富國銀行 (WFC) 2010 Q2 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 second-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 Director of Investor Relations, Mr.

Jim Rowe.

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 second-quarter 2010 results and answer your questions.

Before we get started I would like to remind you that our second-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 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, Jim, and thanks to everyone who has joined us on this call.

We appreciate your interest in Wells Fargo.

I will turn this call over to our CFO, Howard Atkins, shortly for a more in-depth look at our quarterly results but first I would like to comment briefly on the strength of our franchise, the status of our Wachovia merger integration, and the current regulatory environment.

As to our financial performance, our second-quarter results again reflected the underlying strength of our company with all three business segments contributing to our profitability.

Our net income was up about 20% from last quarter and represents just the fourth time in our history that we have had quarterly net income over $3 billion.

More importantly, we are winning new business every day, seeing growth in certain loan portfolios, and more instances where conversations are turning into new relationships and new commitments.

It is early yet to call these sustainable trends but it is real progress and it is in the right direction.

While the uneven economic recovery continued to create some headwinds to loan and revenue growth, we have continued to see the core power of our diversified business model at work.

For example, we think it is meaningful that Q2 revenue held up well versus last year despite year-over-year decline in mortgage banking revenue of about $1 billion along with a steady decline in earning assets over the year, a real testament to our diversified business model's resilience.

Continuing to focus intensely on helping our customers succeed financially has allowed us to perform well through various economic cycles, a hallmark of our business.

In addition, we are now about halfway through our three-year Wachovia merger integration plan.

We successfully integrated the California Wachovia stores in April and this weekend we will integrate Texas, our largest overlapping market, and Kansas which will complete the integration of all of our overlapping markets.

During the quarter we also completed one of the industry's largest trust conversions, $150 billion in trust assets representing about 81,000 accounts.

In addition, we completed the conversions in our unsecured loan portfolios, credit card rewards program, and mutual fund businesses.

And we have now done a lot of the heavy lifting to prepare for the integration of our East Coast markets which begins in September with Alabama, Mississippi, and Tennessee followed in the fourth quarter with Georgia.

Our entire team is working exceptionally well together, and culturally and financially this merger is exceeding my expectations.

I couldn't be more excited about the opportunities ahead.

Now there is no question that our industry is experiencing some uncertainty regarding the impact of regulatory reform, so let me spend a few minutes talking about the changing landscape based on what we know today.

First of all, Wells Fargo has always been focused on doing the right thing for our customers and adhering to a philosophy of transparency with all of our stakeholders.

Those are core to what we do.

While portions of the newly signed legislation are consistent with that operating philosophy, which is positive, we remain concerned that some aspects may have unintended negative effects for America's financial system, for consumers, and for businesses.

Right now we are proceeding with our efforts to gain a better understanding of all the components and we will work internally with our regulators on implementation plans as the rulemaking process evolves.

At this stage it is too soon to definitively estimate the financial impact given the varying implementation timelines for different components of the bill, the need for some additional clarifications since the actual rule writing is still on the horizon, and the size of potential financial offsets.

Nevertheless, we believe the impact on Wells Fargo overall will be lower than the impact of our large bank peers, particularly in areas such as proprietary trading, derivatives, and private equity.

In areas where we will be affected, like debit interchange, there is simply insufficient information at this point for us to make a determination as to the next economic outcome.

Any estimates would be premature in our view; it is just too soon.

With that being said, Wells Fargo joins others in our industry in wholly dedicating our talents and resources to the biggest priority we share with the American public, the return to a vibrant US economy.

To that end Wells Fargo is continuing to supply significant credit to the US economy, including consumers, small and medium-sized businesses, and large corporate clients; about $990 billion over the last 18 months.

We have also helped more than half a million people keep their homes since January 2009.

We believe Wells Fargo has shown that its business model remains successful throughout these tough economic times and we have positioned our franchise well for better economic times ahead.

We have grown our customer base by providing a full spectrum of products and services to meet their needs throughout this period.

We have an unmatched distribution platform nationwide, we have maintained our increased market share across many of our businesses, and our leadership team is encouraged by signs of continued improvement in the credit landscape.

In my view, Wells Fargo has a banking franchise second to none in this country and we believe we are right where we need to be to continue to meet customers' financial needs while growing our business profitably.

Now let me turn this over to Howard.

Thanks, John.

My remarks this morning will follow the slide presentation included in the quarterly supplement available on the Wells Fargo Investor Relations website.

Page 3 of the presentation gives you a very broad overview of the quarter and the topics I would like to cover today.

I will start my remarks with some detail about our earnings of $3.1 billion, very strong of course, and I will conclude my remarks with some detail about our balance sheet and how that positions us for even more growth going forward.

In between I would like to leave you with three important take always about our quarter.

First, what you saw in the quarter was the Wells Fargo business model at work.

With $21.4 billion in revenue the Wells Fargo growth machine continued to fuel revenue and market share gains across many of our businesses in the quarter.

Second, the combination with Wachovia is producing better-than-expected results and in particular incremental revenue.

And, third, credit quality clearly improved significantly in the second quarter even earlier and more significantly than we originally projected.

Slide four goes through our earnings for you.

Wells Fargo earned $3.1 billion in the quarter producing record net income applicable to common of $2.9 billion, up 21% from the first quarter.

Since our merger with Wachovia we have earned $18 billion reflecting the strength of our franchise and the benefits of the merger.

Earnings last year, of course, were affected by higher credit costs as well as strong mortgage hedging results.

Earnings so far in 2010 reflect lower mortgage hedging results as the yield curve has moderated but businesses as diverse as commercial banking, investment banking, asset base lending, auto dealer services, debit card, global remittance, mortgage servicing, and many, many others have had strong top-line and/or bottom-line results so far this year.

Now in an organization with as many business activities as ours there are always pluses and minuses in every quarter, and while in my view the results are the results, I will quickly mention a view of the more significant items in the second quarter.

First, a $500 million release of loan loss reserves reflecting improved loan portfolio performance; second, commercial loan resolutions in the PCI portfolio increased $324 million from the first quarter.

This is a reflection of our success in selling or resolving commercial PCI loans at realized values above the marks we took when we closed the Wachovia merger, and we believe there may be additional recovery potential in this portfolio going forward.

Operating losses in the quarter were $627 million, up $419 million from the first quarter primarily due to additional litigation accruals.

Merger expenses in the quarter were $498 million, up from $380 million in the first quarter and we had $137 million of severance costs for the previously announced Wells Fargo financial restructuring.

Now the pluses and minuses of these particular items for the quarter had a negligible impact on the bottom-line results.

Slide five indicates our various operating margins and financial returns which continue to be among the best in the industry with 4.38% net interest margin, 1% ROA, and a 14.6% return on tangible common.

At our investor conference in May my business colleagues and I explained the importance of return on assets, a key operating metric.

As shown on slide six, we continued to generate the highest ROA among our large peers in the second quarter as we have for many, many years.

Our higher ROA was driven by a couple of factors.

First, the higher proportion of checking and savings accounts in our deposit mix.

In the second quarter, low-cost checking and savings accounts combined rose to 88% of total deposits.

Second, our lower credit -- we have a lower credit loss rate in our loan portfolio, a reflection of our disciplined underwriting culture, proactive loan surveillance, and concentration in lower loss rate real estate secured loans.

Our consolidated loss rate of 2.3% compares with an average of 3.9% for the other three large peers, although keep in mind this comparison is impacted by the respective PCI portfolios at each bank.

And, third, we have a higher proportion of total revenue coming from fee income which tends to be less asset intensive.

Our revenue per dollar of assets was 7% in the second quarter compared with an average of less than 5% for the other three peers.

Now this is largely a function of our success in cross-selling non-credit products in addition to the credit products we provide our customers.

Slide seven shows that all business segments contributed to earnings in the second quarter with particularly strong results coming from Community Banking which was up 21% and Wholesale Banking which was up 18% from the first quarter.

Wealth, brokerage, and retirement services earned $270 million, down about 4% linked quarter.

Within our three reporting segments we operate more than 80 businesses.

Across all of these businesses in total consolidated revenue was flat linked quarter and down about 4% year-over-year with declines in MSR hedging revenue offset by revenue growth in our other 80-plus businesses, particularly those businesses where revenue is driven by sales including double-digit linked quarter revenue growth on greater customer volume in commercial and corporate banking, commercial real estate brokerage, asset-based lending, international, auto dealer services, merchant services, and debit cards.

Starting on slide eight I will quickly go over the results by each of these business segments.

Wholesale Banking accounted for about 45% of consolidated earnings in the quarter and that has had consistent revenue growth for many years including the last six quarters since the merger.

Revenues reached $5.7 billion in the segment in the second quarter, up 8% from a year ago and up 25% linked quarter annualized.

The Wholesale business is very diverse with revenue growth in the second quarter coming from commercial, corporate, Eastdil Secured, our commercial real estate brokerage business, Wells Fargo Capital Finance, our asset base lending business, international, and loan resolutions more than offsetting lower trading revenue in the quarter.

This business has been reducing non-strategic, high-risk loans and securities position since the merger cumulatively earning in excess of our initial write-downs during this period.

The business segment has been consistently growing deposits which are up 18% year-over-year and has recently seen signs of loan growth with loans to commercial customers, global financial institutions customers, and asset-based lending up in the second quarter.

Net income in this segment was up 32% from a year ago on higher revenue and lower charge-offs.

Credit losses remain relatively low and declined 10% in the second quarter.

Slide nine, our community banking business, provides credit, mortgage, deposits, and payment services to more than 20 million retail bank households and over 2.5 million small businesses and business banking households with more banking stores to serve communities across the United States than any other bank.

Earlier this month we announced that we will be integrating the separate store distribution channel for consumer finance into the regional banking channel to better provide product coverage for consumer finance customers and branch consolidation savings in the process.

This resulted in a $137 million restructuring charge in the second quarter for severance.

Our community banking business earned $1.8 billion in the second quarter, up 21% from the first quarter.

This business segment has been profitable throughout the credit crisis and earned nearly a 1% ROA in the second quarter despite elevated credit costs and the impact of merger integration expenses for Wachovia.

The results in this segment essentially reflect the sale machine that is inherent in our regional banking distribution.

Legacy Wells Fargo core product solutions of $7.3 million are up 15% from a year ago and store-based small business solutions were up 31%.

Cross-sell for legacy Wells Fargo reached a record 6.06 products per household of Wells Fargo products, up from 5.84% a year ago, and reached 4.88 Wachovia products per household, up from 4.55 a year ago.

Total consumer loans were down but certain portfolios increased linked quarter, including core auto loans which are up 4% and private student lending which was up 1%.

Mortgage applications rose 14% in the quarter and the unclosed mortgage application pipeline was $68 billion at the end of the quarter, up 15% from the first quarter.

New small business loan commitments rose 30% from the first quarter.

While there are too many imponderables on the reg reform bill, here is how we are thinking about Reg E and the Card Act.

First, Reg E and other overdraft changes; we estimate a $225 million after-tax impact in the third quarter and about $275 million in the fourth quarter not including any offsets.

Since Reg E changes would not begin until early July for new customers and will not begin for current customers until mid-August, the third quarter will have limited revenue benefit, potential offsets from customer opt-in.

We expect revenue benefits and potential offsets to increase going forward.

Q4 will potentially benefit from an increasing opt-in rate.

Because of potential offsets and changes in customer opt-in rate, it is likely that run rate costs will diminish over time from the numbers that I just quoted you from the third and the fourth quarter.

The impact from the Card Act will be relatively small, approximately $30 million after tax in the third quarter.

Much smaller than our peers given our significantly smaller credit card portfolio.

Slide 10; one of the keys to the consistent sales growth in the regional banking group has been our ability to attract and retain consumer checking accounts across the country.

Combined legacy Wells Fargo and Wachovia consumer checking accounts were up a net 7.4% from a year ago.

California continued to be our fastest growing state in the West, up 9%, and we continue to see checking account growth accelerate in the East with New Jersey up 10% in the second quarter, doubled the growth rate from late last year.

The Wealth, Brokerage, and Retirement business has had solid revenue results over the past six quarters even though the markets have been very volatile.

Second-quarter revenue included strong asset-based fee growth and steady brokerage transaction revenue.

Retail brokerage client assets were up 6% year-over-year while core deposits grew 7%.

Institutional retirement plan assets rose 10% on the market improvement and new customer growth.

Net income in Wealth, Brokerage, and Retirement was up 5% from the second quarter of 2009 with growth in managed accounts fees driven by a 22% increase in managed accounts assets and 8% growth in investment management and trust revenue year-over-year.

Slide 12 covers lending at Wells Fargo and I would like to spend some time on this slide.

On this slide we have split quarterly loans outstanding into the so-called liquidating or non-strategic portfolios and the all other portfolios which our portfolios where we plan to continue to originate loans.

The non-strategic portfolio is comprised of about $125 billion in loan portfolios where we exited or no longer write new business, including Pick-a-Pay, indirect home equity, legacy Wells Fargo Financial in direct auto, Wells Fargo financial debt consolidation, and commercial and CRE PCI loans.

Please see the appendix for more details on the composition and the managed run-off of these loans.

Now apart from these non-strategic loans we had $620 billion in loans in the continuing portfolios.

In the year prior to the second quarter all other loans declined $10 billion to $20 billion, roughly, per quarter but in the second quarter all other loans were down only $5 billion or less than 1%.

About $3 billion of the $5 billion decline was due to mods and normal payoff activity in the non-Pick-a-Pay mortgage loan portfolio.

Importantly, for the first time in the second quarter we began to see some life in certain lending businesses including linked quarter growth in wholesale commercial, wholesale asset-based lending, global financial institutions, wealth, brokerage, and retirement, auto dealer services, and private student lending.

We believe we are gaining share in those lending markets we continue to serve.

As we have throughout the credit crisis, we continued to supply credit to the US economy in the second quarter.

In the second quarter alone we originated or committed to $150 billion of credit, up 17% from the first quarter.

You can see the breakdown of that on slide 13.

The growth in commercial and commercial real estate originations and commitments was the largest quarterly increase since the merger.

Shifting to the other side of the balance sheet on slide 14, we continue to grow checking and savings deposits which were up $59 billion or 10% from a year ago.

Checking and savings deposits account for 88% of core deposits and at quarter end our core deposits funded almost 100% of consolidated loans.

The size, growth, and high concentration of checking accounts in our deposit base represent important differentiators for Wells Fargo and important sources of cross-sell and revenue growth.

We have significantly reduced higher cost CDs with $114 billion of Wachovia's higher rate CDs maturing since the merger.

Approximately 57% of maturing Wachovia CDs were retained in lower rate CDs or checking and savings deposits.

Now most of Wachovia's higher rate CDs have matured with only $4 billion scheduled to mature in the second half of 2010.

Slide 15; an important part of our revenue growth is the incremental revenue Wells Fargo is earning from the merger with Wachovia.

There are many, many examples of this merger-enabled growth, if you will, a few of which are listed on slide 15.

Let me just mention a couple of these.

First, Wachovia cross-sell, as I mentioned before, has now increased 7% from 4.55 just after the merger to 4.88 in the second quarter of 2010.

So we are clearly getting good cross-sell growth in the East.

Within Wholesale Banking the products and expertise that we gained from Wachovia is driving increases within investment banking.

The amount of investment banking revenue coming from our own commercial banking customers is up 45% since the merger, in part as more and more of legacy Wells Fargo commercial and corporate customers are using Wells Fargo securities to underwrite their bond and equity financings.

Within government and institutional banking cross-sell revenue is up 43% in the first half of 2010.

In the wealth and retirement and brokerage business client assets, deposits, managed accounts are all up significantly since the merger, and in our retail brokerage group we are significantly cross-selling loans, which is one of the reasons our loan growth occurred in the second quarter.

We now shift to slide 16 in terms of our non-interest expenses.

We continue to invest in our businesses in the second quarter in ways that better serve our customers, opening 13 new banking stores in the quarter, converting over 1,400 ATMs to envelope-free web-enabled ATMs, and increasing regional banking platform banker FTEs in the East, up 500 from year-end 2009.

Most of the increase in non-interest expense from the first quarter was due to three items -- $419 million in additional operating losses, as I mentioned earlier, primarily due to additional litigation accruals; the $137 million in severance costs related to the Wells Fargo Financial restructuring; and $118 million in higher merger integration costs compared with the first quarter.

As John mentioned earlier, we continue to make great progress on integrating Wachovia and we will start to convert our stores in the East later this quarter after completing the overlapping markets this coming weekend.

In the first half of this year we spent about $900 million on the Wachovia merger integration and we expect to spend approximately $1.2 billion in the second half of the year.

We now expect to spend approximately $1.4 billion for the integration in 2011 bringing the total Wachovia merger integration costs to approximately $5.7 billion.

Now this is an increase from our most recent estimate of approximately $5 billion and was driven by several factors including, first, increased scope and complexity associated with certain merger projects, such as the development of our international products and systems; second, additional enhancements and upgrades, especially in our treasury management products; and additional testing than was originally contemplated, including building substantial test environments for our complex systems.

Now on the savings side we have already achieved about 80% of the expected $5 billion in annual run rate savings.

As I mentioned on our investor day, as part of our One Wells Fargo effort to bring the entire organization efficiently to each of our customers we intend to simplify and streamline our company to make it easier for our customers to do business with us and therefore earn more of their business going forward.

Our objective is to improve customer service, reduce turnaround times, and improve time to market, but the expense savings associated with simplifying and streamlining our company could be very significant.

The announcement we made earlier this month to close 638 Wells Fargo Financial stores is but one example of the type of savings that would fall into this simplification and streamlining category.

Let me now shift to credit on slide 17.

As I indicated earlier, credit quality improved significantly in the second quarter.

Net charge-offs declined earlier and more significantly than originally projected and were down 16% linked quarter and down $924 million from the peak in the fourth quarter of 2009.

However, earlier credit quality indicators continue to improve with non-accrual inflows down 18%, commercial criticized loans down 14% year to date, and early-stage delinquencies improving almost across the board.

Our PCI portfolio continued to perform better than expected resulting in the release of $1.9 billion from the non-accretable difference for the Pick-a-Pay portfolio which will add to future income over the life of the loans.

At quarter end we had $25 billion of allowance for credit losses, about 3.27% of total loans, and additionally we had $16.2 billion in remaining non-accretable difference, about 26% of the PCI loan unpaid principal balance.

Because of improved portfolio performance we released $500 million of reserves in the second quarter with the potential for additional releases absent significant deterioration in the economy.

A couple of highlights about the credit quality in the quarter starting on slide 18.

The 16% decline in charge-offs from the first quarter was pretty much across the board, commercial real estate losses down about 10%, consumer losses in total down 21% including a 23% decline in first mortgage charge-offs, 18% decline in junior lien mortgage charge-offs.

Credit card charge-offs were down 10% and revolving credit card loan charge-offs were down 34%.

Slide 19 shows trends in consumer delinquencies.

Early indicators continue to improve with 30 days past due improving in many consumer portfolios including credit cards, student lending, home equity, and Wells Fargo Home Mortgage.

On slide 20 shows you the Pick-a-Pay portfolio where credit trends continue to improve in both the non-impaired and impaired Pick-a-Pay portfolios with performance better than originally expected at the time of the merger.

The roll rate of loans from current status to 30-plus days past due stabilized or improved in both the PCI and non-impaired Pick-a-Pay portfolios, and the percentage of first-time delinquent loans in the non-impaired portfolio is down for the fifth consecutive quarter.

And in the PCI portfolio first time delinquencies were at levels not seen since prior to the merger.

We also had improvements in net charge-offs in the non-impaired Pick-a-Pay portfolio, which were down $148 million or 35% from the first quarter.

As shown on slide 21, non-accrual inflows in the second quarter were down 18% with consumer inflows down 23% and commercial down 7%.

In addition, outflows increased 12% from the first quarter.

Now this combination of this dramatic slowdown in inflows and higher outflows resulted in a significant deceleration of non-accrual loan growth, which was up only 2% in the second quarter.

Now one of the reasons the level of outflows is not yet higher is that it is taking somewhat longer to resolve residential real estate loans, in part because of federal and state regulations that have had the effect of elongating the modification and foreclosure process.

Again, loans are written down when necessary and we get realizable value when we sell but they are currently remain in non-accrual for slightly longer periods of time.

On slide 22 we consider the combination of $25 billion in the allowance and $16 billion remaining non-accretable difference to be robust, especially now that charge-offs are declining.

As I mentioned earlier, during the second quarter we released $500 million of loan loss reserves reflecting improved performance of the loan portfolios, both consumer and commercial.

The purchased credit impaired portfolios have performed better than originally expected; slide 23 provides a lot of details on this.

We already saw improved performance in the Pick-a-Pay portfolio in the first quarter when we released $549 million of non-accretable difference.

In the second quarter, with sustained positive performance in this portfolio, we released an additional $1.8 billion reclassified to accretable yield.

Now the improvement in life of loan loss estimates is primarily attributable to our significant modification efforts as well as the stabilization in the portfolio's delinquencies over the last several months.

I should mention that this $1.8 billion reclass of the non-accretable to accretable did not affect income in the second quarter but will be realized over the remaining life of the portfolio, approximately a year.

Now with the remaining non-accretable difference of $16 billion there may be additional potential for further releases from non-accretable to accretable if this portfolio continues to perform better than original expectations.

In the commercial PCI portfolio we did, as I mentioned earlier, have a release of non-accretable difference from resolutions of loans either through payment, from customers, or sales to third parties.

Since the merger we have written off $6.1 billion against the original PCI unpaid principal balance of $29.2 billion and the remaining commercial non-accretable difference represents about 15% of the remaining commercial PCI portfolio.

I will conclude with a couple of remarks about our balance sheet.

On slide 24 the strength of our business model continued to produce high rates of internal capital generation as reflected in our significantly improved capital ratios.

During the quarter we added $4 billion to tangible common equity through retained earnings and other internally generated sources of capital producing an annualized increase in tangible common of 20%.

Our Tier 1 common ratio increased 44 basis points to 7.53%.

In the second quarter we purchased 64% of the TARP warrants auctioned by the US Treasury which reduced our Tier 1 common by about five basis points, but which we expect to be accretive to earnings.

We expect to opportunistically repurchase more warrants in the open market from time to time at economic prices.

We have about $19 billion of outstanding trust preferred securities and $7 billion of those will convert automatically to qualifying Tier 1 capital under their original terms.

So under the new Financial Reform Act only about $12 billion is expected to be disqualified over the three-year period beginning in 2013.

The elimination has no impact on Tier 1 common and, given internally generated growth that is likely in capital over this time period, we would expect the elimination of these trust preferreds to have only a small impact on our Tier 1 capital.

Slide 25; in terms of our balance sheet we believe our balance sheet is stronger than ever.

Our capital ratios are now substantially higher than they were before we doubled the size of the Company with the Wachovia acquisition and our capital ratios have been growing rapidly through internal capital generation.

Tier 1 common, for example, is up a full 100 basis point year to date.

Our loan loss reserves and remaining on non-accretable difference with the PCI portfolio are strong at a time when losses are coming down.

The loan portfolio is now funded with core deposits and we have significant capacity to add mortgage-backed securities to build revenues and earnings even more at higher long-term yields.

In effect, our current income is running less than it could be as we keep our investment powder dry.

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

(Operator Instructions) Chris Kotowski, Oppenheimer & Co.

Good morning.

I was wondering if you could talk a little bit about the geographic differences in the loan portfolios.

And are you noticing any growth in any of the markets that are less stressed in housing than the other markets?

And how much of a -- in your judgment, how much of an impact is that or has consumer behavior sort of been broadly changed in all geographies, in all different kinds of markets?

Want to take a shot at that, Chris.

On the mortgage side most of what we did in the second quarter on the first mortgage was refinances and there is not a geographic bias to that per se.

But what we are seeing is, as we have mentioned and Howard talked about, it's more portfolio unique than geographic specific.

So we are -- the growth we are seeing is, for example, in autos; we are seeing it there.

We are seeing -- in some of our small business we are seeing some more activity there; student lending and so forth.

But I wouldn't -- there is not a geographic bias that would stand out.

Okay.

And switching to asset quality, any view on when you would expect total non-performers to peak?

We have -- I think we have said in the past that it's -- we are getting close and it would not surprise me that -- I mean if you look at the deceleration of our growth you can make your own assumptions about that.

But you know, the issue there is the inflows have significantly reduced.

The key is for us to get the outflows going faster and that is somewhat impeded by regulatory and other issues related to, especially on the residential side, state issues.

Okay.

And then finally, how much do you expect the integration costs to carry on into 2011?

Is there --?

Well, we have said that -- we first started out saying that we thought the costs were somewhere in the $8 billion range.

We took that down to $5 billion.

We think it's going to be something more than that now; Howard shared those numbers.

And we expect that to be -- those costs to be used up or completed at the time of the merger completion which is at the end of 2011.

Okay, thank you.

Thank you.

Betsy Graseck, Morgan Stanley.

Couple of questions; one on the NIM.

Howard, you mentioned the ins and outs there and I was intrigued by your comment that you indicated a significant capacity to add RMBS.

Could you just talk through how you are thinking about shifts in the composition of earning assets and the potential impact on NIM if rates were to stay flat with where they are today?

Well, the key thing on NIM, as we have said for a long time, is deposits so the more we keep growing deposits that is going to be beneficial to the NIM.

The earning asset competition in part is going to be a reflection of whether loan demand comes back more vigorously, which we would all like to see.

We began to see signs of that in the second quarter in both commercial and to a lesser extent in the consumer, so we hope that continues.

The mortgage -- the MBS portfolio is going to be a function of whether yields are appropriate to add to the portfolio.

But, Betsy, I would say it this way; we don't run the Company around the NIM.

The NIM is what it is.

If we like MBS yields, and at some point in time we will, and we have huge capacity to add those, it might be negative to the NIM but be positive to net income.

And that would be the right thing to do.

So if -- the NIM is not the goal here.

Right.

And so -- but are you at the stage where you would be interested in shifting some of your liquidity into RMBS at this stage?

It depends on deposit growth, Betsy.

The purpose of the MBS portfolio is really to match off against our long-duration liabilities.

The more deposits grow we get a little longer on the right-hand side of the balance sheet.

We could get to a point where just to manage the risk of that we want to add to the MBS portfolio.

But absent that, we are very focused on long-term yields and that is what we will stay focused on.

Okay.

And then on the accretable yield and the release of the accretable yield, could you just talk through what you would need to see to have more of that occur?

Obviously a little bit was released this quarter.

Well, I think, Betsy, in that case it's all about performance so we look at the cash flows and we look at how those portfolios are performing.

And I think we shared a lot of detail at the investor conference.

I think there was a lot of confidence in how we are managing that and we will continue to make that analysis.

And you know how that works.

If we take the benefits over the remaining life and if we miss on the other side we have to put reserves up right away, so we want to be absolutely sure as we go through this process that we are sure on the performance of those portfolios.

But the biggest amount left relates to the Pick-a-Pay and we probably have the most confidence there about how that portfolio is performing.

And the driver there of course, Betsy, is the success we have had in modifying these loans, which is really the factor that is -- the horse that is driving the cash flow.

So with the passage of time and the success in modifying loans in that portfolio that tends to increase our confidence around releasing more non-accretable.

Okay.

And then could you just speak to your outlook for house prices?

There has been some question in the marketplace as to whether or not they will stay where they are right now given the reduction in stimulus to the housing market.

So I think that would have an impact on how much you release there.

Yes, so if you think about the Pick-a-Pay that happens to be -- about two-thirds of that portfolio happens to be -- of the impaired portfolio happens to be in California.

Most of those loans were your first time home buyer or second-time home buyer homes and this state, California, and that price has seen more recovery than most places.

So we have been -- that has been a benefit to us.

You talked housing I think -- and we are seeing other states where housing also is -- and the low end has improved, bounced off the bottom.

As I mentioned a number of times, when we do take back properties and sell them we are getting multiple bids and most of them are cash bids.

So there is -- and while the first-time home buyer credit was important it's not the only thing that is driving this.

These are record low interest rates these days, employment is pretty steady, and home price affordability has never been better.

Okay, thank you.

John McDonald, Sanford Bernstein.

Good morning.

Just a clarification on the NIM.

Howard, if we look at the increase in the NIM quarter to quarter, understanding that you are not managing that, was the purchase accounting accretion a driver, a big driver?

Yes, that is correct.

Okay.

That is the $506 million?

Well, that was the level.

The change from first quarter to second quarter was about $300 million so you can do the math in terms of how much basis point impact that incurred.

Okay, great.

Then on the MSR hedge could you just kind of update us where you stand, not in numbers but just conceptually.

Are you fully hedged still or are you biased towards becoming less hedged?

As you would expect, when interest rates are declining and/or low we tend to be more fully hedged in that -- against the MSR asset.

And when rates go the other way we tend to be a little less fully hedged, which is one of the reasons why we feel that we are keeping our powder dry in the investment portfolio because we are relatively fully hedged on the MSR.

Okay.

And are you still getting what you have called in the past carrying income on the hedge this quarter as well as kind of the change in the value of the hedge?

Yes, we are still getting -- the mark on the hedge is a reflection of both the change in price as well as the carry.

There is still carry income coming through.

The total hedge result was down about $300 million from first to second quarter largely as a result of a flattening of the curve.

Loan rates came down almost a full point in the quarter and that was the main driver there.

Okay.

Question on reserve release; Wells Fargo has historically not released reserves even when others have.

Could you give us a little color on in your models what drove the release this quarter and what is driving your commentary that you could have continued reserve release in coming quarters?

What is different than in the past?

It's very simply charge-offs dropped substantially and the loss continent, as we see it in these portfolios, has dropped.

And as a result you have too release reserves to a certain extent when the loss content in the portfolio declines as it did.

So it's just a revision of your 12 month or 24 month outlook on losses?

We look at losses over what we call a loss emergence period and that is what defines the loss content in these portfolios.

And the loss content, as defined, has dropped pretty significantly which you see in the first quarter of that loss emergence period manifested in the second-quarter results.

Okay.

And I guess declining balances is also a factor there as well?

Yes, but not as much, John.

That has -- it's more of what Howard just said.

We take a look at this emerge period and -- but this should be expected.

When we were going through this last year and the other side of the curve we knew this would be the case and this is --.

Okay.

The last question and maybe this is for John or Howard.

Just regarding the exit of the Wells Fargo Financial business, John, you are in this business for over 100 years; you have long thought it to be a profitable, valuable business.

In the press release it cited your increase in bank branches and density as a driver of the decision to exit.

Is there other things that caused your change in the view of the profitability and attractiveness of that business, besides just your number of branches?

Well, a couple of things; we announced all at the same time.

We want to be relevant and be able to provide products and services where our customers live and work.

When you add another 3,500 or 3,300 stores in the East we had the distribution.

Secondly, some of the product or one product, the debt consolidation product that we were doing, we really weren't doing much of it.

So -- and if you look at the rest of the things we were doing, we were doing those in other channels.

We could do it more efficiently, provide a more consistent experience for the customers so it was a very obvious thing to do.

So we think about 100 years of experience; we will still have that experience in a lot of our other distribution channels.

We can do it, again, more efficiently and more effectively for customers.

Okay.

Thanks, guys.

Mike Mayo, CLSA.

Good morning.

One simple question and one hard question.

The simple question is what is your commercial loan utilization in the second quarter and how does that compare to the first quarter or last year?

What is your simple question?

I don't have the number here in front of me, Mike, but our -- my --

It's relatively unchanged.

Relatively unchanged with perhaps a tad better given both the increase in commitments as well as some early signs of demand on the commercial side in the second quarter.

Still historic lows.

All right.

And then the hard question is how much of the $506 million of the accretable yield would you consider sustainable?

And I have a couple other questions related to that, but that is the gist of my questions.

So I guess what was -- the accretable yield this quarter was $506 million and what was --.

The release from non-accretable to accretable on the commercial side was $506 million.

Right.

So the accretable yield, which is an income statement item, was $506 million positive?

Correct.

Well, $506 million for the quarter, up $300-some-odd million from the prior quarter.

We have been getting releases through accretable in this portfolio for a couple of quarters now.

And so the first quarter it was $200 million and change and before that it was around the same level?

It was a little bit lower in the prior quarters but, yes.

And so should we expect a $500 million run rate going forward or how do you think about that?

No.

Again, this is -- the total amount of non-accretable against this portfolio is $2.9 billion, as I mentioned, which is about 15% of the remaining unpaid principal balance.

So we are hopeful that we will get additional recoveries from that $2.9 billion, particularly given our success and given where the markets are now.

Markets are liquid; these borrowers are able to refinance and finance out of these positions.

We mark these positions, as you know, down very heavily at the close.

But while we expect additional recoveries in this portfolio, it's an exhaustible resource; it does end at some point.

But, Mike, think of it this way.

There is also offsets to that.

We are taking higher losses in that portfolio right now and there is more costs of managing that portfolio.

So it's not like -- it is an exhaustible resource but I wouldn't think of it in terms of this is good news and that good news ends sometime.

There is also some bad news that also will end as we work through this portfolio.

I understand it's a testament to your conservatism at the time you closed the merger because you wrote down these loans.

Well, it's also more than that.

As John says, there is costs and risks still -- we would like to see this go away because there is costs and risks associated with this portfolio.

But I would also say we were conservative at the time but I got to tell you, and you know some of our people, Mike, we have just terrific people working on these portfolios.

If you know the time that Dave Hoyt and his team spend on these sorts of things the same way we are spending time on the Pick-a-Pay, it's all hands on deck.

And if you are recognizing this difference over eight years, why was so much of the difference recognized in the second quarter?

In other words the uptick of $300 million.

The commercial -- the release on the commercial portfolio is immediately recognized.

On the consumer side, because we are talking about a portfolio, that is where you get the release over time.

So commercial is loan by loan.

Loan specific on the commercial side.

But the $1.8 billion transfer was specifically for Pick-a-Pay?

Yes, the $1.8 billion is Pick-a-Pay.

That had no impact on second-quarter income but will accrete into income over roughly an eight-year period, whereas on the commercial side the recovery, if you will, was immediately in income.

So that was really the big driver for the quarter then.

And what part made you more optimistic about the commercial impaired loans?

(multiple speakers) That is actual [recovery of] loans.

You actually saw the loan; you do a deal.

Customers were actually cash in hand.

The customer refinanced or we sold the loan or it was resolved in some way.

There is no guesswork there, Mike.

It's done.

All right.

And so just a last follow-up, so if someone asks me how much of the $506 million of the accretable yield is permanent, what would your answer be?

I would ask the question why do you say permanent.

What is the -- I mean, it happens.

It's done.

It's income that was booked in the second quarter, Mike.

Okay.

So next quarter and the quarter after you will just see?

Next quarter we will have either -- hopefully we will have more recoveries over time and hopefully on the other side the cost of working off this portfolio will decline and the risk will go away.

All right.

Well, thanks a lot.

Nancy Bush, NAB Research.

Good morning, guys.

I promise I will not ask a question about accretable yield.

I am still trying to get my head kind of wrapped around this Wells Fargo financial move, and I understand the economics of having a larger branch system, etc., etc.

But is your Wells Fargo Financial client going to come into a branch to do business?

Yes.

And when he is in the branch, he or she, do you think that you can get them to do quote more banking type transactions?

I'm just having trouble sort of migrating one business to another.

Nancy, that is already happening.

In fact, if you would look at the Wells Fargo traditional store network, you call branch, store network, not all those customers are prime customers to begin with.

In fact, we have been serving them for a number of years.

This way we can serve them even better, more consistently and we are taking a lot of the front-room folks, the sales folks from our Wells Fargo Financial system that has now been eliminated and putting them in our stores.

And yes, we are trying to sell them other things, help them succeed financially.

So it's -- and we actually did some in the last year or so some tests on this and it works very, very well.

So that gave us the confidence that we could do that in our banking stores.

I guess this is more a question for Howard related to the same topic.

How do we look at the migration of revenues and expenses?

Will this take margins down, particularly as the subprime mortgage business runs off or goes away?

How do we think about the P&L changes that this move is going to?

Well, we are not talking about a big component of the balance sheet, but in concept, Nancy, these are slightly higher-margin assets that will go away, but by the same token, they are also higher loss content portfolios.

So losses will be on the margin a little lower and --

Nancy, I would answer it this way.

Everything that was being done in the financial stores except for the debt consolidation portfolio loans will be done someplace else and they are being done right now.

And, frankly, in the last year or two we were doing almost zero debt consolidation loans for our portfolio anyhow.

So we are just not losing that much and the gain is, we think, significant in that you bring financial bankers who are really good at loans in to our stores.

They help our store people become better at loans, the store people help them become better at opening up checking accounts and so forth like that.

So I see this as win; better for customers, better for team members, better for shareholders and I don't see the downside here.

So when will this migration be completed, John?

When is this completely done and we start seeing the impact?

It's going to be -- think of it as -- well, the stores are being shut down as we speak.

So this is -- and [Gary Tulset] has worked with Dave Kvamme and [Kevin Ryan] on that team about people migration and so forth.

So think of it as third quarter.

Okay.

And, Howard, one quick question on operating losses.

I know this is a lumpy number; how do we think about that number going forward?

Is there some baseline that we should be thinking about?

I am assuming that $400 million or so increase in the quarter is abnormal.

Was there anything particularly driving it in the second quarter and when does this number start to tail off?

Again, it is higher than that not only the first quarter but higher than the average for the prior five quarters so you can sort of make your own judgment about what an average quarter would look like.

In this particular quarter we just had a confluence of litigation matters that we accrued for all in the same quarter.

Okay, great.

Thanks.

Thanks, Nancy.

Fred Cannon, KBW.

Thanks.

John, in your -- at the investor day you had stated that preemption was your biggest concern about reg reform.

In your introductory comments today it appears that there is a number of other issues that have you concerned about how reg reform plays itself out, as the rules get written.

I was wondering if you could add a little color on that.

Sure.

There are parts of reg reform that they really got right and I want to compliment those who are involved in that.

Things like the systemic risk regulator, a way to unwind large systemically important firms.

We have always had that on the banking side, commercial banks, but didn't have it in financial services.

And consumer protection; we will have to see how the bureau works but the concept around consumers should be able to buy products from providers who have proper regulation.

We think that, and a level playing field, that is all good.

On the part that -- there is a big omission here in the reform bill and there is nothing in there, not one word about the GSEs, Fannie and Freddie.

You could ask any American and they would say housing was not the epicenter of what happened it was very close to it, and who are the two biggest players there, Fannie and Freddie.

So now with respect to preemption, they got it mostly right.

I think it could have been even better for Americans but they got it pretty close there.

And that is why I am hopeful that as we see it work in reality that we will be able to continue to provide products and services across the country.

Consumers can live and work and borrow and use ATM machines and understand that there is consistent laws across the land.

Of course, I don't see how debit card fees between banks and merchants had anything to do with what happened in the last couple of years as a downturn.

So we are still working through the impacts of that.

So there are -- so think of it this way, Fred, there are things that we agree with and we think will make the industry and the country stronger.

There are things that weren't tackled that will need to be tackled in some way, shape, or form.

And there is things that I don't understand how it impacted the downturn and, frankly, I don't agree with parts of it.

I couldn't agree with you more on the GSEs.

Just as a follow up, John, the consumer financial product bureau that is being set up, how much -- how concerned are you about that and about who gets nominated to run that new agency?

Again, it's so early.

We have always been, here at this company, strongly aligned with the interests of our consumers.

People have asked me, I have been asked this question a thousand times, what did you see in real estate that others did not that caused you not to make negative option arms.

And we said we didn't see the downturn coming, we just knew it wasn't good for consumers and that is what -- we have always been guided by that.

So how the bureau works, who is named, that is all stuff for another day.

We will just continue to do what is right here and I am sure that we will be able to adopt our and work with whatever the outcome is.

All right, thanks.

One final one.

Your loan mods; I believe in the press release up to date you have the about 76,000 HAMP and about 430,000 of your own.

Do you see more loan mods, those numbers continuing to climb, and do you see the HAMP ones beginning to accelerate?

Kind of where are we on that whole thing?

We are doing about three mods for every one foreclosure.

And I have got to tell you, while we continue to get better and we need to get better, I am very proud of the work that over 16,000 or 17,000 of our people do every day to help Americans stay in their homes.

We do about 2,000 mods per day.

There continues to be changes and some that the industry has suggested to help make HAMP more friendly, more usable but I have got to tell you we are also doing a lot of things that we think are best practice kinds of things.

We are now doing our 10th or 11th weekend event in large cities across America where we have home preservation workshops where we bring our people in.

They are all hooked up to online so people can sit down and have a modification done right at the event.

We are doing many other outreach kinds of activities.

So I don't know that one will grow more than the other, but we have all of our people that are involved in this very committed to help Americans stay in homes.

All right.

Thanks so much.

Thank you.

Paul Miller, FBR.

Thank you very much.

Talk a little bit about your MSR portfolio.

You have it definitely lower than anybody else in the industry at 76 basis points.

I know a lot of that was driven by that 10-year going from 4% to 3% but you are not releasing a big uptick in refis or whatnot as a lot of people talk about a refi burnout.

Can you add some color about how you might be able to capture some of that value there?

Because you definitely don't need to hedge it down at this level given where rates are.

Well, you always have to worry about whether rates go up, down, or sideways so we can't not -- we can't ignore our hedging in the portfolio.

But, yes, at 73 basis points if rates go back up or we decide to hedge differently, there could be very significant up-value in that activity.

But, Paul, you do raise, I think -- I don't know if this was part of your question, but there might be a point in time we have a view that rates can't go much lower and they are going to go up.

We might have a bias.

We might take a company view that rates will go up and in those times we might decide to not as fully hedge based on that view.

But we sat here just a quarter ago and rates were 100 basis points higher.

People said at the time it couldn't go any lower and it went 100 basis points lower.

So the goal there on the MSRs is not to -- it's really a risk management activity and it's not -- so that is the reason for the hedge.

We might have a bias one way or the other but it's predominantly about risk management.

Well, I guess I am more -- it's definitely about risk management but it's also just the confusion of the accounting.

A lot of people have to use that 10-year as a basis but you are just not seeing the refis so is the -- and so is really the accounting value matching the economic value?

In my mind there is a huge difference between the two at this point.

I don't know if you want to address that at all on the call, but it just seems to me that there is a lot more economic value than (inaudible) [value is allowing you to discount].

Actually refinance volumes have jumped quite a bit recently.

There is a fair amount of activity there.

On the other hand, you are right that not everyone can refinance because of the loan-to-value requirements, but if you are interested in a longer conversation to this we will shortly arrange for that.

But I think it's pretty obvious we have a set of 9 million or so customers who we make 25 basis points on the servicing, which is -- we discount that back.

We put an asset on our balance sheet.

We think that asset is conservatively valued, like you said 70 some basis points; lowest in the industry.

In fact, I think it's the lowest we have ever had it because rates are so low.

We still have a few more questions from the line.

We will try to take one from a few more people.

Joe Morford, RBC Capital Markets.

Regarding capital can you update us as to what your current expectations are for what new requirements you may be held to as well as when you think we may hear something specific on that?

And then given the strong internal generation rates, when might we see Wells start to deploy some of its capital through dividend increases or share buybacks, and where would your preference be between those two?

Joe, all I can tell you is what I read because I don't know a lot more than that.

The Basel III accord, there is lots of discussion going on about that.

I would expect that it's in the interest of the banks in the US, our economy, and the world that there be a resolution on that sooner than later.

I don't know where those numbers are going to go, but there has to be some call about how much capital is enough.

Hopefully, whoever makes the call relates it to the risk inherent in the companies -- one size does not fit all here.

I can tell you in our Company's case our Tier 1 is now higher than it has ever been in my 30 years with the Company or 29 years with the Company.

Our Tier 1 common now is as high as it has ever been.

We are generating it at very rapid speed, pace.

And, frankly, it's time we start rewarding our owners, our stockholders with a more representative dividend given the performance of this company.

And that is job one around here.

We want to get that done.

Okay, thanks.

Thank you.

Matt O'Connor, Deutsche Bank.

Hi, guys.

If I could just circle back to the expense reduction conversation that you were having earlier, obviously there is the opportunity of cutting costs in financial.

It seems like if you are already at 80% of the Wachovia targeted cost saves and there is still a ton of integration to be done, it seems like there might be some upside there.

So I guess I was just hoping that you could try and size up how big all of the cost savings might be and the timing of when you might start realizing some of them?

Well, as we mentioned, Matt, we have got a lot of things in various stages of thought and development on expenses.

We are still committed to realizing the $5 billion of annual savings from the consolidation.

We talked about the Wells Fargo Financial; we have put some estimates into the public on the potential positive impact of that and timing of that going forward.

And as I said, we have got a variety of other things that are going on that are just in very early stages of development I would say.

So we will -- as we know more and could put some specificity around that we will disclose more of that.

Okay.

When do you think you will be doing that?

Throughout the next four or five quarters probably.

Okay.

All right, thank you.

Ed Najarian, ISI Group.

Hi, Howard.

Just a quick question to clarify this accretable thing.

Could you just give us the actual total accretable difference in the first quarter and then what it was in the second quarter so we can not only see that $300 million step up but what the actual numbers were?

I know that $506 million is just related to the commercial PCI portfolio; I was interested in the totals.

Well, we have got -- as I said, it was about $1.8 billion on the Pick-a-Pay side and the $500-and-some-odd million on the commercial side.

I am talking about the amount that flowed through net interest income, excuse me.

The only thing that went through net interest income was the $506 million compared with roughly $180 [million] in the first quarter.

So there was no consumer related that flowed through in the second quarter?

No, because again the consumer is just in the yield and the bulk of the increase was the $1.8 billion in the second quarter.

And that had no impact on second quarter.

Okay.

And then secondarily, on the US Bancorp call they indicated that the change in -- their estimate for the change in FDIC insurance costs for 2011 would be about $200 million annually.

You guys have a little over four times their deposits, is that something around $800 million a number that you would think would be about right for you guys?

I don't know where they get that number so I can't comment.

And you don't have any estimate for that number?

No.

Okay, thanks.

We will take one more question.

Moshe Orenbuch, Credit Suisse.

Howard, just first a clarification.

I think the previous questioner was asking also about the accretion, which was like up roughly $40 million from like $640-some-odd million last quarter to $680-some-odd million this quarter.

I think that is what the reference was.

Yes, well that is $40 million -- I think the big item is the difference between the 180 and the 506.

Right.

Just to get back on the expense side, it just seems like there is -- maybe I am understanding this wrong, but if you have said that you have already got 80% of the reductions in there out of $5 billion it means that there is $1 billion of incremental savings.

Yet you have still got $2.6 billion of spending to go.

Could you kind of reconcile what that spending is going to get you if you have got 80% of the savings in the [revenue]?

What it's going to get you is signage and systems conversions and principally the non-overlapping stores on the East Coast.

So we have gotten -- the sort of staff consolidation expenses are now behind us, those are the savings, and the bulk of the remaining expenditure gets consolidation in, as I say, the non-overlapping states.

Is there kind of an incremental revenue benefit?

Because I gets otherwise it seems like it's a little disproportionate.

You get the benefit from having everybody on the same system and all the revenue benefits of cross-selling comes with that going forward.

But the two are really not as connected as you might think.

So you have your integration and it cost money to change systems, to change signs, and all those other things, and then you have your savings.

So I wouldn't -- you can't -- it wouldn't be the right analysis to say you are through 80% of your conversion, you should have 80% of your savings.

Those two are really not as connected as you might think they are.

Right.

I don't want to harp on it but it seemed to me that it usually went the other way.

That a lot of these spending comes up front and the savings are realized afterwards so this for some reason seems to be reversed.

Well, when you have -- in our case where you have two companies and you only need the one CEO, you need one head of retail, one head of operations, those kind of things, you make some of those changes pretty quick.

You want advertising budget and it's a --.

If you have a systems conversion that is necessary to consolidate two branches then, yes, you can have -- you spend the money first, you consolidate the systems, and then the savings come when you actually mush the branches together.

But, as I say, in this case we are converting the nation's systems of systems and the bulk of the work effort there is connected with the non-overlapping states.

So you have to do the work and the benefit, as I said, will be all the revenue synergies and all the other goodies that come along with having everybody on the same system.

Great.

Thanks.

Thank you.

I want to thank all of you for joining us.

We very much appreciate your time and we will see you next quarter.

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

You may now disconnect.