富國銀行 (WFC) 2010 Q1 法說會逐字稿

Good morning.

My name is Celeste and I will be your conference operator today.

At this time, I would like to welcome everyone to the Wells Fargo first-quarter 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).

I would now like to turn today's call over to Mr.

Bob Strickland.

Please go ahead, sir.

Good morning.

Thank you for joining our call today during which our Chairman and CEO, John Stumpf and CFO, Howard Atkins, will review first-quarter 2010 results and answer your questions.

Before we get started, I would like to remind you that our first-quarter earnings release and quarterly supplement are available on our website.

I would also like to caution you that we may make forward-looking statements during today's call and that those forward-looking statements 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 and the earnings release and quarterly supplement included as exhibits.

In addition, some of the discussion today about the Company's performance will include references to non-GAAP financial measures.

Information about those measures, including a reconciliation of those measures to GAAP measures, can be found in our SEC filings and in the earnings release and quarterly supplement available on our website at WellsFargo.com.

I will now turn the call over to our Chairman and CEO, John Stumpf.

Thanks, Bob and thanks to everyone who has joined us on this call.

We appreciate your interest in Wells Fargo.

Before I turn this over to Howard Atkins for a more in-depth review of our results this quarter, let me review some highlights from the quarter and why I am excited about how Wells Fargo is positioned for the future.

Our first-quarter results reflect underlying strength with revenue growth that demonstrates the power of our diversified business model and combined franchise.

In fact, during the challenging economic environment of the past couple of years, which continues to affect employment, housing values, loan demand and interest rates, we have been afforded a great opportunity to clearly demonstrate how well our business model works for our customers and for shareholders, no matter what the economic conditions are.

This wasn't by chance, but reflects the benefit of our long-standing focus on diversification.

Our team has continued to meet our customers' financial needs while pulling together to make our merger with Wachovia the largest in US banking history a success.

Over the past year, we have completed a tremendous amount of work behind the scenes, choosing and enhancing systems and products, aligning jobs and completing detailed integration plans, so we are now well-prepared for the more visible work you will see happening this year and next.

To date, we have converted a number of business lines, including mortgage and credit card, and four of our overlapping banking states and we are preparing to complete the California conversion this weekend.

Texas, our last overlapping state, will be converted in July.

Our eastern states will begin converting in the third quarter and we are on schedule to complete all conversions by the end of 2011 as we had planned.

This merger has been a team effort and our entire team is working exceptionally well together.

Culturally and financially, this merger is exceeding my expectations and I couldn't be more excited about the opportunities ahead.

At this point, we believe we have turned the corner on many of the credit challenges of the past two years.

Throughout this economic downturn, we have continued to lend to our customers, but customer demand and therefore earning asset growth remains soft.

Against this backdrop, it is important to note that we remain firmly committed to our discipline in managing credit risk and interest rate risk and to managing our Company for long-term earnings growth, not short-term quarterly results.

In short, we believe we have had demonstrable success throughout these tough economic times and we have positioned our franchise well for better economic times ahead.

We have held onto customers by providing a full spectrum of products and services to meet their needs throughout this period.

We have dominant market positions in consumer, commercial, retail brokerage and other key business areas.

We have a tremendous nationwide distribution network.

In other words, Wells Fargo has proven to have the right business model and is right where it needs to be to be successful going forward.

In our view, while the US economy is gradually regaining its footing, it has yet to deliver a broad-based recovery for our country and for many of our customers.

Though the signs of strength we are seeing in the economy are encouraging, we are not counting on them alone to deliver the performance you have come to expect from Wells Fargo.

I'm confident our Company will continue to find and leverage opportunities that are unique to our diversified business model, our valued customer relationships and our disciplined approach to managing our balance sheet.

Now let me turn this over to Howard Atkins, our Chief Financial Officer.

Thank you, John.

My remarks will follow the presentation that is included in the first-quarter quarterly supplement that is available on the Wells Fargo Investor Relations website and I am going to focus in on first-quarter earnings, capital and credit.

Slide 3 of that presentation provides a high-level summary of the key messages about our first quarter.

There are essentially three things I would like you all to take away from our first-quarter results.

First, we are very pleased with the $2.5 billion profit that was earned in the quarter, but we are even more pleased with the way that those results were achieved.

Our earnings were broad-based.

Each major business segment earned money and each contributed to the overall earnings result.

Businesses as diverse as trust and investments, debit card, merchant processing, insurance, asset-based lending, real estate brokerage, all had very strong revenue growth year-over-year.

In essence, as we think about our earnings, our earnings continue to come from core retail and commercial banking.

Less than 3% of our total revenue this quarter was from trading and market-sensitive income and less than 5% of our total revenue was from net mortgage hedging results.

The second message is that credit appears to have turned the corner.

When we look back at this period, we will likely mark the third quarter of 2009 as the peak in provision expense and the fourth quarter of 2009 as the peak in charge-offs.

Provision expense, charge-offs, early-stage delinquencies, roll rates on both the impaired and unimpaired Pick-a-Pay portfolios and inflows to non-accruals all continued to show improvement in the first quarter in both the total consumer and total commercial portfolios.

In part, this is related to the gradual improvement we have seen in housing and labor markets, but this largely reflects the actions we have taken beginning almost three years ago to reduce risk and reduce loss in our loan portfolios.

And our third message is we continued to build capital in the quarter.

Our balance sheet, which has always been very strong, has never been as strong as it is right now.

So let me delve into these key messages in a little bit more detail.

On slide 4, you can see that we earned again over $2.5 billion in net income after tax in the first quarter.

That equates to $2.37 billion net income to common, roughly in line with the net income available to common we earned in the first quarter of 2009, which was a record at that time and we earned that even with the decline in loans and increase in merger integration expenses from last year.

Diluted earnings per share, of course, in the quarter was $0.45.

We have always had among the best operating margins among large peers and we continue to do so in the first quarter, as you can see on slide 5.

One of the key metrics we look at is return on assets.

This is the metric where growth, operating margin and risk discipline all meet.

We have always had one of the highest return on assets among large peers and we once again had among the highest in the first quarter at 84 basis points.

We would like to see our return on assets closer to the 1.5% we have earned historically.

Our return on assets is typically higher than our peers for four reasons.

First, our net interest margin tends to be higher.

Our NIM was 4.27% in the first quarter, up 11 basis points year-over-year, largely reflecting the fact that we continue to experience very strong growth in checking and savings deposits, which were up 12% year-over-year.

Secondly, we tend to have a lower credit loss rate on our loan portfolio because of our strong underwriting discipline and the concentration of our loan portfolio in lower loss rate real estate secured loans.

Third, we tend to have a very positive operating leverage.

Our efficiency ratio in the quarter was 56.5%, in line with the prior quarter's post-Wachovia's acquisition.

And fourth, a higher proportion of our total revenue comes from fee income, which is less asset-intensive and this derives from the cross-sell model that we have always had at the Company.

Our business model also generates internally lots of new capital, which is why we have among the highest ROEs among large commercial bank peers even as our total capital increases.

Now we have always been committed to maintaining a strong capital position for growth that is consistent with our risk profile.

As you can see on slide 6, our capital ratios are now higher than pre-Wachovia and pre-TARP levels, while, at the same time, we are a more balanced, more diverse, less risky company with Wachovia in the mix.

We are certainly more diversified geographically, by customer segment and by source of income.

Our capital ratios have been growing rapidly because our business model produces such a high rate of internal capital generation.

In the first quarter, we added 60 basis points to Tier 1 common, all internally generated.

As I see it, we have never been better positioned in terms of our balance sheet strength.

Our Tier 1 capital is now at $98 billion.

Our allowance for credit reserves is now at $26 billion.

The remaining non-accretable difference for purchase credit impaired loans is almost $20 billion.

Our mortgage repurchase reserve is $1.3 billion and we have $7.4 billion of unrealized gains in our available-for-sale securities portfolio.

We are more liquid and have greater capacity to add assets than at any time in my tenure as the CFO of this Ccompany.

We would love to see more loan demand or add more securities, but we are not willing to compromise our underwriting or pricing requirements or add long-term securities at what we believe to be low, long-term yields.

Now despite a 7% decline in loans year-over-year, our total revenue is actually up 2%.

There are four reasons for this increase as I see it.

First, our NIM, as I mentioned before, was up 11 basis points.

That is a function of strong deposit growth and the strong composition of checking and savings that we have in our overall deposit mix.

Secondly, as John mentioned, we are already realizing revenue synergies from the Wachovia acquisition.

Cross-sell is going up at Wachovia.

We have got a broader distribution of core banking products through Wachovia's powerful financial advisor channel and the application of Wachovia's product set to the Wells Fargo customer base is also adding revenue.

Third, the breadth of our business model clearly contributes to our overall revenue.

Other revenue sources, of course, made up for the decline in lending income, including trust and investment fees, which were up 20%, insurance revenue up 7% and processing and other fees, up 14%.

Fourth, underpinning all of the above is the continued growth in cross-sell in our Company.

So on cross-sell, retail banking -- the retail banking business achieved record sales of $7.81 million solutions, sales in other words, in the first quarter, up 16% from a year ago and also record cross-sell, which crossed six products per household on average.

Keep in mind that this increase in the average products per household has been occurring on a growing base of households.

In other words, productivity is going up, as well as deeper product penetration.

One of the main opportunities from the Wachovia merger was to deepen customer relationships at Wachovia through cross-sell.

When we acquired Wachovia, we estimated that the retail cross-sell was about 4.5 products on average compared with Wells Fargo's 5.8.

So getting Wachovia just to where Wells Fargo was a year ago represents about a 30% lift to revenue from Wachovia's retail customer base, which is roughly the same size as the legacy Wells Fargo customer base.

By applying Wells Fargo's retail business model to the East footprint, we are well on our way to realizing that opportunity.

Legacy Wachovia cross-sell increased from 4.55 products to 4.85 products, which helped drive the overall Company's revenue growth year-over-year.

Slide 9 shows you our loans.

A couple of key points on this.

First, we continue to supply large amounts of credit to the US economy, over $128 billion in new originations and loan commitments just in the first quarter of 2010.

But as John indicated, loan demand overall remains soft.

Now, we did see some signs of growth in loans in some portfolios.

Auto loans, for example, increased 14% linked quarter annualized.

Student loans increased 13% linked quarter annualized and anecdotally, we are also experiencing more conversations at least with commercial customers about their potential credit needs.

But fundamentally, we don't expect material new loan demand until the economic recovery really takes hold.

Fortunately and typically when that happens, Wells Fargo tends to get the first shot at the loan because the customer already has all its other noncredit businesses with us.

When we acquired Wachovia, we committed to aggressively reduce the higher-risk nonstrategic assets that we inherited from Wachovia and as you can see on slide 10, we have continued to do that.

Reducing the Pick-a-Pay portfolio, indirect home equity and Wells Fargo's indirect auto portfolios, a combined $23 billion or about 20% since the merger.

To put that in context, about a third of the decline we have experienced in our total loan portfolio since acquiring Wachovia is from our actions to reduce risk, not from reduced loan demand.

On deposits, slide 11, we continue to get great deposit growth.

We measure success in deposits in one fashion by looking at our net gain.

In other words, net new checking accounts.

Net new checking accounts are up 7% year-over-year for the Company.

In fact, in two important markets, one on the west coast, California, one on the East Coast, New Jersey, those markets are experiencing net gain growth that is well above the average across our footprint.

Period-end checking and savings deposit balances were up 12% year-over-year and very importantly, 88% of our core deposits are now in the form of checking and savings accounts.

So we continue to appear to be the bank of choice for our consumer and business customers to place their operating balances.

We now have run off almost all of Wachovia's higher-rate CDs with only about $5 billion maturing in 2010.

And throughout this process, including the first quarter of 2010, we were very successful in retaining those deposits into lower-rate checking, savings and CDs.

A couple comments on expenses, slide 12.

As you can see, our operating expenses were relatively flat year-over-year.

When we think about expenses in the Company, essentially we break down into three important missions for managing expenses.

First, we are endeavoring to achieve the targeted consolidation expense savings.

We calculate that we have already realized about 70% of the annualized savings on an annualized run rate basis.

In the first quarter of 2010, we incurred $380 million of integration costs.

That is up from $205 million a year ago and we expect to incur approximately $2 billion in integration costs during 2010, roughly in line with our original expectations.

We are entering the more challenging part of the integration, as John mentioned before, but so far, we have achieved all the milestones.

Everything is on schedule and we still expect to realize the $5 billion in run rate saves [from] systems and store conversions are fully completed in late 2011.

The second mission is on problem loans.

We are diligently but quickly resolving problem loans on foreclosed assets [with a view towards] resolving problems as quickly as we can and ultimately reducing the costs that are connected with the resolution process.

Costs connected with credit resolution were up about $250 million from the first quarter of 2009, but trailed off by about $25 million from the fourth quarter of 2009.

And third on expenses, we continue to invest for long-term revenue growth, particularly in building distribution for sales and technology for customer service.

A couple of things on the individual business lines I would like to point out.

As I mentioned before, each of our main business lines -- community banking, wholesale banking, wealth and brokerage services -- were profitable in the quarter.

Quickly, on community banking, as you can see on slide 13, we had record sales, record cross-sell, very strong deposit growth.

The mortgage servicing portfolio reached $1.8 trillion, up 2%.

At the end of the quarter, the mortgage application pipeline was up about 4% from the prior quarter.

In wholesale banking, slide 14, wholesale banking has been very consistent in producing solid revenue growth.

In the first quarter this year, revenue growth once again was up 9% from a year ago despite the decline in commercial loan demand over the last year.

And in the asset management group, we have now reached $465 billion in assets under management.

In wealth brokerage and retirement services on slide 15, we are getting very solid growth in this business.

Revenue was up 16% from the first quarter of '09 and we have now reached $1.1 trillion in retail brokerage client assets.

That is up 22% year-over-year.

Let me now turn to credit.

Slide 16 provides some detail on the impact of adopting FAS 167 on our credit portfolios.

It is important to understand this detail in order to understand the underlying trends in credit quality at the Company.

While FAS 167 had only a one basis point impact on Tier 1 common, it added $909 million to non-accruals in the quarter and $123 million to charge-offs in the quarter.

In addition to the charge-offs from FAS 166, 167, charge-offs in the first quarter included $145 million related to newly issued regulatory charge-off guidance applicable to collateral-dependent residential real estate loan modifications.

That relates to high LTV, low FICO, interest-only, consumer real estate mods that have already been reserved for.

So with that as perspective, on slide 17, as John indicated before, we believe that credit at Wells Fargo has indeed turned the corner.

Provision expense appears to have peaked in the third quarter of 2009 and the first quarter of 2010 provision expense of $5.3 billion was down almost $800 million from the peak and about $600 million from the fourth quarter of 2009.

As indicated in the slide, the $5.3 billion provision expense in the quarter included the $145 million for collateral-dependent loans and the $123 million for FAS 167.

So provision expense for all other charge-offs was $5.06 billion, down from $5.41 billion in the fourth quarter on an apples-to-apples basis.

Two quarters ago, as you can see on slide 18, we were one of the first and few banks to project a peaking in credit costs and we now believe charge-offs already peaked in the fourth quarter, earlier than we previously thought.

Commercial and commercial real estate losses actually declined $356 million in the quarter, declining in all major commercial categories -- C&I lending, commercial real estate and lease financing.

Losses in our $132 billion commercial real estate portfolio declined in the first quarter by $59 million, reducing the net charge-off rate to about 2%.

This portfolio is secured by a well-diversified mix of property types across wholesale banking, community banking and wealth brokerage and retirement services.

The performance of the CRE portfolio has benefited from some price stability, increased liquidity and the actions we have taken over the past year focused on restructuring disposition and workout strategies.

Slide 18 also indicates where we have charge-offs in the consumer portfolios for FAS 167 and modified loans.

Apart from those two items, all other consumer charge-offs were essentially flat in the quarter with all other revolving credit and installment charge-offs actually down largely due to improved auto finance markets.

One of the reasons we are confident credit has turned is the stabilization and improvement we are experiencing in early-stage delinquencies across the major consumer portfolios as you can see on chart 19.

Card and auto delinquencies stabilized in the middle of last year and showed noticeable improvement in the most recent quarter.

Secured real estate is taking a little longer, but began to show improvement in delinquencies in the first quarter of 2010.

Our $125 billion non-PCI home equity portfolio also demonstrated some positive credit trends in the first quarter.

The delinquency rates on this portfolio, two or more payments past due, decreased in the first quarter to 3.4%, down from 3.58% in the fourth quarter.

Delinquencies declined in both the liquidating and the core portfolios and for loans in both California and Florida.

Delinquency rates on loans in the core portfolio with a combined LTV above 100% were only 5.27% as the vast majority of customers with negative equity continued to make their payments.

On March 17, we announced that we signed the agreement for the second-lien modification program and we expect to begin offering the second-lien programs to customers who have both a Wells Fargo first and second lien customers within the next couple of weeks and we will offer the program for other customers later in the second quarter.

On the Pick-a-Pay portfolio, which is highlighted on slide 20, roll rates on both the impaired and unimpaired Pick-a-Pay portfolio continued to trend better.

The size of the Pick-a-Pay portfolio continued to decline in the quarter with $82.9 billion outstanding at quarter-end, down over $10 billion from a year ago.

This portfolio continued to perform better than expected at the time of the merger, driven by 57,000 completed modifications experiencing lower than industry redefault rates and stabilization in home prices in certain markets where we have significant outstandings.

This quarter, the current LTVs actually declined in both the impaired and nonimpaired Pick-a-Pay portfolios.

Early-stage delinquency trends improved, 30 days past due loans stabilizing and showing early indications of improvement in both the PCI and nonimpaired portfolios.

We also saw continued improvements in first-time delinquencies, which are the percentage of new 30 plus day delinquent loans that are delinquent for the first time in the life of the loan.

In the nonimpaired portfolio, the percentage of first-time delinquents has dropped for four consecutive quarters and in the PCI portfolio, the ratio of first-time delinquents was at levels not seen since early 2008.

These improved trends led to our confidence in releasing $549 million of the remaining $14.5 billion non-acceptable difference into accretable yield related to the improved life of loan loss estimates that we now see.

And this compares with only $27 million released in all of last year.

This increase in accretable yield, of course, will be recognized through interest income over many years.

Let me now turn to non-accrual loans on slide 21.

Non-accrual loans, as you can see, were up in the quarter.

$909 million, of course, as I said, related to the FAS 167 amounts, but we do not believe that the increase in non-accrual loans translates into increased future losses since these non-accruals have either already been written down or their expected loss content has already been reserved for.

A couple of important statistics on non-accrual loans.

37% of our total consumer non-accrual loans have already been written down and approximately two-thirds of consumer loans have either been written down or have current LTVs below 80%.

On the commercial side, 29% of the commercial non-accrual loans have already been written down, 69% have been reserved for at life of loan projected loss content through the FAS (technical difficulty) allowance process and the remainder are accounted for with reduced future loss projections and reserves through the general allowance assessment.

Over 45% of commercial and CRE non-accruals are currently paying interest that is applied to principal.

All of the increase in OREO in the quarter by definition represents assets that have been written down and the bulk of the increase in OREO reflects Ginnie Mae guaranteed mortgage pools or PCI real estate that shifted into OREO from accruing PCI loans.

The increase in non-accrual loans primarily came from consumer real estate and commercial real estate.

Non-accruals in all of the other loan categories have stabilized or declined.

Consumer real estate non-accruals remained elevated, largely due to slower outflows, not increased quarterly inflows.

Our efforts to keep customers in their homes through loan modifications require customers to provide updated documentation and complete six-month trial repayment periods before the loan can be removed from non-accrual status.

In addition for loans in the process of foreclosure, many states, including California and Florida, have enacted legislation that significantly increases the timeframes to complete the foreclosure process, which can be as long as 18 months, which means that loans remain in non-accrual status for longer periods even though the loss has already been taken.

Once a loan completes the foreclosure process, we have been able to sell the property in a very timely fashion.

When a consumer real estate loan is 120 days past due, we move it directly to non-accrual status and when the loan reaches 180 days past due, it is our policy to mark it down to net realizable value.

Thereafter, we revalue each loan in non-accrual status regularly and recognize additional charges if needed.

Since home prices have stabilized in many metropolitan areas, we do not anticipate significant additional write-downs on consumer real estate loans that are already in non-accrual loan status.

On the commercial side, CRE non-accrual loan inflows actually declined 27% in the first quarter, but is typically in everyone's economic interest, including ours, to write the loan down, but to continue to have the developer work the project for us rather than foreclose.

The process of restructuring and executing these solutions can take several quarters to complete and throughout this process, these loans are closely monitored, collateral is reevaluated and if necessary, loss content is recognized.

It is worth noting, I believe, that, compared with our large peers, our total loan portfolio is comprised of proportionately less unsecured credit.

For example, only 3% of our total loans are credit cards and proportionately more real estate secured loans, both consumer and commercial.

Now what this means is that some of our large peers have higher reserve coverage, which makes sense because unsecured loans, credit card in particular, have higher loss rates and therefore, they have higher charge-offs and fewer non-accruals since unsecured loans are charged off more quickly.

By comparison, a portfolio with proportionally more real estate secured loans like Wells Fargo would be expected to have lower loss rates, lower charge-offs, but lagging non-accrual improvements due to the extended period that real estate secured loans need in order to have complete resolution and with more collateral supporting the non-accruals.

Page 22 goes over our PCI loan portfolio, which is clearly performing better than our original expectations.

Since the final true-up write-down of the PCI loan portfolio, we have now realized $476 million of value for PCI loans paid in full.

We have realized $207 million on the loans sold.

We have reclassified $1.1 billion into accretable yield for improving cash flow.

And remember that will be taken into income over a long period of time.

And we have also provided $1 billion for loans that have deteriorated since the Wachovia acquisition was completed.

When you add all those things together, that gives you a net increase of $774 million in the value of the PCI portfolio.

Slide 23 goes over our allowance.

At March 31, our allowance was $25.7 billion, up almost $4 billion from the close of the Wachovia merger.

That is equal to five times a decline in quarterly charge-off and 3.3% of our total loans.

In addition, of course, we have the $19.9 billion in non-accretable difference for our PCI loans.

So very quickly in summary, we had $2.5 billion in earnings across a traditional and diverse business, serving consumers, small businesses and commercial customers.

We believe credit has turned and our balance sheet has never been stronger and our financial capacity for growth never better.

I would like to now open up the call for questions.

(Operator Instructions).

John McDonald, Sanford Bernstein.

Hi, good morning, Howard and John.

On the repurchase reserve, Howard, do you have any visibility on how far along we might be in this process?

Have we potentially turned the corner here?

Do we know?

We think we are pretty far along.

Most of the activity here relates to some of the older vintages, which we think have now been cleared through.

So obviously we take this one quarter at a time, but we did add a pretty significant $400 million to the reserve in the quarter and we think it is a robust reserve at this point.

Okay.

And have you disclosed the amount of the reserve?

$1.3 billion.

Okay.

And then on the net interest income fund, Howard, could you discuss a couple of the -- kind of what influenced the margin decline quarter-to-quarter and just looking ahead, what are your ability to grow net interest income or at least stop it from going down if loan demand does not come back?

Well, ironically, the four basis points is largely attributable to the strong deposit growth that we have had in the quarter.

We are, as I mentioned, very, very liquid.

We continue to get this very strong deposit growth and soft loan demand and we are keeping our powder dry on the investment portfolio.

So what all that means is the deposit growth, which is good for revenue and good for earnings, is really winding up being invested in short-term cash.

So that is really why the margin went down the four bps.

And we will take the deposit growth because that really leads to all kinds of other good things in the Company and we will just have to see where loan demand goes.

And in terms of securities, you are still cautious waiting for higher yields to reinvest?

Yes, this is a long-term proposition.

We obviously evaluate it quarter-to-quarter, but securities were down, they are maturing and we are keeping our powder dry.

We obviously manage interest-rate risk here very carefully.

We want to keep our rate risk as neutral as we can, but we still think that the right thing to do is invest for the long term.

Related to that on the MSR hedge, were you relatively fully hedged this quarter and are you bias towards becoming less hedged as rates rise?

Can you kind of discuss how you think about that?

We have been relatively fully hedged, as you would expect, as long as long-term rates have been coming down as they have for the last several years.

We did shift the composition in the hedge somewhat in the quarter, which is not unusual.

But we do want to take into account the possibility of extension risk in the hedges and if anything, we may have tilted a little bit towards a slightly lower hedge because we think, again, the odds of higher long-term rates are greater than the odds of lower long-term rates.

So naturally in that kind of situation, we would be a little bit less hedged.

But I don't want to make too much of that.

We didn't significantly reduce the size of the hedge.

We are just sort of tilting that way a little bit.

It wasn't clear to me in the documents, maybe you disclosed it, did you have a reduction in the carry income on the hedge this quarter and did you disclose the amount on that?

We didn't.

The overall hedging result was down about $900 million in the quarter, to bring it roughly in line with where hedging results were in the early part of last year, sort of more typical for this point in the cycle, largely due to change in the composition of the hedge and as I say, we tilted it a little bit more from higher coupon mortgage forwards into lower note rates and into interest-rate swaps to get a little bit more balance in the hedge.

Okay and my last question is on the PCI portfolio, the accretable yield balance went up to $15.8 billion.

It looks like the drivers are both the modifications and then some change in your life of loan loss assumptions.

Is that right?

They both contributed?

That is correct.

Although the more important effect will be the modifications.

We have been very successful in modifying this portfolio.

And as a result, cash flows are improving.

Is there room -- last quarter, you mentioned that if current trends continued, there is room to change the life of the loan loss assumption if those trends continue.

Is there room for that to change ahead going forward?

Yes, again, we are being very cautious and very diligent about that and we did, as I mentioned, take in some this quarter and there is more to come if this process continues and things improve, there definitely is some possibility there down the road.

Okay.

And the nine-year life of loan loss assumption, the nine-year duration assumption on the Pick-a-Pay, is that starting from here or over the life meaning that there is more like five or six years left to go?

That is basically -- it is roughly from here, but again, that is an estimate.

These portfolios have -- it is duration, it's not fixed maturity, so that can change as interest rates change up and down over the cycle.

But that is roughly the period over which you would recognize that accretable yield?

Correct.

Thank you.

Well, again, you have got to be -- that's an estimate, so just be careful.

It is a rough number, right?

Okay.

And is it even over that life or does it fade as the balance of impaired loans goes down?

It is rough John.

It is going to change, okay?

The main point is it is going to -- we are not taking all of this into income right away and it will just be spread over a period of time as these loan balances mature over that time period.

I think, John, the takeaway here is cash flows are improving.

We are starting to move very cautiously, but moving non-accretable into accretable.

More and more of these loans, we are moving out of the Pick-a-Pay category into fixed-rate, so they don't have the negative am opportunity and we feel good about where we are in that portfolio.

Okay, thanks, guys.

Matthew O'Connor, Deutsche Bank.

Hi, John, Howard.

I guess first a big picture question.

What is your strategy on home equity?

We are seeing some banks essentially exiting the business and anticipating a lot of runoff there.

So you have got about $100 billion book I think in the core portfolio.

Just what is the strategy and then any guess on where those balances bottom out?

Well, Matt, we are in that business.

We think it is an important product to offer as part of the product suite to help customers succeed financially.

We are doing that business, obviously, differently in some cases than we've had in the past.

But frankly now is some of the better time to do that business.

And I think as a general statement, consumers will probably borrow less in the future compared to the past as they save more, but we are not exiting that business.

Okay.

So it is not going to go down like 50% or 75% like we might see if some other banks (multiple speakers).

As we sell more and deepen relationships with customers, we do business with one in three Americans one way or another, so I can't make that prediction.

But we sure like the performance of the vintages in the last few years.

Okay.

And then separately, a little more of a detail question, as we think about the net interest margin, one thing that is dragging it down in the industry and I think for your guys would be the high level of nonperforming assets and yours are up to I think about $30 billion, $31 billion or so.

Do you guys have a rough estimate on what the drag is to the NIM from the NPAs and some of the interest reversals?

Well, the NPAs themselves, at this point, given the fact that short-term interest rates are so low, is really not a big impact.

As I said before, the bigger impact is the cash that we have on the balance sheet that has been built up on a trend basis, but --.

You can just -- if you just (multiple speakers) our average loans equal about 5% give or take and you can --.

We are talking about bps on that.

We are not talking about --.

Actually, the bigger cost, Matt, to be honest about it, is all the people we have decked against all the modifications and the workouts and so forth.

That is not an insignificant number.

And as we get through this cycle, of course, we will be very thoughtful about taking those numbers down and getting that team right-sized.

I guess on that note, do you have an estimate of what the environmental costs are?

They are a lot.

Well, as I said --.

We have 17,400 people decked against just in the mortgage company.

So that is one area of doing modifications and there is lots of other folks around here doing commercial and other areas in loss mitigation besides all the appraisal costs, legal costs and so forth.

Yes, I mean just to give you some idea, as I mentioned earlier, if you just add up all the foreclosed property expense and the people that we have got decked up against loan resolution, that cost alone is up about $250 million from a year ago, maybe running around $150 million, $170 million in the first quarter of this year above the average from last year.

So that is going to stay high for a short period of time, but really does represent a pretty important opportunity down the road to unwind those costs in the future.

Okay.

Thank you very much.

Chris Kotowski, Oppenheimer.

Yes, good morning.

I wonder can you describe the second lien program a bit that you said.

And you said it was first with Wells being both in the first and second position and do you forgive principal or just stretch it out?

And then how would you modify a mortgage where you are the second to somebody else's first?

Hello?

Yes, I mean we do this a lot of different ways.

We have been modifying seconds frankly for a long period of time, so the program here is really not very different from the way we have been doing it all along.

We do modify in terms -- sometimes in terms of interest, sometimes in terms of principle, so we use all the methods to make this happen.

And is there anyway you can sketch out what, if any, financial impact that has and what -- I mean would we see it on the charge off-line?

Would we see it in the yield line?

Is this something that we are going to notice at all in the financials in any meaningful way?

Yes, I think at the end of the day, we don't think these programs are going to have a meaningful difference in net losses.

It is just we are using many of these tools already in the toolbox and so whether it be 2MP or whatever the case is, we are working with these customers and in most cases where we do use a principal forgiveness, customer has to have at least enough income to pay the new payment and you have to look at a house or a housing situation where there is a highly -- it's highly unlikely that value will come back in any reasonable period of time.

But this is just one of a number of tools that we use as we work with these customers.

And I'd say the 2MP program itself, again, is very consistent with the way we have always been modifying seconds and therefore, you could conclude that the estimates of what that means financially we have already, in effect, accounted for in our reserve position.

Okay.

And then secondly, on the Wachovia synergies, you have said that you have realized 70% and obviously there has been many quarters now since the merger happened and there is organic growth and expenses and cutting.

I lost a bit of track of it in the numbers, but is there a reasonable way to think about this that, if you are originally said you would have $5 billion in savings and you still expect to get 30% of that, that would be about $1.5 billion.

And so if we look at the rate of expense growth from 2010 to 2011, if we were going to say there is a $40 billion base and you would have 5%, 6%, 7% growth off that, then we subtract out $1.5 billion, is that the right way to think about it?

That's a good approximation, yes.

Okay, thank you.

And recognize we have been reinvesting, right, in distribution, in people and that is -- we always want to do that so we can serve our customers completely and develop those relationships.

Okay.

Thank you.

Betsy Graseck, Morgan Stanley.

Thanks, good morning.

Good morning, Betsy.

Two questions.

One, can you tell us how much cash interest on non-accruals you received this quarter?

I don't think -- do we have that, Howard?

We will get back to you on that, Betsy.

Okay.

And then secondly, the question I always get on the second liens is, gee, why are their delinquencies so low when there's obviously a relatively high portion that is underwater.

Maybe to address that question, could you just give us a sense of what you see as the drivers for the delinquencies in your home equity book and the drivers for the charge-offs because it is clearly not LTV?

Well, as I think I've mentioned in the past, I actually grew up as a collector and the things that cause delinquency and frankly loss are the same things that were there 35 years ago when I started and the biggest issue there is unemployment.

If people have a job, they want to and tend to pay their bills.

So what causes loans to go into a delinquency situation typically is, if you want the big four, it is death, divorce, unscheduled medical payment and a lack of a job.

And lack of a job is the big one.

So we have many, many of our customers in the home equity area who are either high loan-to-value, over 100% combined loan-to-value who are paying as agreed, never missed a payment.

In fact, there is, in many cases, there is little correlation between LTV and delinquency.

But there is a big correlation between high LTV and loss because when they don't have any income and they are upside down, there is going to be a loss there.

So then you have got the --.

So Betsy, so I look at jobs more than I look at LTVs with respect to the performance of the home equity portfolio.

Okay.

That's helpful.

Because the other question is on the seconds, was this really a secured product or is the documentation such that it is a secured product and does that matter for how you are reserving for it?

Well, again, it is secured to the extent that there is collateral there, right?

But it is also -- people are -- there has been times in my life I have been upside down on a mortgage and if you give people a job, they want to stay in their home, they pay.

And then on the HAMP programs where there is the new program that came out a few weeks ago that hasn't yet started, but where, on the first liens, you would be required to potentially do principal forgiveness, seemingly to a greater degree than you have done already.

Is that going to change how you are thinking about recognizing loss content in the portfolios that you've got?

I know, Howard, you have indicated that you are already reserved for a large part of what you are seeing in the home equity portfolio, but I am wondering if the principal forgiveness in the HAMP ones is going to impact that at all?

No, we have -- I think through the first quarter, we have forgiven $2.8 billion on programs outside of HAMP and we think that was the right thing to do.

And it is just one of the tools we use and it doesn't work for every customer.

But no, that won't have a significant impact on how we look at reserves or how we look at that portfolio.

And again, Betsy, keep in mind that while HAMP is new and 2MP is new, we have been modifying these portfolios for the last five quarters.

So that is not new, so we have been employing all of these methods for a longer period of time.

Okay, thank you.

Chris Mutascio, Stifel Nicolaus.

Good morning, thanks for taking my call.

Hey, Howard, I don't want to beat a dead horse on the liquidity, but I'm looking at your Fed funds sold position and at $54 billion, that's more than some of the banks I cover.

Is there any --in terms of assets -- is there any point on the curve I should be paying more attention to that would suggest when you start reinvesting some of that massive excess liquidity?

Yes, at the point where rates are higher.

Is it a five year, is it a seven year, is it two year, is it the Fed just moving interest rates on the short end?

Well, look, I think the notion of buying really long-term assets before the Fed has actually even started tightening is just something that we would need to think really carefully about.

So this is not new, Chris.

We have always managed the portfolio this way, as you know.

We keep our investment portfolio itself pretty liquid.

It is typically mortgage-backed securities and --.

Plain vanilla.

Very plain vanilla.

It is designed to frankly manage -- to keep the balance sheet risk, interest-rate risk neutral against a growing base of long-duration deposits that we have on the other side of the balance sheet.

And it just makes sense to us to take our time here and do this right as we always have.

And frankly, Chris, we have been also sellers, as you recall, when we think things are -- at the right time, we have moved assets off the balance sheet because we were afraid of things going up.

So I think we have shown discipline over time both in the buy and sell side.

No, that's fair.

I think you have shown the discipline.

I am just looking at a huge amount of excess liquidity that you are kind of underearning on that until rates go up I guess.

(multiple speakers).

In the meantime, Chris, as you know, we have also been paying down debt on the other side of the balance sheet.

We have a very, very flexible debt issuance position right now.

We have, relative to the large peers, about half as much debt maturing in the next couple of years as the other big companies.

So we actually think of the balance sheet as being a very flexible position and we are going to manage it as neutrally as we can.

Kind of a follow-up question?

When I look at your tax rate this quarter, you kind of skirted or kind of bucked the trend in that many of my banks are showing lower tax rates.

You guys had a significant increase in tax rate.

If I calculate it correctly, your taxable equivalent rate was about 37%.

Is that a good run rate going forward or is there -- I saw in the release it was impacted a little bit by a certain item, but still it seems like a pretty high tax rate going forward.

We calculate it out around 35%, Chris and it did include the $50 some odd million item that we indicated.

Likely that it will be slightly down over the balance of the year.

And again, that gets impacted in our case by, as you know, by the mix between taxable income and tax exempt income and the overall net income before tax.

So that is one of the reasons it goes up and down, but I think you should expect it to be down a little bit over 2010.

And just one final thing.

Can you refresh -- given the stories in the news about CDOs, can you refresh my memory on what your exposure is from the Wachovia side to CDO products and what you have written them down to?

Well, on the Wells side, we were never in that business and Wachovia was mostly in commercial real estate, but exited that business toward the end of 2007, which was a year before the merger.

Have you disclosed what the collar is and what they have been written down to?

We haven't, but I think generally you could assume that we have written them down to fair value at kind of the worst point in the cycle.

Okay.

Anything else you can add to that or no?

Nope.

All right.

Thank you.

Nancy Bush, NAB Research.

Good morning, guys.

Two questions.

Pick-a-Pay, can you tell us what the life on that portfolio is at this point?

In other words, at what point do we start just sort of ignoring the Pick-a-Pay portfolio from a size perspective?

I would like to ignore it now, but I can't.

Well, it is roughly an $89 billion portfolio that has dropped -- it's dropping --.

$82 billion.

I'm sorry, $82 billion.

That's declining a couple billion dollars a quarter.

So we are down $10 billion year-over-year.

So as we said before, there's around nine years or so left from a duration perspective.

And we are also moving the portfolio away from the Pick-a-Pay option to a fixed or a non -- negative am kind of product.

So Nancy, about two-thirds of our PCI portfolio in Pick-a-Pay is in California and over 50% of the total portfolio is here, which has been good news for us because that kind of housing -- the average loan there is $220,000 or so, is more of a starter home and that housing has reached a bottom and probably bounced off the bottom here.

So of all the portfolios I worry a lot about, this is not one of them.

My second question would just be this.

I mean as rates rise, and inevitably they will hopefully, do you expect any changes in deposit behavior, in the stickiness of deposits?

Do you expect that you are going to have to share more of the rise with consumers as they become more knowledgeable that rates are coming off of the floor?

If you could just give us your thoughts about any inflection point in rates and how it impacts deposits?

Yes, what happens, Nancy, is that typically on the upside when rates start to turn around, we actually, at least how it works historically, historically, we actually see a benefit because some of the deposits we have are fixed rate and some of the assets reprice earlier.

And secondly, this company versus almost any other of our competitors, so many of our deposits are either interest-free or near free that they don't reprice and we are paying the price today because you can't bring them any lower than zero in their cost.

When rates turn around, they become more valuable of course.

So who knows what happens this time around, but we want to be competitive, we want to give our depositors a fair deal and we are thoughtful on the way up, but I don't view that as a big risk.

All right, thank you.

Joe Morford, RBC Capital Markets.

Thanks, good morning, everyone.

You mentioned commercial real estate inflows were down 27% sequentially, but commercial real estate non-accrual loans were up 20%.

Just wondering if you could reconcile that?

Is it just the lag of migration or the fact that you let developers continue to work the projects and where, in the commercial real estate portfolio, are you seeing the most improvement?

Yes, developers are working the projects, Joe.

That is exactly the issue.

And many times, we are not experts in this and we will -- the ultimate resolution that maximizes values where we want to be.

So in many cases, we will put something on non-accrual, we will still be collecting interest, like Howard said.

Almost half of our commercial real estate loans that are in non-accrual are still paying interest and -- but we want to be conservative and take that route and get those things worked out.

And that really is the point, Joe.

So the non-accruals -- the inflows are going down a lot, which is good news for the future.

And it is just -- it is just in everybody's interest to have a developer continue to work the project and keep whatever cash flow is going going rather than toss it into foreclosed and have us try to deal with it.

So that is just economically better for everybody.

That makes sense.

Does that 27% decline include construction or is it just term CRE?

It's --.

It's everything.

(technical difficulty) CRE.

Inflows are down 27%.

Okay.

And then separately, would you please update us on your expectations for the impact of Reg E and the change in overdraft fees and talk about any efforts you are working on to mitigate that?

It hasn't changed from what we had previously announced and we are going to be coming out shortly with the way that we are going to work with customers and provide them choice as part of the changes that will affect new customers July 1 and I think existing customers on August 16.

Okay.

And can you remind us how much of your revenues currently come from overdraft fees?

I think we have mentioned that it is a $500 million impact for this year.

Okay.

All right.

Fair enough.

Thanks so much.

Moshe Orenbuch, Credit Suisse.

Great, thanks.

I was intrigued by the comment in the press release about the rate of NPA increase kind of lagging charge-offs.

I mean I think that is very different than kind of prior cycles.

Is that a function of the charges you have taken on NPAs, the marks on the credit impaired loans, some combination?

Because that is not -- normally it is the other way around.

Normally charge-offs kind of keep going up well after NPAs crest.

Well, again, that phenomenon in part is due to the nature of the portfolio being a secured portfolio.

So the sequencing is we charge it down, write it down, but it may hang in non-accrual for a period of time as either the commercial loans get worked off or the consumer real estate gets modified or something else happens to the loan.

So it is just the nature of the portfolio, Moshe.

And it's -- I guess is it a different way of working it out, it's with the existing either homeowner or developer somewhat longer.

Is that -- I mean is that the upshot?

Well, I think the modification process and the fact that so many of these loans are now out there is taking perhaps a little bit longer than it would normally take in prior cycles.

But fundamentally, it is the nature of the portfolio again being very different than an unsecured portfolio, just much higher losses, but you are getting rid of the non-accruals by just getting rid of the loan.

Great, thanks so much.

Thank you.

Well, -- is the operator -- okay, well, thank you all very much for joining the call.

We appreciate your interest in our Company and we thank you for your time and we will talk to you next quarter at the same time.

Thank you very much.

Ladies and gentlemen, this concludes today's Wells Fargo first-quarter earnings call.

You may now disconnect.