富國銀行 (WFC) 2020 Q2 法說會逐字稿

Good morning. My name is Regina, 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. (Operator Instructions) Please note that today's call is being recorded.

I would now like to turn the call over to John Campbell, Director of Investor Relations. Sir, you may begin the conference.

Thank you, Regina. Good morning, everyone. Thank you for joining our call today where our CEO, Charlie Scharf; and our CFO, John Shrewsberry, will discuss second quarter results and answer your questions. This call is being recorded.

Before we get started, I would like to remind you that our second quarter earnings release and quarterly supplement are available on our website at wellsfargo.com. I'd also like to caution you that we may make forward-looking statements during today's call that 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 containing our earnings release and quarterly supplement. Information about any non-GAAP financial measures referenced, including a reconciliation of those measures to GAAP measures, can also be found in our SEC filings, in the earnings release and in the quarterly supplement available on our website.

I will now turn the call over to Charlie.

Good morning, everyone. Thank you, John. I'm going to open the call by reviewing what is clearly a very poor quarter for us. I will review the drivers of our results, make some comments about the environment and discuss the rationale for the intended dividend reduction. I'll then turn the call over to John to review second quarter results in more detail.

Our view of the length and severity of the downturn deteriorated considerably from our assumptions at the end of the first quarter, and this, as well as the knock-on impacts from COVID, substantially impacted our results this quarter. We added $8.4 billion to the allowance for credit losses. Charge-offs increased $204 million from the prior quarter to $1.1 billion. Net interest income was down 13% from the prior quarter, driven primarily by lower rates. The constraints of operating under the asset cap has limited our ability to offset lower rates with balance sheet growth.

And we actually took actions during the quarter to limit loan and deposit growth, which John will highlight. Expenses included approximately $400 million related to decisions we made due to COVID, most of which we do not expect to be permanent but was the right thing to do for employees and to improve the safety of our facilities; about $350 million of deferred comp with an offset in fee revenue; $1.2 billion of operating losses, primarily for customer remediation accruals related to our ongoing work to remediate the historical issues in Community Banking as we took another look under new leadership at outstanding matters. This accrual will enable us to do the right thing for our customers while resolving these matters as quickly as possible.

Revenues were lower by about $295 million due to COVID-related fee and interest waivers for certain products. In addition, a strong quarter of mortgage production revenue was partially offset by a $531 million write-down of our mortgage servicing rights asset due to higher projected defaults and faster prepayment assumptions. And while it's a smaller part of the company, we did have record revenues this quarter in our corporate and investment bank.

Even with the loss this quarter, our CET1 ratio increased to 10.9% from 10.7% last quarter and is well above our regulatory minimum of 9%. As a reminder, our regulatory minimum reflects our expected stress capital buffer of 2.5%, the minimum possible.

As you know, Wells Fargo is predominantly a U.S. bank that takes deposits and makes loans. Our balance sheet composition is 80% cash loans in our investment portfolio. When consumers, small businesses, middle-market companies and corporates suffer, we do as well. As the economic environment brought on by COVID negatively impacts our customers and clients, it will filter through to our results, primarily in the form of outsized credit losses and compressed net interest margins.

Additionally, given we operate with a balance sheet cap, we must prioritize balance sheet capacity, both assets and deposits. And there is certainly an opportunity cost for us in an environment like this. In addition, given the uncertainty in the recovery, we must manage the balance sheet to a level where we can remain below the asset cap, even if there's another period of material loan drawdowns upward -- or upward pressure on our deposit base.

Having said that, we are responsible for the position we're in. The balance sheet cap exists because leadership failed to both oversee and build the appropriate infrastructure of the company, and our financial underperformance is because leadership didn't make the difficult decisions necessary. We are focused on both of these. We still have much to do to build the right risk and control foundation, which is what our regulators expect, and nothing can or will stand in the way of those activities. It is our highest priority. But we also recognize that we've been extremely inefficient for too long, and we will begin to take decisive actions, none of which will impact our risk and regulatory work, to increase our margins.

To the first point, we continue to make meaningful changes to improve the foundation of the company. In the second quarter, we announced a corporate risk organizational structure to provide greater oversight of all risk-taking activities and a more comprehensive view of risk across the company. Our new risk model will have 5 line of business chief risk officers to complement the teams and leaders by risk type.

During the quarter, we hired a new chief operational risk officer, a new chief risk officer for consumer lending and a chief control executive. We continue to add additional talent to the senior leadership team. Since I joined the company 9 months ago, I've announced 6 new members to the Operating Committee, all coming from outside of Wells Fargo with strong and relevant industry experience. Over 2/3 of our Operating Committee have joined Wells Fargo since 2018. All of our business lines' CEOs are now in place, including Mike Weinbach, who joined Wells Fargo in May as CEO of Consumer Lending; and Barry Sommers, who joined at the end of June as CEO of Wealth and Investment Management.

Lester Owens will be joining us next week in a newly created role as head of operations. Lester has more than 30 years of experience in the financial services industry and senior operations roles. He will be responsible for building a more integrated approach to Wells Fargo's business operations functions. He has a proven track record in delivering a better customer experience while driving substantial efficiencies at the same time.

We also made significant hires in roles one down from our Operating Committee, including a new head of government relations, corporate communications and corporate responsibility as well as chief administrative officer, and a new head of our home lending businesses.

We continue to have over 200,000 employees working from home, and we plan to have employees who are currently working from home continue to do so until at least September. It is too early to determine exactly when we will ultimately return to a more traditional work environment, but we will be cautious about bringing people back into the office. While I do believe there are meaningful benefits of people working physically together, we will move forward when we are comfortable that the health risks are manageable. Where there is a specific need, we will do so with the appropriate safety precautions in place, and we will make these decisions by geography, by facility. We have done this since the beginning of the crisis, and we will continue to do so and serve our customers and communities.

We've made significant accommodations for our customers. Through the end of June, we have helped more than 2.7 million consumer and small business customers by deferring payments and waiving fees. This includes over $2.5 million of payment deferrals, representing more than $5 billion in principal and interest, including $3.2 billion in mortgage loans serviced for others. We provided approximately 6 million fee waivers for consumer and small business customers exceeding $200 million.

For our commercial clients, we processed approximately 246,000 deferrals, representing more than $1.5 billion of principal and interest payments.

In addition, for commercial distribution and auto finance customers, we provided maturity date extensions, representing approximately $6.6 billion of outstanding principal and interest.

Through the end of June, we have funded 179,000 PPP loans totaling $10.1 billion with an average loan size of $6,000. 60% of those were for loan amounts of less than $25,000, 84% of those were for companies that had fewer than 10 employees, 90% have less than $2 million in annual revenues, and 41% were to companies in low- and moderate-income areas, or at least 50% minority census tracks.

And we announced last week our Open For Business Fund. We have committed to donating approximately $400 million in gross processing fees earned from the Payroll Protection Plan to help support businesses impacted by the COVID-19 pandemic. And we will work with nonprofit organizations to provide capital, technical support and long-term resiliency programs to small businesses with an emphasis on serving minority-owned businesses.

Customer deposits have continued to increase, reflecting unprecedented government stimulus programs, lower spending and customers converting investments into cash while commercial deposits declined, reflecting actions we took to manage under the asset cap, which John will describe in more detail.

In March, our commercial customers utilized over $80 billion of their loan commitments during the market turbulence at the onset of the pandemic, and almost all of those loans were paid down in the second quarter. Debit card spend started to increase in April, and returned to pre-COVID levels in May and in the last full week of June, were up approximately 10% from the same week a year ago.

Consumer credit card spend improved steadily starting in mid-April but was still down approximately 10% from a year ago as of the end of June. Commercial card spend remained significantly lower throughout the second quarter and was still down over 30% in the last full week of June compared to the same week a year ago, with declines across industry segments. We continue to monitor our consumer and commercial customer spending trends as the nation goes through the various stages of reopening.

Trends in digital usage are strong. Mobile deposit dollar volume was up over 100% in the second quarter compared with a year ago. In the second quarter, digital log-ins were up 21% from a year ago.

Let me turn to the dividend now. Today, we announced that our Board expects to reduce our dividend for the third quarter to $0.10 per share. The Federal Reserve has authorized banks to pay common stock dividends that do not exceed an amount equal to the average of the bank's net income for the 4 preceding calendar quarters. Based on these instructions, we previously announced that this limitation would cause us to reduce dividend from the current level of $0.51 a share. In addition, while this requirement currently applies to the third quarter, the Federal Reserve stated it reserves the right to extend the limitations as it learns more about the evolution of the COVID event.

Separately from this, our Board has been reviewing the level of the dividend, and I've discussed a way in which we would approach evaluating the right go-forward level. We first would look at our capital position. As I said, our capital position remains quite strong, so our current capital level is not the driving factor in our decision. Having said that, as we look forward, we do not pretend to have a deeper understanding of the path of the recovery than others. Using our economic assumptions, our capital levels remain above the minimum required, and our CCAR results confirm the strength of our capital position. But we believe it's prudent to note that our assumptions are just that. So we felt it was appropriate to factor this uncertainty into our thinking around the appropriate dividend level in this environment.

After evaluating our capital position, we considered our current and expected earnings level. We expect the impact of COVID to continue to negatively impact our earnings until we see a clear trend of meaningful improvements in unemployment and GDP. This will result in continued lower levels of NII and certain economically sensitive fee revenues as well as potentially unforeseen expenses to operate in this environment.

In addition, while our ACL is intended to cover expected losses based on our current economic assumptions, we're mindful of the uncertainty and the need to reevaluate these assumptions continually. And I will discuss this more, but while we have actively begun to address the fact that our expenses are significantly too high, it will take some time to see the impact of our actions in our results.

Putting this all together, it is critical in these uncertain times that our common stock dividend reflects current earnings capacity, assuming a continued difficult operating environment, evolving regulatory guidance, and protects our capital position if economic conditions were to further deteriorate. Given this, we believe it's prudent to be extremely cautious until we see a clear path to broad economic improvement. We're confident that this eventual economic improvement, combined with our actions to increase our margins, will allow our wonderful franchise to support a higher dividend in the future. We're extremely disappointed to take this action and do understand that many rely on this stream of income. However, we must be prudent in this environment.

I have acknowledged in the past that our expenses are too high and that we're building road maps to improve our efficiency ratio. To repeat, there is nothing structurally different about Wells Fargo that should prevent us from being as efficient as our large peers, but we are far from it. For us to bring our level of efficiency close to our peers, the math would tell you we need to eliminate over $10 billion of expenses.

While our work is not yet complete to commit to specific numbers and time frames, we expect to take a series of actions beginning in the second half of the year to begin to reduce our expense base and bring our expenses in line with the size and composition of our businesses. This will be a multiyear effort for sure but would like to see a reduction in expenses next year.

And now -- we now have a centralized team driving the effort across the enterprise, and our lines of business and functional areas have dedicated resources stacked against this. This work did not start in the last few months, but the extremely challenging operating environment and uncertain outlook has accelerated our sense of urgency. It is important to note that I deeply believe that this exercise is about making us a better and more efficient company, not just about reducing expenses. We have too many management layers, spans of controls for managers are too narrow, and we have resources dedicated to activities that are not a priority today. This cannot continue.

We also have the opportunity to apply lessons we have learned since the onset of the pandemic to drive efficiency across the company. Over the medium term, we have the opportunity to materially reduce our expense, including increasing digital adoption for retail and commercial clients; reducing third-party spend; consolidating locations, including branches, field offices and corporate sites; and at applying technology differently. In addition, the opportunity to consolidate our operational platforms is still meaningful.

As a financial company and, specifically, a G-SIB we must be strong financially to serve our customers and support our communities but also to provide growing opportunities for our employees. And while our balance sheet is strong, our margins are too narrow. To ensure we're that source of strength, we need to begin to take action to improve our results.

As I've said, and I'll say it again, we will not do anything that will impact the work we have underway to build out our risk and control environment. The opportunity to become more efficient exists elsewhere in the organization, and we will protect this work at all costs. I will continue to share more specifics about our plans as they develop, and we will be talking more about this next quarter.

While there remains much economic uncertainty, many market liquidity trends are strong as Fed programs continue to effectively support the smooth functioning of the capital markets. While still wide to pre-crisis levels, market spreads have continued to improve since the peak of the dislocation and have retraced 70% to 90% of their mid-March widening. Liquidity and treasury and interest rate swap markets returned to precrisis levels, and the Fed's open market purchase program has stabilized mortgage basis valuations and improved liquidity. HQLA bid-ask, a measure of the cost to transfer risk, has retraced to precrisis levels, while measures of volatility are now below precrisis levels.

However, the economic recovery will not be smooth. Much of the economy is still essentially closed or just beginning to open, and additional restrictions are being implemented as the spread of the virus continues to increase in many areas of the world. While consumer spending has increased from levels at the end of the first quarter, it is still down from a year ago with significant declines in areas like travel, entertainment and restaurants. And while government stimulus programs provided a safety net for many, they are scheduled to run off, raising the possibility of more economic hardship ahead.

Having said all of this, cities, communities, people and businesses are all learning what it takes to reopen safely, and there is progress on vaccines and therapeutics. We will do what we can to support the fastest recovery possible, but we will be cautious in our outlook until we see the facts.

I want to conclude my comments today by discussing an important topic: racial injustice. In my conversations with different groups over the past months, the pain and frustration with the lack of progress within both our country and Wells Fargo is clear. Inequality and discrimination has been clearly exposed and must not continue. Wells Fargo has not been effective in creating enough diversity or a consistently inclusive environment, and I've outlined a number of actions we are taking around race to change the outcomes, including creating a new role [in diversity] which will have a broad mandate of driving diversity and inclusion in both the workplace, but also our business.

We'll be evaluating Operating Committee members based upon their progress in improving diverse representation and inclusion in their area of responsibility, and it will have a direct impact on year-end compensation decisions. And we've announced the donation of these gross processing fees for PPP, estimated to be approximately $400 million.

This is just the beginning of the work needed to address this crisis and to meaningfully contribute to the change that is necessary. But I believe that this is a watershed moment, and we will be part of making sure this time is different.

Finally, I want to thank all of the employees at Wells Fargo who continue to work tirelessly to serve our customers and successfully execute on our priorities.

I will now turn the call over to John.

Thanks, Charlie, and good morning, everyone. Charlie's comments covered most of the information on Page 2 of the supplement, including the largest driver of our reported loss, which was the $8.4 billion increase in the allowance for credit losses in the second quarter. So let me highlight just a couple of things here.

First, our income taxes in the second quarter reflected the impact of annual income tax benefits, primarily tax credits, driven by our reported pretax loss. As a result, we currently expect our effective income tax rate for the remainder of the year to be approximately 26%, excluding the impact of any discrete items. Also, deferred compensation plan investment results increased net gains from equity securities by $346 million and increased personnel expense by $349 million. As we've highlighted many times, while these hedges are largely P&L-neutral, they can result in large swings in our reported revenue and expense trends.

In late May, we entered into arrangements to transition these economic hedges from equity securities to derivatives in the form of total return swaps. As a result of this change, starting in the third quarter, our reporting for this item will be less volatile since most of the accounting impact from deferred comp hedges will be reported in personnel expense.

Turning to Page 3. Charlie covered the support we're providing to our customers and communities during the pandemic, but let me just highlight that the approximately $400 million donation for small business recovery efforts we announced last week through the new Open For Business Fund will be donated when the gross fees are recognized in revenue.

Turning to Page 4. While our earnings in the second quarter were significantly impacted by the economic environment, our capital and liquidity continued to be strong, with both our CET1 ratio and LCR increasing from the first quarter. Our CET1 ratio increased to 10.9%, 190 basis points above our current regulatory minimum of 9%. We expect our stress capital buffer to be 2.5%, which is the lowest possible under the new framework, and would result in the regulatory minimum for our CET1 ratio remaining at 9%. Even with the large increases in our allowance over the past 2 quarters, our CET1 level was $23.7 billion above the regulatory minimum.

Our LCR increased to 129%, 29 percentage points above our regulatory minimum. And our primary unencumbered sources of liquidity were approximately $511 billion.

Turning to loans on Page 5. Similar to industry trends, period-end consumer and commercial loans outstanding declined in the second quarter, but average balances grew, reflecting increases in outstanding balances late in the first quarter. I'll explain the drivers of consumer and commercial period-end loan balances in more detail, starting with consumer on Page 6.

Consumer loans were down $20.1 billion or 5% from the first quarter. This decline includes the reclassification of $10.4 billion of conforming first mortgage loans to held-for-sale status to provide flexibility to manage our balance sheet under the asset cap. The economic slowdown from COVID-19 reduced consumer spending and was reflected in lower credit card balances, lower auto originations and other revolving and installment loan balances. In addition, we took actions during the second quarter to tighten credit standards given the current economic environment and to manage to the constraints of the asset cap. These actions included no longer purchasing jumbo mortgage loans through our correspondent mortgage business and not accepting home equity and personal line of credit applications.

In the auto business, we've taken actions to mitigate future loss exposure, and our spreads on new originations improved to their highest levels since 2016. That said, as states began to reopen later in the quarter, we saw increased loan demand, including higher credit card spending and higher auto loan originations.

Turning to commercial loans on Page 7. C&I loans declined $54.9 billion or 14% from the first quarter, driven by paydowns of revolving loans following increased loan draws in the first quarter during the market turbulence at the onset of the pandemic. As Charlie highlighted, almost all of the $80 billion of loan draws in March were paid down during the second quarter. These paydowns were partially driven by strength in capital markets and helped drive record revenues in the second quarter in our corporate and investment bank.

Commercial real estate loans increased $2.1 billion from the first quarter, with growth in both commercial real estate mortgage and in construction loans.

Turning to deposits on Page 8. The industry has experienced very strong growth, but due to our asset cap constraint, we've worked to manage growth of certain lower liquidity value deposit categories. However, even after these actions, average deposits grew 9% from a year ago and 4% from the first quarter. The linked-quarter growth was driven by noninterest-bearing deposits, which were up 18%, while interest-bearing deposits declined 1%.

Period-end consumer and small business banking deposits grew $78.6 billion from the first quarter. This strong growth reflected COVID-19-related impacts, including customers' preference for liquidity; loan and tax payment deferrals, which otherwise would have reduced deposits; stimulus checks; and lower consumer spending.

Wholesale Banking deposits declined $32.1 billion, reflecting actions we took to manage under the asset cap, including an emphasis on reducing certain nonoperational deposits. Average deposit cost declined to 17 basis points, down 35 basis points from the first quarter, with declines across all of our lines of business. While Wholesale Banking deposit costs declined the most, reflecting higher deposit betas, both WIM and Retail Banking deposit costs also declined. We currently have no active Retail Banking promotions, and we expect deposit costs will continue to decline in the second half of this year and reach the single-digit lows realized in 2015 and 2016.

Net interest income declined $1.4 billion or 13% from the first quarter due to balance sheet repricing driven by the impact of a lower interest rate environment; $275 million less favorable hedge ineffectiveness accounting results driven by large interest rate changes; $187 million of higher MBS premium amortization due to higher prepayment rates; and these declines were partially offset by a shift to a lower cost mix of funding.

Net interest income was down 13% for the first half of the year. And as I discussed in June, we currently expect net interest income to be in the $41 billion to $42 billion range for the full year 2020, which would be down 11% to 13% from the full year of 2019. This decline reflects the lower interest rate environment and the constraints the asset cap places on our ability to grow the size of our balance sheet as well as higher MBS premium amortization, which we expect to persist for the remainder of the year.

Turning to Page 10. Noninterest income increased $1.6 billion or 24% from the first quarter, driven by a $1.9 billion increase in net gains from equity securities, reflecting lower securities impairment and higher deferred compensation plan investment results. I'll explain some of these drivers in more detail.

Deposit service charges were down $279 million from the first quarter driven by COVID-19-related impacts, including lower overdrafts as customers have reduced debit card transactions and increased deposit balances as well as higher fee waivers. Trust and investment fees declined $223 million from the first quarter. Investment banking had a strong quarter, with revenue increasing $156 million or 40%, driven by strength in debt and equity capital markets. This growth was more than offset by both lower retail brokerage advisory fees, which were priced at the beginning of the second quarter when market levels for advisory assets where pricing were lower, and decline in brokerage transactional revenue.

Mortgage banking revenue was relatively stable linked quarter, with strong growth in mortgage loan originations more than offset by declines in servicing income. Total residential held-for-sale originations increased 30% from the first quarter to $43 billion, primarily driven by lower mortgage interest rates. Lower interest rates drove strong industry volume, with second quarter estimated to be the largest origination market since the third quarter of 2003. As we managed our application pipeline to handle the strong demand, our margins increased.

In the second quarter, our production margin on residential held-for-sale mortgage loans was 204 basis points, up from 108 basis points in the first quarter. We've continued to add capacity and expect originations to increase in the third quarter if rates remain low, and we would expect margins to be relatively stable with second quarter levels.

Servicing revenue declined $960 million from the first quarter. The decline was driven by a lower valuation of our MSR asset as a result of updated assumptions, including higher prepayment assumptions, and higher expected servicing costs due to an increase in projected defaults. Servicing fees were also lower due to payment deferrals and fee waivers provided to our customers in response to the pandemic.

Finally, net gains from trading activities increased $743 million from higher trading volumes across many products, increased volatility leading to wider bid offer spreads, and substantial spread and price improvement in certain capital markets.

Turning to expenses on Page 11. As Charlie highlighted, our expenses are too high, and we're beginning to take further action to improve our efficiency. The $1.5 billion increase in our expenses from the first quarter was driven by higher operating losses as well as higher personnel expense, reflecting a $947 million increase in deferred comp expense.

Charlie described the $1.2 billion of operating losses, which included $765 million of customer remediation accruals for a variety of matters as well as higher litigation accruals.

The $597 million increase in personnel expense included the increase in deferred compensation, which is P&L neutral; and $231 million of COVID-19-related employee expenses, including premium pay for those who had to come into the office, and payments for backup childcare. Most of the COVID-19-related employee expenses have now expired.

We also had $133 million of higher COVID-19-related occupancy expense to make our properties safer for our employees and customers, including enhanced cleaning, additional supplies and workstation modifications. These costs will likely remain elevated until the pandemic ends.

The impact of COVID-19 also reduced some of our expenses, including travel and entertainment and advertising and promotion expense.

Turning to our business segments, starting on Page 12, as Charlie highlighted, we now have the leadership for our 5 business segments in place, and we will transition to reporting our segments in accordance with the structure starting in the third quarter. Community Banking reported a net loss of $331 million driven by an increase in provision expense. On Page 13, we provide our Community Banking metrics. We had 31.1 million digital active customers, up 4% from a year ago. While the number of digital customers remained stable from the first quarter, these customers are doing more digitally, with log-ins up 10% from the first quarter; and the number of checks deposited using a mobile device reaching a record high in the second quarter, up 32% from the first quarter.

Approximately 20% of our branches are temporarily closed due to COVID-19. As a result of fewer branches being opened and increased digital usage, teller and ATM transactions were down 19% from the first quarter and 28% from a year ago. However, we still have approximately 1 million teller transactions occurring at our branches every business day.

Our customers' demand for cash has decreased by approximately 20% compared to a year ago. This decrease was reflected in lower demand for cash in our branches. While ATM transaction volume was down, the amount of cash withdrawn at our ATMs has increased, reflecting higher levels of cash per withdrawal, in part, driven by the higher ATM withdrawal limits we implemented in the first quarter.

Charlie highlighted the improving trends we experienced during the second quarter for debit and credit card spend. Higher debit card spend later in the quarter resulted in total second quarter spend being flat compared with a year ago. However, transaction volume was down 13% from a year ago, with customers spending more per transaction. As a reminder, debit card fees are based on transaction volume, not dollar volume.

Turning to Page 14. Wholesale Banking reported a net loss of $2.1 billion as revenue growth was more than offset by an increase in provision for credit losses. I've already discussed the drivers of loans and deposits, so let me highlight a few other business drivers.

Corporate and investment banking capital markets had record revenue in the second quarter, driven by the trading revenue increases I described earlier and record investment-grade debt issuance. Wells Fargo Capital Finance was the #1 book runner of asset-based loans, with year-to-date market share increasing to 20%. We maintained our leadership position in this market by providing an important source of liquidity to our customers during a very challenging time.

Wealth and Investment Management earned $180 million in the second quarter, down 61% from the first quarter, primarily driven by an increase in the allowance for credit losses, the lower interest rate environment and lower market valuations at the beginning of the quarter. We continued to experience strong demand from clients for liquidity products with growth in deposits and money market funds in our asset management business.

Wells Fargo Asset Management achieved a record high $578 billion in assets under management in the second quarter, up 12% from the first quarter, driven by continued momentum in the money market business, higher market valuations and fixed income net inflows. While advisory assets in our brokerage business increased 14% during the quarter, we had lower retail brokerage advisory fees since they're priced at the beginning of the quarter when market valuations were lower. These fees will benefit from the stronger markets at the beginning of the third quarter.

Turning to credit results for the company on Page 16. Our net charge-off rate was up 8 basis points from the first quarter to 46 basis points, which is still a historically low level, particularly during an extremely challenging economic environment. Keep in mind that the significant amount of customer accommodations we provided for our consumer and commercial customers since the start of the pandemic will delay the recognition of net charge-offs, delinquencies and nonaccrual status for those customers who would have otherwise moved into past due or nonaccrual status. However, I will point out that this dynamic was considered in our allowance for credit losses.

Commercial-criticized assets increased $13.3 billion or 53% from the first quarter, with C&I up $7.2 billion and CRE up $6.1 billion. Nonaccrual loans increased $1.4 billion from the first quarter, driven by growth in commercial nonaccruals. I would note that 75% of our commercial nonaccrual loans were current on interest principal as of the end of the second quarter. We provide more detail on C&I nonaccrual loans on Page 17.

While C&I loans outstanding and total commitments declined from the first quarter, nonaccrual loans increased 59%, driven by oil and gas and real estate and construction C&I loans, which includes credit facilities to REITs and other nondepository financial institutions. Last quarter, we provided more details on industries with escalated monitoring, and those industries largely drove the increase in criticized assets in the second quarter, including retail, entertainment and recreation.

Turning to our commercial real estate portfolio on Slide 18. We are the nation's largest commercial real estate lender, and our portfolio is well diversified, both by property type and geography. Our commercial real estate loans are subjected to rigorous underwriting standards and are well structured. Before COVID-19, this portfolio was performing at historically strong credit levels with a good mix of assets and geography, a well-capitalized customer base and overall low levels of leverage. We have proactively reduced our exposure to retail and have minimal exposure to land or condos where losses were highest in the last cycle.

Since the pandemic began, we've worked to assist customers on a case-by-case basis. We've continued our strict routine monitoring process with the goal of identifying problems early. Our CRE team has an experienced bench with workout backgrounds and perspective in times of distress, which has enabled us to ramp up quickly. However, these are unprecedented times, and nonaccruals were up $286 million or 30% from the first quarter.

Given what's been going on in the economy, it's not surprising that shopping centers, retail and hotels, motels, accounted for 59% of nonaccrual loans in the second quarter and accounted for 90% of the increase from the first quarter.

Criticized assets were up $6.1 billion or 140% from the first quarter, driven by the same sectors that drove the increase in nonaccruals, with the addition of office buildings.

Turning to our oil and gas portfolio on Page 19. Oil and gas loans accounted for 1% of our total loans outstanding, with $12.6 billion outstanding at the end of the quarter down 12% from the first quarter. Total commitments were down $1.7 billion from the first quarter, reflecting the impact of spring redetermination changes on borrowing basis, proactive portfolio management, as well as the weaker credit environment. Net charge-offs increased $111 million from the first quarter, with 87% of second quarter net charge-offs from the E&P sector. Nonaccrual loans increased $865 million from the first quarter, with approximately 93% of nonaccruals still current on payments. Criticized loans increased 26% from the first quarter, reflecting downward credit migration resulting from commodity price volatility and included numerous credit downgrades of publicly rated companies.

On Page 20, we provide detail on our allowance for credit losses. The $8.4 billion increase included $6.4 billion for commercial loans and $2 billion for consumer loans. Our allowance coverage for total loans was 2.19%, up 100 basis points from the end of the first quarter, with the largest increases across commercial loans, junior lien mortgage loans and credit card loans.

We highlight the key drivers of the increase in our allowance for credit losses on Page 21. We considered current economic conditions, which worsened significantly compared to prior expectations as unemployment levels reached 14.7% in the second quarter. In addition, over $2.4 trillion in fiscal stimulus programs as well as customer accommodations provided near-term support for borrowers. On this page, we provide details on the economic forecast in our base case scenario for the second quarter allowance, which assumes near-term economic stress recovering into late 2021, including unemployment levels declining to approximately 6% by the fourth quarter of 2021.

While housing prices are forecasted to remain relatively stable, commercial real estate prices are forecasted to decline by low to mid-teens with hotel, restaurant and retail sectors expected to decline much further. In addition, collateral prices remain highly uncertain given limited property sales.

While the large majority of weight is placed on the base case scenario, we apply some weighting to a downside scenario to reflect the uncertainty in the economic forecast. And as I previously mentioned, customer forbearance and other deferral activities provided in response to COVID-19 were considered in our loan portfolio performance expectations and loss forecast. However, please keep in mind that our allowance for credit losses is influenced by a variety of factors, including changes in loan volumes, portfolio credit quality as well as general economic conditions.

While the timing of the end of the pandemic and the eventual path to economic recovery remain unclear, we believe that our allowance captures the expected loss content in our portfolio as of the end of the second quarter.

Turning to capital on Page 22. As I highlighted earlier, our CET1 ratio increased to 10.9% in the second quarter. We elected to apply the modified CECL transition provision in our -- to our regulatory capital. The impact of this election was an increase in capital of $1.9 billion and a 14 basis point increase in our CET1 ratio. Additionally, as a result of senior debt issuance during the second quarter and a decline in our RWA, our TLAC ratio increased to 25.3%, which provides a significant buffer to our required minimum of 22%.

In summary, our results in the second quarter were disappointing, and economic conditions remain uncertain. But we're focused on doing the work necessary to improve the earnings capacity of the company, including reducing our expenses while meeting our regulatory commitments.

And Charlie and I will now take your questions.

(Operator Instructions) Our first question will come from the line of Erika Najarian with Bank of America.

My first question is a clarification question for Charlie. Charlie, during your prepared remarks, you noted that your expenses were about $10 billion greater than your peers or where you need to be to be equivalent to peers on efficiency. Are you saying that lopping off $10 billion in expenses is an eventual long-term goal for this company to be in line with your larger peers?

Well, I mean, what I said was that the math -- if you do the math, what it says is that when you look at their efficiency ratios versus ours, our expenses are at least $10 billion higher than they should be, and there's no reason why that should occur. And so we are doing the work to create a road map for a company which is significantly more efficient. Exactly what the time frame is and where we ultimately get to, I think we'll provide more information on that in the future and it will play itself out. But we can do the same math that you can do, and there's no reason why, as a management team, we don't have the ability to be as efficient as the rest.

Got it. That's clear. And my follow-up question has to do with the potential for the Fed to extend the income test beyond the third quarter dividend. And I'm wondering, so as we think about -- you mentioned that expenses should start coming down in 2021. As I think about how consensus is formulating future earnings power, I think consensus is expecting that your -- the majority of your reserve build should be behind you. But I don't think that restructuring costs, for example, that would relate to future efficiency initiatives are in with consensus.

And I guess the question that I'm really asking here is that if the Fed extends the income test beyond the third quarter, do you feel confident that according to how they're looking at dividend capacity, that $0.10 is supportable going forward?

Sure. This is John. They certainly have the ability to extend the current framework. And frankly, it even seems likely just given the way the calendar lines up and the resubmission process is going to work for the next CCAR.

I think Charlie's point is we're going to do what's necessary to get as efficient as we can be. And to the extent that, that kicks off onetime charges, which you might expect, and if that has an influence on our dividend capacity as a result of the Fed keeping the current regime in place, then we'll have to tolerate that. I don't think we're not going to do what's right economically because of accounting consequences. We're going to do -- we're going to follow GAAP. We're going to get as efficient as we can.

The outcome is going to be the outcome. We, in part, we set the current dividend or proposed to set the current dividend where it is so that it would buy us plenty of room to operate while we get through the next few quarters and chart the eventual path to greater profitability. But accounting consequences will be what they are. It wasn't a primary consideration in setting the number where we did.

The only thing that I would add is I think -- is that when we think of the work that we did, we didn't -- our Board didn't approach this conversation around the dividend with an idea of looking at it each quarter and making a determination. And so our hope is that this does become a level which is sustainable as we go through this period of uncertainty and as the Fed decides how they want to treat capital return over the next series of quarters.

We do have some items that impact our capital -- our ability to return capital with this rule that doesn't reflect our earnings power going forward, right? We had a $3 billion settlement with the Department of Justice, which is, in our historical numbers, that $3 billion, when you look at it, is something like, round numbers, $0.18 a share of a negative that ultimately will roll out and is already actually in our capital numbers. So we have these dynamics that the Board thought about when we set the dividend level for the quarter that don't relate to the future earnings capacity of the company even as we look out into 2021.

Your next question comes from the line of John McDonald with Autonomous Research.

John, could you remind us just where you are on the asset cap flexibility? What needs to be done each quarter now with deposits coming in and some loan demand? And what kind of flexibility you have to operate under that and where you are today on the way it gets measured?

Sure. Sure. So we were in compliance with it at the end of the second quarter. And the items that we did during the late first and early second quarter to maintain compliance were really focused on our wholesale funding footprint by shrinking the amount of external repo and other financing that we do and taking trading assets down. And then we had a focus on certain categories of nonoperational deposits, the ones that have very low liquidity value.

And it's really -- this is -- from this point forward, this is more of a liability management exercise to make sure that we don't retain too much in the way of low liquidity value deposits, that we're thoughtful about other liabilities.

On the asset side, there's so much cash on the balance sheet right now that it gives plenty of flexibility, I think, to do what we need to do with loans. You saw that our LCR print is 129% for the quarter, and deposits have grown nicely. So we're very thoughtful and cautious about how we price deposits, about those that have low liquidity value. We're thoughtful about maturities as they come up in nondeposit funding because with the inflow of deposits, we can rely more on that and less on notes and institutional CDs and other things. That's the work that we've been doing, and that's the path that we have for the next quarter or 2.

Okay. And you reiterated the net interest income outlook for the year. How should we think about kind of the jumping-off point for the net interest margin and net interest income as we go into next quarter? What are some of the puts and takes that we should factor into the model?

Yes. I think it's going to be relatively flat from where it is today. We're sort of -- we're in that zone. And as I said, $41 billion to $42 billion for the year still feels like the right number. So I think it'll be -- we're not really carefully managing the NIM. It's we're looking for the dollars in net interest income. But it shouldn't deviate too much from where we are right now.

Okay. Got it. And is there anything in terms of asset cap progress, Charlie, you can comment on? I know you can't say too much, but in terms of the work being done and progress and doing what you need to do to satisfy the Fed?

John, I appreciate everyone being interested given the limitations of it and asking the question. It's going to be the same response every single quarter, which is we're focused on it. It is, along with the other enforcement actions, the biggest priority that we have. We're doing our work. And the Fed will determine when the work is done to their satisfaction.

Your next question comes from the line of Scott Siefers with Piper Sandler.

John, just was hoping you might be able to sort of update or refresh your thoughts on how and sort of when losses might evolve. I guess embedded in that is sort of how are you treating reups, deferral requests, things like that. And I guess additionally, the updated reserve build kind of implies sort of what you're thinking about cumulative losses through the period. But just any updated thoughts you can share, please.

Yes. Well, as it relates to deferrals, which generally speaking, is the consumer side of the house, the fact that we are deferring definitely pushes out roles through delinquency buckets into charge-off. And so the actual charge-offs themselves will probably come later than they otherwise would. We believe that we've fully provided or captured that in the allowance. And so we've taken the credit charge today that we think is the right one at the end of the quarter, even if the charge-offs come somewhat later.

We're also seeing -- we saw a tick-up in charge-offs in commercial, but there also, things do take a little bit before they roll. I think I guess I would expect the charge-off rates, and it will be different by asset category, to sort of move up slowly through the end of the year, even into the first couple of quarters of next year and then start to flatten out after that, just based on the way things progress through loss recognition.

Okay. Perfect. And then maybe just to switch gears a little, the additional customer remediation accruals. Charlie or John, can you go through sort of the -- I know you alluded to sort of taking a fresh look at things under new management. But I guess just curious, given the charges we've already seen over the past couple of years, sort of what drove those additional accruals and the new thinking.

Yes, it's as Charlie said. It was -- it's new leadership at the top of the organization in Consumer Lending and in the center, capability that we have running customer remediation. I think they've gone item by item and thought about how to be a little bit more expansive, a little bit more consumer friendly. Many of these things aren't crystal clear, and you're always making a judgment as to who it applies to, how much should apply and over what time frame. And really in an effort, as Charlie said, to speed it up and move it through, they were a little bit more expansive in order to accomplish that.

But it's -- by and large, it's the same items that we've been talking about for the last couple of years. There are always new things that come in and out of that bucket, but the bigger dollars relate to the same topics that we've been covering for a while.

And the only thing I'd emphasize, as John said, is most of the dollars do relate to those items. And there's a lot of value in getting these things behind us. It's the work, it's the overhang. It's what our customers and communities think about us. And so we're obviously going to do what's right for the financial position of the company. But we want to treat people properly, and we want to move on and move to the future. And so we made decisions around what we were willing to do, certainly with that balanced lens.

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

A couple of questions. So first off, Charlie, just want to get a sense as to where we should be thinking about where the expense improvements come from. And the reason I'm asking is, I know you're in the middle of the business unit reviews. You've got new business unit heads in several places. Typically, folks like that are going to want to make investments. You're not going to touch the regulatory side. So where should we anticipate you have room to start bringing down expenses ahead of regulatory framework changes?

Yes. And I think your point is actually a very important one, which is part of the reason why we've been -- we're trying to be very careful about making it clear that we are going forward and actively going to start to take actions to reduce expenses. But we don't want to back ourselves into a corner until all of our work is done because of those 2 things that you mentioned, which are very important.

Having said that and I -- the reality is that the work that we have to do, the foundational work to build the risk and strong infrastructure and ultimately satisfy the work that the regulators would like us to satisfy, it's clear. It's distinct. It is fairly broad across the company, but we know exactly what it is and what resources are decked against that.

When we look elsewhere in the company, and I think I used the words in the prepared remarks, it is we just -- we have spans and layers at the company which are well beyond what I've seen at other places and makes us a very, very inefficient company. When we just look at the work that's being generated, the things that are being done, we, as a management team, believe that we can change the priorities so that we're being really clear on what has to get done and stop a bunch of work that has to get done. We have duplicative platforms, duplicative processes across the company. And so as we think about a series of these things, they are extremely significant because these things exist just about in every part of the company.

In addition, I just also want to point out that we have stopped any reductions that were going to take place, just given the environment. And so there is a series of actions that we are ready to take. In fact, we have a series of employees who've been told that their jobs will ultimately go away, but we're going to let some time pass as we got through the initial stages of the COVID crisis.

So we do see a clear path to start making an impact on the expense base. And it's like an onion. The more we do, the more clear the next round will become.

And is that something that you could start in the second half? I know you mentioned that we'd see the benefits here in 2021 with expenses below '20. But should we anticipate that some of this will start in second half '20?

We are clearly going to take the actions in the second half of this year. And obviously, depending on what the economics of all that is and the accounting of it, not quite sure whether you'll see it here or in next year.

Got it. Yes, okay. That's understandable. And then could I just switch gears to a question on mortgage? So the question here...

I just want to add one thing, which I just think is important, which is because I didn't say this in the prepared remarks, but I've certainly talked about this inside the company, which is we don't look at a quarter like this and just say, "Okay. That is what it is." Losses are higher. Our margins are narrow. We know we've got some work going on, and so we'll eventually get around to it.

While we knew these things had to get done and the work was getting done, it's not lost on us, our underperformance relative to where we should be earning. And so while I think there was a sense of urgency towards both getting the regulatory work done and improving our performance, whatever sense of urgency existed before is going to be small relative to what it is going forward.

Yes. Yes, I got that. No, I get that. And I also am hearing in your commentary that the costs around the regulatory and the risk and the -- those costs, is it fair to say, are more known today than they were maybe a year ago?

Yes. I think absolutely. As time goes on and we become -- we get clear on what has to be done, it's clearly easier for us to put a broad understanding of what that takes.

And again, just to be clear, when we go -- and part of the reason why it takes us a period of time to do this properly is we're going to have very formal processes in place to ensure whatever reductions in our expense base we take that they do not impact any of that work. And so that will be informal, and it will be very, very formal. Because that would be just a terrible, terrible mistake for everyone if we were not to do that properly. So beyond-heightened consciousness on that issue.

Okay. All right. Just switching to mortgage. Refi speeds have been incredibly high and -- through second quarter. And John, I just wanted to get your sense as to what's in your base case assumptions for 3Q, 4Q? I mean part of the reason for asking is it impacts the servicing prepayment speed that impacts your NII outlook with refinancing on the agency. And then I also just wanted to have a quick follow-up question here on the Ginnie buyouts that you did that the American Banker highlighted this morning. Just understand, is that the first of many or not?

Yes. Good question. So on mortgage fees, and it shows up in the MSR, shows up in our investment portfolio, and it shows up in the runoff of booked loans that are in our held-for-investment portfolio in loan form. The speed assumptions vary, depending on the vintage, the coupon, the debt-to-income, the LTV, et cetera, and the refinance ability of borrower by borrower. But I think we're as aware as anyone of how fast things have gotten. And we're seeing 30-handle CPR on various pools of loans.

And so while we think we've captured that in our updated estimates on the MSR, in particular, it does feed into this level of, call it, $500 million to $700 million per quarter of premium amortization for mortgage securities, which we -- as I said, is likely to remain for the rest of the year.

On Ginnie buyouts, as -- what's happening there is that there are loans that have gone delinquent, in part because of COVID. And as the servicer, we essentially have the accounting consequence of owning them, whether we buy them out or not. They're deemed -- because the option to purchase them is so deeply in the money, we're deemed to have bought them.

And so our calculus was either to have a giant pile of cash and that consolidated asset or to go ahead and buy them out and not have that asset -- essentially that asset twice but use the cash to buy the asset. And these are guaranteed loans, from our perspective, not a huge credit consequence. It's just carrying the asset for a period of time before it either gets redelivered or sold or worked out in some way. So that's why we were a big buyer in the -- actually, that was after the end of the quarter.

And then with respect to whether it continues on, it's, well, it's facts and circumstances. The same tension will apply. If we're deemed to have them on our books because we have the option to buy them, then we may -- and if cash levels remain where they are, then we may go ahead and do it, just so that we don't really double up the size of our balance sheet. And that is an asset cap consideration.

Yes. No, that makes a ton of sense. But so it's a function of more forbearance from here. Is that the driver?

Yes. More/ongoing, that's right. And whether we're the servicer or not, but that's right.

Your next question comes from the line of Ken Usdin with Jefferies.

Just a follow-up question on the NII outlook. It seems like in the second half, some pluses or minuses to get to the mid-zone of your 41, 42. But just can you help us understand just how much more roll-through there needs to be from here on both asset yields and securities yields to your earlier points of how you're reinvesting? And then what from here can also happen on the deposit cost side as a partial offset?

Yes. So I think on the deposit cost side, the -- our anticipation is that between the reduction in pricing for interest-bearing deposits and the growth or continuity of noninterest-bearing deposits that our average deposit cost is back in the single-digit basis points by the third or fourth quarter. That's the trajectory that we're on. That's where we were in 2015, 2016.

On the asset side, depending on what happens to LIBOR, probably, in particular, the spreads are holding firm where we're lending. And there will be some -- it could be some lower spread loan product that is replaced with higher. You've heard about that in autos. It's true in some categories of C&I. But that's a piece of it.

On the securities front, we've been trying to stay invested, but the level of prepayments that Betsy just referred to, I think, had our securities portfolio down by almost $30 million in the quarter. And so how much more duration we want to add at these low yields is a separate issue. We haven't been adding much in credit-related securities product.

But as I mentioned, I think to John, the outlook for NIM is relatively range-bound through the rest of the year. And we're sort of bumping along what we think the bottom could be. I mean, obviously, things could change. But at 0 in the front end and 60, 70 basis points in the long end, this feels about like where we're likely to be with the things that I mentioned.

Right. And then so I guess then it really just NII growth next year or just -- you're starting from a high point this year. So we'll probably be in the hole still next year. But really, does it depend on the asset cap then? Or does it depend on the mix of earning assets in order to get that kind of off this $10 billion-ish type of NII number?

Yes. It's a good question. It's both. So it's what choices we make on the asset side and what the market is offering, what -- where loan demand comes from, I think, will matter a lot; the slope of the curve. If things get a little steeper, that obviously could be helpful because we're so exposed at the long end. And then if there's an opportunity to have a bigger balance sheet, we're certainly not budgeting that way or counting on it, but that would be a difference maker.

Okay. One just quick follow-up, John. On the servicing side of mortgage, great production and then the tougher servicing results. There's both the core fees that are contracting because of the prepays, and then there's all the hedging. What's the best way you can help us understand how that mortgage banking line item just trajects from here, given especially the uncertainty in how you model out the servicing side?

Yes. It's tricky. But -- so I think what we've said is we expect volumes on the production side to be a little bit higher and margins to be relatively constant. So if those 2 things hold true, the third quarter should be a great -- relatively great production environment for mortgage.

And on the servicing side, we think we've captured the higher servicing costs for default servicing, modification servicing, et cetera. We now have faster speed expectations in the model. Although we said that a quarter ago, too. We were surprised on the downside. But if we've -- if both of those things are captured, then we will produce lower servicing fees because the book itself is getting smaller. But I'll take smaller servicing revenue to -- as long as we're not taking big write-downs on the assets that are offsetting the benefit that we're generating on the origination side. And hopefully, the third quarter reflects that.

Your next question comes from the line of Saul Martinez with UBS.

First of all, a really, really specific question related to the fourth quarter dividend cap. Can you just verify, John, that that's based on net income before preferred stock dividends? And because I think that the guidance from the Fed is public that it's based on your Y9-C net income figure. And for you guys, obviously, that does matter given the size of the preferred stock dividend. So I just wanted to make sure that, that point is clarified.

Yes. The way we're calculating its NIAT after tax but before preferred stock dividends, which gets you to NIAC, available to common.

Okay. Got it. Okay. So you're calculating before preferred stock dividends, just to be clear?

Correct. Yes.

Okay. Got it. A much, much, much broader question. And kudos on the donation to CDFIs. I think a lot of them do a lot of very good work. And I guess on that point, though, I do think that it's pretty clear that Wells does have to, maybe more than others, really focus on multiple stakeholders and different goals. And the idea of strictly shareholder-driven capital is obviously already under attack. And you have to meet your regulators, meet their demands, employees. I think you genuinely are concerned about the well-being of the communities you work in.

And then you have guys like me who talk about your ROTCEs and super high-efficiency ratios and how you're going to rightsize your cost structures. And I guess how do you think about that, the balancing act and of those competing demands? I think in the past, most management teams have argued that they can do all of those things simultaneously. And I think to a certain degree, maybe that is true, but there are some trade-offs and some element of the zero-sum dynamic going on. So I guess, Charlie, I'm curious maybe just more philosophically how you kind of think about that. And I guess, ultimately, how do you think about shareholder value in that totem pole of goals?

Yes. I guess I don't think about it as a trade-off, and I don't think about it as something which is different for us versus other significant companies, whether you're a financial institution or not. I think it is very, very clear that our ability to be successful as a company for our shareholders includes the fact that we are broadly considering a much broader set of stakeholders. If we don't do that, customers, whether they're consumers or companies, ultimately won't want to be supportive of us. We'll have issues in our local communities. It will filter through to the legislative and likely the regulatory agenda.

So I think we very much think that they are very much related and that there's no reason why the things that we should be doing to be more thoughtful of a broader set of stakeholders, they aren't a set of financial negatives. Ultimately, it should be something beyond that.

The PPP fees were certainly something that was very unique. We are in the middle of this really horrific time for small businesses and especially minority-owned small businesses. The right thing for us as a significant company in this country is to be as helpful as we can with that community. It's also ultimately helpful for us if we can make a difference in the communities that we operate. And then we also looked at that relative to just the -- what we thought was fair for us in order to participate in the PPP program.

And so I think you put all those things together, and there is alignment. And those that don't think about it that way will likely suffer over the long term.

Your next question comes from the line of Steven Chubak with Wolfe Research.

So I wanted to start off, Charlie, with -- just a theoretical question on the asset cap. You talked about the proactive steps that we're taking to manage the balance sheet to stay below, how that's negatively impacted NII. Since most investors are focusing at this juncture on normalized NII and through-the-cycle revenue growth expectations. If the Fed were to lift the asset cap tomorrow, I was hoping you can give us some idea or context around the amount of pent-up growth potential in the balance sheet today. Just -- I think it would be helpful if you could frame the impact of the asset cap on NII or at least volume growth based on where things stand today.

So this is John. If -- just as a data point using rough math, if our balance sheet was expanded by, call it, $200 billion or about 10% during this COVID time frame, and there is a question about whether there was ample opportunity to do that around several asset classes but in certain areas, there certainly was. With something like our average NIM, the impact that, that would have had on us would have been -- and these are approximations, but to reduce the drawdown on NII by 50%. So half of how things have worsened would have been covered by that expansion of the balance sheet. That's one way to think about it.

There were more immediate opportunities to put loans on, in particular, I'd say, in March, as capital markets were closed. I think everybody knows that. And we saw customers drawing on available facilities and other requests for new facilities.

The bigger, probably more constant, piece of an increased balance sheet, at least in the businesses that we serve today, would probably be to have a bigger securities and securities financing portfolio in support of our corporate and investment bank, where we have drawn down as part of managing under the asset cap. And there's a handful of benefits to that, including being able to do more business with the companies that we're -- and the institutions that we're financing in that realm. But you also end up with a big LIBOR-funded book that is a little bit less asymmetric in a down rate scenario. And we certainly suffered from that. There's a real benefit to being substantially deposit funded in that it's very low cost to begin with. But in a down rate environment, it's a little bit more violent in terms of the outcome that it generates.

And to have a bigger component piece of LIBOR-funded assets with LIBOR-funded liabilities, it's a little bit less high producing in the best of times, but it maintains its margin in a down rate environment. So that would have been a benefit also.

But Charlie, you may have other thoughts.

I think that's it.

Okay. No, that's helpful color, John. Just -- I have one more question. It's one, I guess, I've asked over the last couple of quarters. But wanted to get some context around the core fee income level or the jumping-off point we should think about for the back half. You cited some of the tailwinds from mortgage production. Trust fees should benefit from the higher markets. But you also have some normalization of trading activity. And just given all the different moving pieces, I was hoping you can give us some sense as to what the right jumping-off point might be for 3Q.

Yes. We don't put a number on it and call it core but rather talk about the component pieces of it. And so service charges on deposits, which is a big one for us, my assumption is that it's going to feel, at least for a while, like it does today. People are spending differently. They're maintaining cash balances at a higher level. And so there are -- whether it's waivers because of high balances or the absence of overdraft, that puts pressure on that line item as our customers do what's right for them in this environment.

You mentioned brokerage advisory, et cetera. That should be stronger going into the second half of the year. Investment banking, we had a record high-grade market in the first quarter. So while other activity may pick up a little bit, my sense is that, that probably normalizes somewhat.

Card fees have reflected what I mentioned on my -- in my prepared remarks, which is at least in the debit card space, we've got balances -- or flows in dollar terms about equal to last year but the number of transactions lower, which has a negative impact in card fees. And credit card fees have been improving but haven't caught up. So that -- I don't think it's going to pop back up anytime really quickly.

Mortgage, I mentioned on the production side, should be very strong or should be strong. And hopefully, we've accounted for faster speeds and higher costs in servicing. Trading, as you said, probably gets a little bit softer. And other items are less material, and there's nothing really noteworthy. So that's how I would think about the categories.

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

I wanted to circle back on kind of the longer-term view of getting your efficiency closer to peers. And I guess the first question is why do you necessarily think it's an expense issue versus a revenue issue? Or is it a combination of both?

It's definitely a combination of both. Revenue, particularly interest income, which doesn't carry a lot of expense load, would be very helpful. I think what we're trying to do is assess where the company is today and what we can do about it. And we can do more about expense than we can about revenue in a balance sheet-constrained environment, in a recession and in a low rate environment. So it's actionable by the management team. But without a doubt, some amount of normalization of certain categories of revenue would be -- would contribute to it.

But having said that, I think we've sort of vectored in a variety of different ways on the idea that all things being equal, and I'm sure they won't be, but at least as we think about it today, that $10 billion is a reasonable amount to go after to put Wells Fargo on a level playing field with the large-cap peers.

And the only thing I would add to what John said is this isn't -- the calculation of the $10 billion, that's a mathematical exercise. When the management team, the Operating Committee gets in a room, there is absolutely no disagreement in the room, not about the math, but about the inefficiencies that exist inside the company away from all of these risk-related activities.

And the work that we've been doing is to build the plans from the bottom-up to identify where that is. And so whether that's the full $10 billion or not, we'll see what we get to. But there is -- we certainly have a clear belief that we can make a significant dent based upon what we know.

And just to be clear what you think kind of the longer-term cost base can be, when you used the $10 billion as kind of a reference point, should we just annualize this quarter's costs? That gets you about $58 billion. You take out $10 billion, gets you around $48 billion? I mean is that the thought process?

I think of $54-ish billion as more of the normalized starting point without the excess expenses that are loaded into this quarter for the items that we mentioned.

So take $10 billion off the $54 billion?

Yes.

Okay. And I guess just related to that, like, whenever I think about kind of cost saves, like there are areas that you'll want to invest in. There is just natural inflation creep. So you guys kind of opened up a little bit of a can of worms on the $10 billion. So I know these are things that are tough to predict, like looking out a few years but...

But we didn't open a can of worms because -- I don't look at it like we opened a can of worms. I think we look at it like we're acknowledging what the facts are, which is -- the facts are is we compete with other companies that are investing tremendously. And with that -- those set of investments, the math says the following. And so what we've been, purposely having said, we're going to reduce our expenses by a certain point in time because we are doing the work to figure out what the timing looks like with our reductions versus our investments.

But I think what's important is not just that we acknowledge that, that gap exists, but we are proactively working to get to a place which makes sense both from an efficiency standpoint, knowing that we should be investing in the business.

Okay. All right. And it sounds like we'll get some more details in the third quarter or so. I think we all look forward to that.

Thanks.

Thanks, Matt.

Our next question comes from the line of John Pancari with Evercore ISI.

On the credit side, just want to see if I can get your updated thoughts around your through-cycle loss estimates that you would expect. I know your 2020 company run DFAST is about $27.7 billion. Is that a fair way to think about it? And then also, I want to get your thoughts around the reserve. You took a pretty good addition this quarter, and now your reserve is about 74% of that 2020 DFAST. Do you think there's likelihood for additional substantial reserve additions from here?

Thanks for the question. So we're -- we do the math to compare our own estimations to the DFAST outcomes, but we don't think of them as necessarily better informed about our loans and our portfolios and our risk profile and our collection activity, et cetera. So that's -- it's a useful data point, and it's an external one that people can judge against. But we're -- we think more about our own experience and the scenarios that we believe are the likely ones in the world that we're living in. And so that's how we focused it.

With the build that we made in the allowance, I think we're at almost 2.2% coverage of the outstanding loan portfolio. And of course, it's very different by loan category like it is for every other bank. I think we believe that if the world unfolds in the way that we've got it modeled and assumed in our both modeled loss estimations and in our bottoms-up portfolio-by-portfolio work that we will have captured the loss content in the portfolio as of the end of the quarter. And as a result, unless things really lag in a worse direction that this would be -- this would have accounted for those losses.

Got it. And then related to that, on the commercial real estate side, just want to see if you could discuss the credit trends that you're seeing in commercial real estate. I know that delinquencies in CMBS structures really spiked for the industry beyond even financial crisis levels. And -- but clearly, that is being staved off somewhat at the banks by forbearance efforts. Are you -- can you just give us a little bit of that granularity around what you're seeing and the level of forbearance in commercial real estate? And is it seeing a greater pressure in the portfolio to forbear to -- given the pressure that your borrowers are seeing?

Yes. Yes. The first distinguishing point I would make is that -- and I know you know this, but for everybody's benefit, CMBS structures are nonrecourse loans. And so there's no alternative other than realizing on the collateral. There's no mechanism for extra cash flow to enter into a structure, unless somebody does something that they're not contractually obligated to do to try and shore things up. And I think as I've seen most recently, the June numbers in CMBS are about 13% of loans are not current.

Conversely, on a bank's balance sheet, most of the loans that we have, have real sponsorship and recourse and, generally speaking, are lower LTV than CMBS to begin with. So our actual performance is quite different.

And then I think we talked about this last quarter, too, but the variation in how deep we'll go from an LTV perspective is, as you'd hope, with the more stable property types, we might have higher leverage; and with the least stable property types, we'd have lower leverage, which helps a lot in a downdraft.

So we have, in round numbers, roughly $150 billion worth of commercial real estate loans outstanding at the end of the quarter. The biggest pieces: 1/4 of that is office; 20% of that is apartments; 12% is industrial; 10% is retail, excluding shopping centers; and then 9% is shopping centers; and everything else is below 9%. Actually, hotels is about 8%, which is a volatile property type.

And then among nonaccrual loans, the shopping centers are 32%; hotels, 14%; and retail, excluding shopping centers, is another 14%; and everything else is below 14%. There's about $1.3 billion of nonaccruals overall.

So that's what it feels like. We're working through these things borrower by borrower. Sometimes, the concessions that we're making are just covenant related. Sometimes, they are real forbearance. And we allow people to take a little bit more time to pay. Our borrowers have been generally calm and constructive. It's not a lot of panic at this point in the cycle. The problem loans have skewed towards retail projects, many of which were already struggling, and then also the hotel owners with lower capitalization. So I hope that's helpful.

Got it. No, that is helpful. So really, you're reserving within commercial real estate. Or you would say that, that represents the similar stance for your overall portfolio? In other words, you're pretty much finished building reserves there as well?

For how we understand the world at the end of the second quarter, yes. And we think that's relatively -- we think it's very realistic. I should also add that in commercial real estate and elsewhere, our teams have gone loan by loan, borrower by borrower and made an assessment of where we think we are and where we think things are going. So it's not just a model set of expectations but a real careful review of every borrower, every property and their circumstances.

Your next question comes from the line of Brian Kleinhanzl with KBW.

One quick question that's more of a clarification. You did mention that on Slide 16 that 75% of nonaccruals were current on interest and principal. Was that referring to the $1.4 billion increase? Or was that referring to the total? And I guess why nonaccrual if they're current on interest and principal?

Total, the total amount.

Okay. And then separately, when you think about the DFAST results, and you're saying that you may perform better than those results, I guess, where do you take exception with kind of how the Fed is modeling your stress losses versus how you see them coming through this cycle?

Yes. Forgive me if I don't start a response by saying we take exception with the Fed's results in the following way because that's not really, that won't be helpful. But they draw from different models and have different approaches. And we draw from our own, as I said, bottoms-up, our own modeled outcomes, our own historical outcomes, changing the composition of the portfolio or changing the underwriting standards and whatever we're comparing it to. And we end up with the numbers that we end up with.

I'm happy to note that I think, in general, the Fed applies, in general, a lower loss rate for a variety of loan categories to Wells Fargo than they have for some other lenders. It's not universally true based on the composition of portfolios. But we're -- we like our numbers where a lot of work with a lot of very close inside knowledge of borrowers, properties, et cetera, goes into it. And it's being compared with something that's more statistically driven from a model that we don't have access to.

Your next question comes from the line of Chris Kotowski with Oppenheimer & Co.

One, just to follow up on Matt's question. I mean just from 2017 to today, I mean, your revenue runway went from $88 billion to roughly $70-ish billion. And your core operating expenses have kind of stayed flattish at $54-ish billion, let's say it. So I mean sitting here on the outside, it would look like it's primarily a revenue problem, not an expense problem. And I mean -- when you put out a number like $10 billion, are you worried that, that is going to like forgo the optionality on capturing back that $18 billion in lost revenues? Or should we assume that that's kind of gone?

Yes. I think you should go back and listen to the words that we used to describe what the $10 billion is and how we're thinking about this.

Listen, there's no question in our minds that we should have the ability to generate higher revenues in the future. No question that will help when it comes to an efficiency ratio. What we're talking about is, if you go back and look at where we were as a company versus the others, the others, the big companies that we compete with have been working on this for 5 to 10 years. And there is, and again, I'm just -- we're being very factual about it, which you should go back and check yourself, which is there is this meaningful difference between what our expense base looks like and theirs.

And then I recognize you're on the outside, but what we're telling you is from on the inside, that we, as a management team, continue to believe that the opportunities are substantial to improve the efficiency of the organization because we see it day in and day out. And we're going through a process to identify exactly what it is, where it is.

It's not just people. It's the third-party spend here is extraordinary. The things that we rely on outside people to do is beyond anything that I've ever seen. Our ability to reduce facilities is substantial. And so there's this long list of things that we will actively be working on. Whether that gets to $10 billion, whether it gets to more, whether it gets to less, we'll see. We're going to share more as we develop the plans. But I think it's just important for us as a management team to be very objective at what things looked like for this company before we wound up in today's environment. And those efficiencies clearly exist in the company.

Okay. And then just a small thing. I thought I heard John say that you're no longer accepting home equity and personal line of credit applications. And I mean I realize that those have been declining categories and that they are not the kind of product lines that -- today that they were before the great financial crisis and all that. But still, aren't those kind of sort of key products in a big consumer bank's arsenal? And doesn't it send the wrong message to not even take the applications?

Well, I guess, let me -- I'll talk about a piece. John can talk about his. I guess the way I think about it is, first of all, we do offer personal lines in the company because we have a credit card business. And so for us, it's a question of making sure that we've got the right product in front of the customer. And so we think we have the ability to do that.

The home equity product, as you rightfully mentioned, has certainly declined in terms of the amount of production that was taking place. But we do have to make a determination in the uncertain environment as to what is a smart thing for us to participate in along with consumers as they add risk to their balance sheet.

As time goes on, if we feel differently about the environment and about real estate values, those decisions could change as well.

Your next question comes from the line of Vivek Juneja with JPMorgan.

Charlie, John, a couple of questions. Firstly, Charlie, are you still on track to be giving us some kind of strategic review or strategic plan towards the end of the year? Or should we expect that with the cost details that you're going to give us in the third quarter? How are you thinking in terms of timing of the 2 things?

I think as we -- between the third and fourth quarter, we're looking at getting both done to share our complete set of thoughts with you.

Okay. So you'll do them -- so you'll give it to us simultaneously so that we can see how the 2 fit together?

Again, I think that's what we're targeting, but we'll have to see how it plays out and our work progresses.

Okay. In that same vein, Charlie, as you're thinking about all of this, you talk about not having too much of an expense dollar relative to your peers. How much of this -- where you find businesses where it's because you just don't have enough scale on the revenue side, are you thinking you're going to exit some of those businesses? What are you thinking there? Are you thinking about more business exits? Any thoughts on that?

Yes. That's a good question, Vivek. I think we've talked about this a little bit over the last couple of quarters. There absolutely are some things that we do which either we don't have scale in or it just might not be big enough to have an impact on the company going forward. And it's not clear that it's integral to us being able to fulfill the primary banking relationships that we have from the consumer to the small business and middle-market up to the corporate.

So I think as we think about what the company should look like, we absolutely are looking at those things. And so we would certainly expect that we would continue to, I think John has used the word, prune some of these things that exist inside the company as we've been doing.

I don't think about them in terms of -- to say it differently, the 5 lines of business that we've determined we do believe are key to the future of the company. But when you go below that, there's certainly some activities which might not meet our criteria for continuing to be here.

Okay. And then when you give us these combined reviews, will you give us some sense of -- we've been -- we've heard about your need to spend more in technology, areas that you're behind in. Will you give us some sense also where that stands business by business and what you need to do and how that sort of dovetails with the numbers, too?

Listen, we'll see when we get closer, the level of detail that we go through with you. But certainly, the work that we're doing contemplates the fact that we don't want to stand still in our businesses.

Your next question comes from the line of Charles Peabody with Portales.

Two questions. One, and I apologize if you've already covered this, but I transitioned over late from the Citigroup call. What were the variables that went into your thinking on the level of the dividend? I mean was it -- this is a level that you didn't have to worry about it again? Was it a function of what you think your core earnings power is going forward? Or is it a desire to build capital more? What were the variables that got you to that level?

A handful of things, of course. And with the expectation that it's likely that the constraints on the calculation of allowable dividend hang around for a while, even though they may not but they certainly may. We found a level that we believe is something that gives us more of an upside ability as the COVID environment clears up, as the medium-term earnings power of the company becomes more known, both in terms of sources of revenue and what's happening with expense, et cetera. So that we don't -- we wouldn't end up or have a low likelihood of ending up in an environment where we're making repeated changes to the dividend.

So not so much about -- our capital levels are fine. We have $23-ish billion of excess on top of our regulatory capital requirements. And we feel -- it's gone up, as you may have observed. And that's even after building a $20 billion allowance. So not so much capital sufficiency, although in the future it could turn out differently than we and others are planning right now, but really more about thinking about the core earnings power and a resulting upward trajectory when the time is right.

And Charles, I would just add, I know we certainly appreciate the multiple calls that are going on today, and it's a busy day for you all. I would encourage you to go back and look at the prepared remarks because we did walk through the thinking.

Yes. And as a follow-up question, there's a June 22 letter from 40 or 50, 60 congressmen on both sides of the aisle, so bipartisan and it's addressed Mnuchin and Powell. And in this letter, they warn of a looming crisis in the CRE and particularly the CMBS market. And they asked for help from the treasury and the Fed. I was curious what actions you think they might be thinking about taking to support the CMBS market? Or what actions would you like to see them take?

I don't know if we have an opinion on what actions we'd like to see them take. I do think that, as between the risk owners and CMBS transactions and servicers and borrowers, people should be looking to maximize recovery value. But the contracts are pretty thoughtful. This isn't the first downturn that those market participants have been through. And my expectation is that a lot of decision-making power is going to end up in the hands of special servicers and I don't know how to -- I don't know why it would be a good idea to impose some other regime on top of that, that changes those contracts. But I don't have a careful, thoughtful review of what's being proposed.

Our final question will come from the line of Gerard Cassidy with RBC.

I apologize if you touched on this already, but when you guys gave us in Slide 2 -- or I'm sorry, Slide 3, the number of customers you have helped with deferring payments and waiving fees, can you give us some color on the trend in terms of the applications for these deferrals? I assume they were very heavy early on, and they have faded downwards. And then second, how many of the customers that have come up for renewal have actually asked for a second extension for the deferrals?

Well, it's different by loan category. And yes, it's true that the people initially asking, there was sort of a high point. We peaked, our peak, was the second week in April. I think, on average, we had about 60,000 or 70,000 accounts per day who were asking. We've dropped, well, almost entirely. I think we're at 4,000 a day for the week of late June. So if that's helpful.

And then, of course, the extension question is related to how long was the initial deferral to begin with. And in general, I would say that more people are getting comfortable with coming out the other side. But yes, we still have a good base of folks who are in deferral.

And then second, John, have you guys got any color from the Fed on how long they're going to be supportive of the industry, yourselves included, in granting these deferrals without having to reclassify the loans and put more capital against them?

I don't think we've got a specific conclusion on that. Although we do assume that there's going to be some point in time after which whether it's the regulators, not only the Fed, and/or our accounting convention is going to cause us to have to consider these as something other than a performing loan. It might be different by category. It might be different by regulator. But the longer we go on, the greater the risk of that.

Great. And lastly, thank you again for the great detail that you guys give on your commercial and industrial loan portfolio. And I noticed, as you mentioned, the increase in nonaccruals on Page 17, the different categories. Can you give us some color on the real estate and construction? The nonaccruals went to $290 million up from, I guess, it was $49 million in the prior quarter. But how much was construction versus loans to the nondepository financials?

I don't think I have the breakout in front of me, but I can have the IR team follow up with you.

All right, guys. Well, listen, thank you very much for the time. We appreciate it, and we will talk to you soon. Take care.

Ladies and gentlemen, this does conclude today's call. Thank you all for joining, and you may now disconnect.