markets.

Second, I'll separately go over a number of important aspects of our residential mortgage banking business.

Wells Fargo has always tried to take advantage of market conditions that, although they may hurt short-term results, will be more than made up for by benefits in the longer term.

In the third quarter we took a number of important strategic actions consistent with this approach.

First, we repositioned our bond portfolio for higher yield and we repaid previously issued high-cost term debt.

Taking advantage of unusually volatile interest rate movements during the quarter, we repositioned the bond portfolio by selling approximately 4 billion of intermediate and longer duration mortgage-related securities, with an average yield of about four percent, and when rates were higher intra-quarter, buying mortgage-backed securities at substantially higher yields.

By undertaking this action, we realized $23 million in bond losses, eliminating substantially all of the publicly traded mortgage-related securities in the available for sale fixed-income portfolio with embedded losses at the time of the sale.

And enhancing the yield on our bond portfolio above what it would have been if we had retained those securities.

As of September 30, the net unrealized gain on the bond portfolio overall was just under $1.4 billion.

Also taking advantage of interest rate movements, we retired $1.8 billion of previously issued intermediate term debt with an average cost of just under 5 percent.

This particular action reduced fourth quarter non-interest income by $125 million, but it will also enhance near-term net interest income and net interest margin.

Secondly, with the rapid run-up in the stock market since midyear, we decided to contribute selected highly appreciated stocks -- approximately 40 percent of our public equity portfolio -- to the Wells Fargo Foundation.

This is a very tax efficient way of funding our charitable giving and will reduce the need to incur expenses to fund the Foundation going forward, while significantly reducing our investment exposure to public equities.

This action impacted a number of different aspects of our income statement.

It generated $48 million of equity gains -- in other words, most of the $58 million in total equity gains earned by the Company in the quarter; it also resulted in $191 million of donation expense, since the stock is contributed at current market value; and in total, it reduced the Company's pre-tax earnings by $143 million and net income after tax in the third quarter by $48 million -- inclusive of all net tax benefits.

Given the very low tax bases of the donated stocks relative to market, the tax benefit realized on the donation of these particular stocks had the effect of reducing our corporate effective tax rate in the quarter and for the year.

Again, this tax benefit is already included in the net reduction in earnings reported from all of the strategic actions we took.

Next, a number of important actions were taken to improve operating efficiency going forward by consolidating facilities and operations.

One of our partially leased corporate facilities in Southern California was sold on favorable terms and an accrual was established for the announced closing of one of our processing sites in Texas, which was part of a strategy to consolidate processing operations in fewer locations.

These actions will reduce the amount of owned facilities by approximately 1.7 million square feet.

We also incurred systems and other expenses in the quarter to implement our strategy to consolidate our multiple bank charters into a much smaller number of legal entities.

We expect to incur additional expense to complete this effort in the next few quarters.

The charter consolidation will lead to a reduction in overhead and regulatory expense.

Taken together, the impact of all of these actions to consolidate facilities and operations amounted to a net reduction in net income before tax of $23 million.

Finally, several vendor contracts were renegotiated to more favorable terms.

The cost of renegotiating contracts added $19 million to expenses in the third quarter, and will result in ongoing reductions to equipment and software licensing going forward.

In total, the strategic actions taken during the quarter reduced revenues by $100 million, increased expenses by $233 million and had a bottom-line impact of reducing net income after all taxes and tax benefits by $171 million, or 10 cents per share.

As reported, 4 percent of the third quarter efficiency ratio was attributable to these actions.

Let me now turn to the mortgage business.

Our residential mortgage business remained robust in the third quarter.

We entered the third quarter with record applications, which resulted in record originations of $151 billion in the third quarter.

With the recent backup in mortgage interest rates, application volumes have declined, but even at September 30, 2003 (indiscernible) the level of $62 billion, the fourth quarter started with a relatively high level of applications in the pipeline.

We would expect to see a slowdown in applications due to the sharply reduced refinancings if interest rates continue to rise from current levels.

Residential mortgage banking growth since last year has had a significant impact on the Company's total revenue growth, but a much smaller impact on consolidated net income growth.

About 58 percent of the Company's total year-over-year revenue growth -- in other words, 11 percentage points of the reported 19 percent growth -- was due to residential mortgage.

This was driven by strong residential mortgage banking fees, which were up 302 million, or 64 percent, since last year, and an increase in the mortgage warehouse.

The average volume of mortgage loans held for sale rose $31 billion from the third quarter of 2002 to the third quarter of 2003.

Since we substantially reduced the amount of mortgage securities in our bond portfolio during the last year as the mortgage warehouse was growing, we have significant capacity to add to the securities portfolio should the warehouse mortgage decline.

72 percent of the year-over-year increase in residential mortgage revenue was offset by increased mortgage company expenses, which accounted for 47 percent of the consolidated company's year-over-year expense growth.

These mortgage expenses, which supported the record volume of originations, include production bonuses, sales commissions, overtime and temporary help.

They are largely variable costs which would be expected to come down should application and processing volumes slow.

Residential mortgage net income growth from a year ago was $108 million -- in other words, less than the $171 million after-tax impact of the strategic actions taken in the third quarter.

Both the residential mortgage results and the impact of the strategic actions are included in our community banking business, and are only two of the many drivers of profitability in that business.

If interest rates remain high and income from the origination part of our mortgage business slows, not only would we expect to see a reduction in origination-related expenses but we would also expect to see an increase in income from the servicing part of our mortgage business.

Indeed, mortgage servicing income has already begun to increase, with the third quarter servicing income up about $76 million from a year ago.

With the average life of the servicing portfolio doubling from 21 months to 43 months between the second and third quarters of 2003, we would expect to see a continuation of reduced servicing amortization and reduced need for further impairment provisioning if interest rates remain at or above September 30 levels.

The carrying value of mortgage servicing rights on the balance sheet increased from 3.8 billion at June 30, 2003, to 5.8 billion at September 30, 2003.

Of this $2 billion increase, $1.7 billion was attributable to real growth in the servicing book of business.

The 1.7 billion was comprised of purchased servicing, newly originated servicing, less the amortization of existing servicing.

The remaining increase in the capitalized mortgage servicing right reflected a $238 million required reversal in the impairment valuation reserve, due to the impact of higher interest rates on the value of the MSR offsetting in the profit and loss statement $206 million of net hedge losses that were also due to higher interest rates.

Our total owned servicing portfolio now stands at $674 billion, up 18 percent from a year ago.

Due to the record refinancing volume in the last several quarters, we have replaced higher note rate loans with lower note rate loans.

The average coupon (technical difficulty) 5.98 percent at the end of the quarter, the lowest average note rate we've ever had.

The cost (indiscernible) servicing portfolio is comprised of servicing originated at the lowest mortgage rates in 40 years, and because long-term rates have began to increase, the expected duration of our servicing portfolio doubled to 43 months.

And the reserve for our potential mortgage servicing impairment stood at $1.8 billion after all required and appropriate charges to the reserve in the third quarter.

Given the increase in size and duration of the servicing portfolio and given our disciplined approach to hedging, the potential value of this asset has increased substantially.

So in sum, mortgage banking had a great quarter in the third quarter, but should we see a slowdown in origination income from that business line, we would expect to reduce variable costs and we would expect to see enhanced servicing income from a larger and more valuable servicing portfolio.

Some final comments.

As previously reported, Moody's upgraded Wells Fargo Bank to AAA in the third quarter.

We are the only large bank in the United States to have the highest Moody's rating.

Even though Wells Fargo debt already traded at a premium to virtually every other large issuer financial institution, our debt costs have actually improved another 3 to 5 basis points following this upgrade.

We believe the upgrade reflects the value of our business model, and we are very pleased with the distinction accorded to Wells Fargo.

Standard & Poor's also upgraded our debt rating in early October.

Second, the Company increased its common stock dividend in the third quarter by 50 percent to 45 cents per share.

We do not anticipate changing our overall well-capitalized target capital ratios and we have continued to buy back shares.

During the quarter, we bought approximately 7 million shares, netting approximately $31 million under open board authority.

On October 16, Wells Fargo received approval from the Federal Reserve Board to complete the announced acquisitions of Pacific Northwest Bancorp and Two Rivers Grand Junction.

These are important bank acquisitions in our footprint and we welcome the employees and customers of those banks to Wells Fargo.

Finally, with respect to FIN 46, FASB announced a delay in implementing FIN 46 several weeks ago.

Our third quarter results have not been adjusted, but we will adopt FIN 46 when it is finalized.

As previously disclosed, its adoption will not have a material impact on our financial statements.

Thank you for listening.

If you have any questions, please call Bob Strickland, director of Investor Relations, at 415-396-0523.