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Bob Strickland - IR
Hello.
This is Bob Strickland.
Thank you for calling in to the Wells Fargo fourth-quarter 2006 earnings review pre-recorded call.
Before we talk about our fourth-quarter and full-year 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 future credit losses and credit quality generally and specifically the expectation that certain actions taken in fourth quarter 2006 will stabilize losses in the auto loan portfolio in early 2007 and will lead to improved loss rates in that portfolio, the belief that certain foreclosed assets have minimal additional loss content and the expectation that losses in the wholesale loan portfolio will increase modestly in 2007.
Additional forward-looking statements include the statement that future net interest income will be increased by approximately $320 million over the next 20 years as a result of the redemption of trust preferred securities.
The belief that opportunity remains for further increasing our cross-sell ratio to our stretch goal of eight and the statement that we expect to open 100 new banking stores in 2007.
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 SEC 8-K filed today, which includes the press release announcing our fourth-quarter and 2006 full-year results and to our most recent annual and quarterly report filed with the SEC and to the information incorporated into those documents.
Now I will turn the review over to our Chief Financial Officer, Howard Atkins.
Howard Atkins - CFO
Thanks, Bob.
Wells Fargo had an exceptional year in 2006, once again growing earnings per share at a double-digit rate and revenue at nearly a double-digit rate while improving our operating margins and further strengthening our balance sheet.
During the fourth quarter, we once again achieved our long-term financial goal of double-digit revenue and earnings per share growth.
Earnings per share grew 12% from a year ago to $0.64 and net income was up a very strong 13% from a year ago to $2.2 billion.
The strong performance in the fourth quarter was driven by solid loan growth, good deposit growth, double-digit growth in fee income and another increase in our industry-leading net interest margin.
Total revenue in the fourth quarter increased 11% from a year ago.
Combined revenue of businesses other than home mortgage was up an even stronger 14%.
We had double-digit revenue growth in businesses as diverse as Commercial Banking, Business Direct, debit cards, global remittance, home equity, corporate trust, asset-based lending, real estate brokerage, insurance, international, specialized financial services, and consumer finance.
Earnings and revenue were broad-based.
Both consumer and commercial earnings and revenue growth were strong.
Both spread income and fee-based income were strong.
We continued to have the widest net interest margin among large bank holding companies and in fact our net interest margin rose once again to 4.93% in the fourth quarter, up 14 basis points from the third quarter of 2006 and up nine basis points from last year.
The increase in the margin was driven by several factors.
First, during the third quarter, we sold our lowest yielding securities that had been hedging a part of our mortgage servicing rights and did not replace those securities at the lower long-term rates prevailing in the fourth quarter.
Second, we had solid growth in high-quality, higher-yielding commercial and consumer loans in the fourth quarter relative to securities and mortgages held for sale.
So average yields on earning assets rose as we experienced this better mix of earning assets.
And third, we continued to experience good deposit growth while maintaining disciplined deposit pricing.
Also, late in the fourth quarter, we culled $791 million in trust preferred capital securities that were issued in 1996 with an average coupon of about 8%.
While we incurred a $31 million cull premium expense during the fourth quarter, the redemption of these securities will add approximately $320 million to net interest income over the next 20 years relative to the cost of replacing this debt.
At 1.79%, our return on assets after all expenses and credit costs remained one of the highest in banking and improved three basis points from the third quarter despite a higher provision for credit losses in the fourth quarter of 2006.
At 19%, our return on equity remained one of the highest in the industry.
These strong operating and financial results were due to strength across our commercial and consumer businesses.
Let me give you some details on how our businesses performed.
Our wholesale commercial banking group, which serves middle-market and large corporate customers, once again had extremely strong results during the quarter.
Net income increased 14% from a year ago, driven by 22% revenue growth.
Wholesale banking accounted for 23% of Wells Fargo's consolidated earnings for the quarter and 25% of the consolidated earnings for all of 2006. 2006 was the eighth consecutive year of record net income for wholesale banking.
Revenue and earnings growth in wholesale were driven by strong loan growth and cross-sell success.
Loans to middle-market and large corporate customers within the wholesale banking group grew 16% year-over-year and 15% annualized linked quarter.
Asset-based lending, trade finance, real estate and specialized financial services, which includes our capital markets' activities and relationships with Fortune 500 companies, all experienced double-digit loan growth.
C&I loans, which includes commercial loans in our wholesale segment, as well as commercial loans in other segments, such as small business, have now grown in the last 13 consecutive quarters.
Average commercial and commercial real estate loans grew $11 billion or 11% from the fourth quarter of 2005 and $3 billion or 10% annualized on a linked-quarter basis.
At quarter-end, C&I loans accounted for 38% of total Wells Fargo loans.
Net credit losses in wholesale banking increased slightly from essentially zero through most of 2006.
We would expect losses to modestly increase in the wholesale portfolios in 2007 as these portfolios age and as recoveries of write-downs on older loans in the portfolio diminish.
Total commercial and real estate secured losses increased this quarter, but only minimally.
The largest loss related to a $7 million agricultural loan.
The other losses were small, not concentrated by geography or industry, and very typical of normal business activity.
Wholesale banking customers had a record cross-sell of six products and our middle-market commercial customers had average cross-sell of over seven products.
Our number one marketshare position in the western United States and our success at cross-sell is driving strong growth in fee income, which makes us somewhat less dependent on loan growth to maintain earnings growth.
Fee income, which includes fees from asset management, capital markets, equity investments, insurance, real estate brokerage and treasury management, contributed 58% of total wholesale banking revenues in the fourth quarter.
Let me highlight the growth drivers in a few of our wholesale businesses.
Our insurance business had strong results across its three main business units.
Accordia, our insurance brokerage company serving primarily middle-market business customers, reported record revenue by growing internally and successfully completing three acquisitions.
Productline revenue, a measure of sales, reached a record $621 million in 2006.
Rural Community Insurance, the largest writer of crop insurance in the nation, had its most successful reinsurance year ever, recording an underwriting gain of 31% of retained premiums.
Wells Fargo Insurance, serving individual and small business customers, increased partner referrals from Wells Fargo's retail bankers this year by over 100%.
This year, Wells Fargo asset management group became the 23rd largest U.S. money manager, up two notches from 2005 and all organic growth.
Over 80% of the 53 Wells capital investment style composites outperformed their relative benchmarks.
Half of the Wells Fargo family of mutual funds are now in the top two Lipper performance quintiles.
Our international business also had double-digit revenue growth for the year.
The business attracts deposits from a variety of relationships and very attractive rates due to our cross-sell success and our AAA rating.
The foreign exchange business continued to grow with 14 foreign exchange desks nationwide and in fact, Wells Fargo now trades one of the largest volumes of foreign exchange sales with customers of any bank in North America.
We increased our international teller sites by 17% during the year.
We now have over 350 locations.
In 2006, we became the first major U.S. bank to enable customers to wire money account to account between the United States and China and Vietnam.
Our remittance business is now in seven countries and growing.
In our asset-based lending business, we completed the acquisition of Evergreen Funding, a Dallas-based receivables factoring firm, and Commerce Funding, a Virginia-based receivables factoring firm.
Also, we continue to add commercial banking offices both inside and outside of our original banking footprint.
Earlier in the year, we opened offices in New Jersey and Buffalo, New York.
These new locations are already generating cross-sell of close to six products per relationship.
In the fourth quarter, we opened a new office in Pasadena, California and Pittsburgh.
All in all, an incredible year of growth and strong profitability in our commercial banking business.
Let me now shift to consumer and small-business banking.
Regional banking, which includes our retail store network, had another great quarter with 4.5 million core product sales, a 19% increase from the prior year.
We are now averaging 1.5 million sales per month.
Only two years ago, we were at one million per month.
Cross-sell continued to improve with a record high of 5.2 products for consumer household, up from 4.8 products a year ago and approximately three products in 1998.
We continued to be successful in selling Wells Fargo packages, which include a checking account and at least three other products, such as a debit card, a credit card, savings account, or home equity loan.
Package sales were up 34% from the fourth quarter of 2005 and are now purchased by 63% of new checking account customers.
We continue to believe that opportunity remains for further increasing our cross-sell ratio to our stretch goal of eight.
Already 20% of our customers have over eight products with us, up from 17% a year ago and approximately 12% five years ago and in our top region, 29% of our customers maintain over eight products, up from 26% a year ago.
Customer penetration and usage of debit and credit cards continued to increase.
At quarter-end, 35% of our retail bank consumer households had a Wells Fargo credit card, up from 33% a year ago and up from 23% five years ago.
Purchase volume on these cards was up 21% from a year ago and average balances were up 19%. 91% of our consumer checking account customers had a debit card, up from 83% five years ago and purchase volume increased by 15% from a year ago.
Growth in sales and usage by our retail banking households contributed to total card fees increasing by 22% from the fourth quarter of 2005.
Average consumer loans decreased $6.3 billion from the fourth quarter of 2005, but excluding the real estate one-to-four family first mortgages, the loan category impacted by ARMs sold during the past year as part of the balance sheet repositioning strategy completed in the second quarter of 2006, average consumer loans continued to grow at a healthy pace, up 16% year-over-year.
On an annualized linked-quarter basis, real estate one-to-four family junior loans grew 13%; credit card balances grew 29%; and other revolving credit and installment loans grew 9%.
Excluding real estate one-to-four family first mortgages, we have had double-digit, year-over-year consumer loan growth every quarter since the second quarter of 2002.
Average core deposits grew 6% from a year ago and were up 11% annualized on a linked-quarter basis.
Average mortgage escrow deposits were up $2.5 billion from the fourth quarter of 2005 and up $846 million from the third quarter of 2006.
Excluding mortgage escrow balances, total average core deposits grew 5% from the fourth quarter of 2005 and accelerated to an 11% annualized growth rate on a linked-quarter basis.
Average retail core deposits, which exclude wholesale banking and mortgage escrow deposits, were up 3% from a year ago and accelerated to 7% annualized on a linked-quarter basis.
Consumer checking accounts were up a net 4.7% from last year and small-business checking accounts were up a net 4.3% from last year.
We are particularly pleased with the growth in consumer checking accounts in our largest market, California, which were up a net 5.6% despite the competition for accounts and customers in this market.
This is the sixth consecutive quarter where net new accounts in California exceeded the average across our footprint.
The incredible success we have had in growing net new accounts in California and throughout our deposit footprint reflects both the success we have had in attracting new customers, as well as retaining customer accounts due to our convenience, service and relationship focus.
We maintained our disciplined deposit pricing during the quarter while competitive pricing pressure abated somewhat in most of our markets, including in California.
We continued to invest in our retail distribution.
In 2006, we opened 109 regional banking stores, including 33 stores during the last quarter, and we expect to open another 100 stores in 2007.
In the last year, we added 1914 platform banker FTEs, including 326 during the fourth quarter.
The number of Internet customers continued to grow.
At quarter-end, we had 8.5 million active online consumers, up 18% from a year ago. 61% of all Wells Fargo consumer checking account customers are now active online customers, almost double the rate of four years ago.
We had 4.8 million bill pay customers, up 43% from a year ago and active online small-business customers increased 25% from a year ago.
We also increased Internet sales with consumer product sales up 29%, checking accounts up 20%, savings accounts up 41% and credit card sales up 40%, all from the fourth quarter of 2005.
These strong financial results are due in part to the progress we are making in improving customer service.
We strive for our customer loyalty, not just satisfaction.
In regional banking, we conduct 50,000 store-based customer surveys per month as part of our focus on the customer experience.
For our customers transacting at the teller line, welcoming and wait time scores have improved 44% and customer loyalty scores have improved 32% since January 2004.
Since beginning the surveys in January 2004, our average profit per household has improved 26% and the percentage of households in our outstanding profit tier, our highest profitability tier, has increased by 41%.
We began surveying customers following interactions with our platform bankers in July 2005.
We have seen a 13% improvement in the overall customer experience during that time period.
We have learned that team member engagement directly impacts the customer experience.
The Gallup Organization helps us survey our team members to assess their level of engagement with Wells Fargo and their local work team annually.
In 2006, the ratio of engaged to actively disengaged team members in regional banking rose to 7.1 to one, up from 5.8 to one in 2005 and more than three times the U.S. average of 1.9 to 1.
This puts Wells Fargo in the top quartile of all companies in the Gallup team member engagement database.
We continued to focus on better serving our small-business customers.
Sales of store-based business solutions in the fourth quarter were up 18% from last year.
Net business checking accounts were up 4.3% from the fourth quarter of 2005 and these strong sales results increased our cross-sell to our business banking households to 3.3, up from 3.0 a year ago.
According to the most recent Wells Fargo Gallup small-business index completed during the fourth quarter and based on a nationwide survey of small-business owners, small-business owner optimism is at its highest point.
This optimism is reflected in our overall lending to small business owners.
Bank loans to small businesses, loans less than $100,000 on our Business Direct platform, grew 18% from the fourth quarter of 2005.
For the full year, loans to small businesses increased 19% from 2005.
For the fourth consecutive year, Wells Fargo is America's number one small-business lender based on 2005 total dollar volume with a 19% nationwide marketshare of bank loans less than $100,000 for the calendar year 2005.
Our small-business bankers talked to thousands of small-business owners every day and access to capital is always top of mind when discussing key business priorities.
Our goal is to continue to deepen our relationships with the 1.5 million small-business households we serve.
Private Client Services, PCS, our private banking and investment business, achieved record results in 2006 with earnings up 14%.
This growth was driven by 15% growth in average deposits and 8% growth in loans along with strong growth in investments.
A year-end stock market rally helped increase brokerage assets under administration to record levels to $88 billion, up 19% from 2005.
Our industry trendsetting Wells trade relationship-based pricing offer, which rewards customers who have broad brokerage and banking relationships with Wells Fargo with some of the lowest commission rates in the industry, increased our self-directed assets under administration by 36% during the quarter.
PCS continues to hire well-qualified private bankers to better serve customers.
At year-end, the number of private bankers was over 800, up 16% from year-end 2005 and up from less than 200 a few years ago.
In 2006, PCS completed the rollout of a team-based integrated service model to its high net worth client base under the new Wells Fargo Private Bank brand.
Wells Fargo Private Bank delivers a customized approach to wealth management through local, dedicated teams of specialists who work with clients who have Wells Fargo relationships in excess of $1 million.
Part of Wells Fargo Private Bank is the new family wealth group, which caters to the unique needs of clients who manage their wealth as a financial family enterprise.
The group provides the services of a multi-family office to clients with typically greater than $50 million in net worth and $25 million in liquidity.
At year-end, PCS served over 35,000 clients with greater than $1 million with Wells Fargo, representing almost $130 billion in assets.
Let me now turn to the mortgage business.
Although down from 2005, mortgage volumes remained respectable in 2006.
Net of co-issue, mortgage originations were $70 billion in the fourth quarter, down about 20% from $88 billion a year ago and down 9% from $77 billion in the third quarter.
For the first time in 2006, mortgage gain on sale margins widened slightly in the fourth quarter due to strong investor demand in the secondary market.
Mortgage applications in the fourth quarter were at $90 billion, down only slightly from $95 billion in the third quarter, but actually up $1 billion from $89 billion a year ago and the unclosed pipeline of $48 billion at year-end comes into 2007 at essentially the same level as the pipeline coming into 2006.
Even though mortgage interest rates were slightly higher than a year ago, the flat yield curve and decline in mortgage rates since mid-2006 has actually stimulated refinancing activity.
For example, as a percent of applications, re-fis rose from 34% at mid-year 2006 to 40% in the last quarter.
The mortgage servicing portfolio continued to grow steadily.
Gross servicing fees of $1 billion were up 50% from a year ago.
About $140 million of which was due to the mid-year acquisition of a servicing portfolio with 1.3 million customers from Washington Mutual.
Our owned servicing portfolio was $1.37 trillion at quarter-end, up 38% from a year ago and mortgage servicing customers of 7.6 million were up 37% from a year ago.
During the fourth quarter, the impact of interest rates and interest rate spreads on mortgage servicing valuations net of hedging results was negligible.
Operating expenses on the originations side of the business continued to be reduced in the fourth quarter while expenses on the servicing side of the business, including the costs of operating the servicing portfolio and associated operating platform acquired from Washington Mutual in the third quarter, increased as the size of the servicing portfolio continued to grow.
Earnings at our consumer finance company, Wells Fargo Financial, increased from $98 million a year ago to $161 million in the fourth quarter of 2006.
Last year's results were reduced by higher than normal charge-offs attributed to the change in bankruptcy law enacted in that quarter.
Earnings were driven by a 22% increase in average loans.
During the fourth quarter, Wells Fargo Financial sold the remaining consumer lending operations in Latin America, which will enable them to focus on their core businesses in the United States and Canada.
This was a small deal involving only $120 million in assets.
As expected, auto losses were essentially flat from the elevated losses we experienced in the third quarter of 2006 due in part to growth, seasoning, and typical end of year seasonal factors, which result in higher losses.
We continued to work vigorously in the quarter to resolve the issues previously disclosed connected with the impact of the integration of our various auto loan platforms on extensions, delinquencies and losses.
In the fourth quarter, we continued to hire and train new collectors, adding 200 and contracted with external collection vendors, increasing capacity by 150 collectors.
We also adjusted account acquisition strategies and pricing to reduce new loan volumes, particularly in higher-risk tiers.
Auto loans grew approximately 7% annualized from the end of the third quarter compared with a 29% increase in auto loans from the fourth quarter of 2005.
Loan extension levels returned to a more normal level in the fourth quarter and we anticipate that all of these actions taken will stabilize losses in early 2007 and lead to improved loss rates.
We monitor vintage credit performance in autos and all of our other portfolios and saw higher delinquency and losses in recent auto vintages consistent with industrywide trends.
One reason for the increase in auto delinquency and recent auto vintages is that we are applying most of our collection capacity to the accounts that have been delinquent the longest in order to help mitigate losses.
However, we did not see any material deterioration in any of the vintages, including the most recent vintages, in our other consumer portfolios, including credit cards and home equity.
While we are disappointed with the short-term performance of our $27 billion auto portfolio, this portfolio has good, underlying credit characteristics.
Over 70% of the auto portfolio has a FICO score above 620 and that is up from 65% last quarter and 80% of new originations have a FICO above 620.
At quarter-end, Wells Fargo Financial's $22 billion real estate secured portfolio was up 18% from a year ago.
This growth rate has slowed from recent quarters due to higher rates and slower growth rates in home values.
At quarter-end, almost 90% of Wells Fargo Financial's real estate portfolio was U.S.-based and non-revolving.
The average FICO score on this portfolio was 644 and the average loan-to-value was 72%.
95% of Wells Fargo Financial's real estate secured portfolio was in the first lien position and the average loan size was $119,000.
Approximately 38% of the portfolio was fixed-rate and funded with fixed-rate debt and 62% were three-year ARMs, also essentially match funded.
The majority of the ARM products are repaid prior to repricing.
Wells Fargo Financial does not offer interest-only loans and requires full documentation and income verification.
Residential real estate secured loans represented 38% of our loans outstanding, down from 44% a year ago.
At quarter-end, we had $53 billion in one-to-four family first mortgages on our balance sheet, representing 11% of total assets, down from 16% a year ago and down from 20% in the fourth quarter of 2004, reflecting the large sales of lower yielding ARMs.
36% of our one-to-four family first mortgages were originated at Wells Fargo Financial and approximately 65% of this portfolio had a FICO score above 620 and 24% of our one-to-four family mortgages were home-equity loans that were in a first lien position.
We do not offer or portfolio any negative amortizing or option ARMs.
We obtain mortgage insurance on higher loan-to-value loans at Wells Fargo Financial and Wells Fargo Home Mortgage and we monitor regional economic and real estate trends and modify underwriting standards as needed.
The credit performance of our real estate secured portfolio also benefits from the fact that Wells Fargo continues to be among the highest-rated loan servicers for prime and non-prime loans.
High-quality servicing improves customer service and has been demonstrated to result in lower foreclosures and losses.
At quarter-end, 17% of our $79 billion national home equity group portfolio was in the first lien position and approximately 55% of the portfolio in a second lien position was behind a Wells Fargo first mortgage.
The average FICO was 746 and the average combined loan-to-value was 57% based on outstanding balances and 68% including unused commitments. 54% of the portfolio was fixed rate and 71% of new production during the quarter was fixed rate.
All loan portfolios, excluding auto, continued to perform at or better than expectations in the fourth quarter.
Loss rates increased modestly from 0.86% in the third quarter to 0.92% in the fourth quarter and were in line with 0.91% in the fourth quarter of 2005, which included $171 million of incremental losses attributed to bankruptcy legislation enacted during that quarter.
We saw a modest increase in residential real estate losses from very low run rates and commercial losses increased, but also remain very low.
Non-performing assets increased $316 million on a linked-quarter basis, consisting of an increase in foreclosed assets of $139 million and an increase in non-accrual loans of $177 million.
The foreclosed assets were carried at net realizable value and we believe have minimal additional loss content.
First of all, $56 million of the $137 million increase in foreclosed assets were Ginnie Mae loans, which are fully collectible because they are insured by FHA or guaranteed by the VA.
The $81 million increase in other foreclosed assets included residential real estate loans and repossessed autos and have already been written down to net realizable value.
With respect to the increase in non-accrual loans, $93 million of the increase was in residential real estate first mortgages, which we view as normal seasoning.
The $75 million increase in commercial non-accrual loans reflected a normal increase from the unusually low levels of the past several quarters.
The $543 million of total commercial and commercial real estate non-accrual loans at year-end remained at historically low levels and had minimal land real estate construction or condo conversion exposure.
A few other items in closing.
Our private equity portfolio continued to generate gains as it has now done for 14 consecutive quarters and it had a cost basis of $1.7 billion at year-end.
At year-end, we had $204 million of unrealized gains in our public equity portfolio and we had an additional $722 million in unrealized gains on debt securities available for sale at year-end reflecting one of the best yielding fixed income portfolios among U.S. banks due to our continued and long-standing focus on long-term yields.
Combined, our securities available for sale portfolio had unrealized gains of $926 million.
As I mentioned earlier, we culled approximately $800 million in trust preferred capital securities with an average rate of 8% late in the quarter.
Because we were able to refinance the trust preferred securities at a rate approximately 200 basis points lower, our interest expense will be reduced by approximately $320 million over the next 20 years.
We also issued new hybrid preferred capital during the quarter at the lowest premium ever paid by any U.S. corporation for permanent capital like these securities.
Wells Fargo Bank was upgraded by Standard & Poor's in 2006 and they have put us on positive watch for a possible AAA rating, which, if it happens, would make us the only U.S. bank with a double triple, a AAA from both large rating agencies.
During the quarter, we bought back 11 million shares of Wells Fargo common stock and 61.8 million shares remained available for repurchase on the board authority at quarter-end.
Last week, we announced that the acquisition of Placer Sierra Bancshares with $2.7 billion in assets.
This is our largest bank deal since the Pacific Northwest acquisition in 2003.
Placer Sierra, with 50 stores in California, is exactly the kind of fill-in acquisition that we love.
It increases our retail distribution in a fast-growing state while meeting our internal rate of return target of at least 15%.
So in conclusion, we ended 2006 setting new records for earnings per share and revenue while we continued to invest in our distribution channels, our team members, and our technology to better serve our customers in 2007, our 156th year of meeting our customers' financial needs.
Thank you for listening, and if you have any questions, please call Bob Strickland, Director of Investor Relations, at 415-396-0523.