Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019



☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file number 1-36768

Wells Fargo Real Estate Investment Corporation

(Exact name of registrant as specified in its charter)



Delaware		56-1986428
(State of incorporation)		(I.R.S. Employer Identification No.)

90 South 7th Street

Minneapolis, Minnesota 55402

(Address of principal executive offices)

(Zip Code)

(855) 825-1437

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Exchange Act:



Title of Each Class	Trading Symbol	Name of Each Exchange on Which Registered
6.375% Cumulative Perpetual Series A Preferred Stock	WFE.PRA	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company' in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer ¨

Non-accelerated filer þ Smaller reporting company ☐

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of July 29, 2019, there were 34,058,028 shares of the registrant’s common stock outstanding.

FORM 10-Q

CROSS-REFERENCE INDEX



PART I	Financial Information

Item 1.	Financial Statements			Page
	Statement of Income			26
	Balance Sheet			27
	Statement of Changes in Equity			28
	Statement of Cash Flows			29
	Notes to Financial Statements
	1	—	Summary of Significant Accounting Policies	30
	2	—	Loans and Allowance for Credit Losses	31
	3	—	Fair Values of Assets and Liabilities	43
	4	—	Common and Preferred Stock	44
	5	—	Transactions with Related Parties	45

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations (Financial Review)
	Summary Financial Data			2
	Overview			3
	Earnings Performance			4
	Balance Sheet Analysis			7
	Risk Management			8
	Critical Accounting Policy			21
	Current Accounting Developments			22
	Forward-Looking Statements			23
	Risk Factors			24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk			19

Item 4.	Controls and Procedures			25

PART II	Other Information

Item 1.	Legal Proceedings			47

Item 1A.	Risk Factors			47

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds			47

Item 6.	Exhibits			48

Signature				49

PART I - FINANCIAL INFORMATION

FINANCIAL REVIEW



Summary Financial Data
								% Change
	Quarter ended							June 30, 2019 from				Six months ended
($ in thousands, except per share data)	Jun 30, 2019			Mar 31, 2019		Jun 30, 2018		Mar 31, 2019		Jun 30, 2018		Jun 30, 2019			Jun 30, 2018		% Change
For the period
Net income	$	334,945		303,439		307,303		10	%	9		$	638,384		626,335		2	%
Net income applicable to common stock	330,548			299,042		302,906		11		9		629,590			617,541		2
Diluted earnings per common share	9.71			8.78		8.89		11		9		18.49			18.13		2
Profitability ratios
Return on average assets	3.93		%	3.49		3.57		13		10		3.71		%	3.61		3
Return on average stockholders’ equity	4.12			3.79		3.79		9		9		3.96			3.88		2
Average stockholders’ equity to average assets	95.26			92.14		94.28		3		1		93.68			92.87		1
Common dividend payout ratio (1)	93.72			98.63		97.41		(5	)	(4	)	96.05			100.39		(4	)
Dividend coverage ratio (2)	7,105			6,948		7,208		2		(1	)	7,105			7,208		(1	)
Total revenue	$	360,116		341,468		333,504		5		8		$	701,584		677,024		4
Average loans	33,923,658			35,003,619		34,234,880		(3	)	(1	)	34,460,655			34,777,709		(1	)
Average assets	34,191,626			35,230,874		34,499,277		(3	)	(1	)	34,708,379			35,031,312		(1	)
Net interest margin	3.92		%	3.89		3.90		1		1		3.90		%	3.86		1
Net loan charge-offs (recoveries)	$	(1,594	)	(626	)	(786	)	155		103		$	(2,220	)	(1,292	)	72
As a percentage of average total loans (annualized)	(0.02		)%	(0.01	)	(0.01	)	100		100		(0.01		)%	(0.01	)	—
At period end
Loans	$	33,352,794		34,564,299		33,599,587		(4	)	(1	)	$	33,352,794		33,599,587		(1	)
Allowance for loan losses	87,885			98,158		112,381		(10	)	(22	)	87,885			112,381		(22	)
As a percentage of total loans	0.26		%	0.28		0.33		(7	)	(21	)	0.26		%	0.33		(21	)
Assets	$	33,377,272		34,636,027		33,747,152		(4	)	(1	)	$	33,377,272		33,747,152		(1	)
Total stockholders’ equity	32,439,876			32,419,328		32,387,804		—		—		32,439,876			32,387,804		—
Total nonaccrual loans and foreclosed assets	161,415			181,813		190,136		(11	)	(15	)	161,415			190,136		(15	)
As a percentage of total loans	0.48		%	0.53		0.57		(9	)	(16	)	0.48		%	0.57		(16	)
Loans 90 days or more past due and still accruing (3)	$	3,460		3,018		2,641		15		31		$	3,460		2,641		31


(1)	Dividends declared per common share as a percentage of earnings per common share.

(2)

The dividend coverage ratio is considered a non-GAAP financial measure. Management believes the dividend coverage ratio is a useful financial measure because the certificate of designation for the Series A preferred stock limits, among other matters, our ability to pay dividends on our common stock or make any payment of interest or principal on our line of credit with Wells Fargo Bank, National Association, if the dividend coverage ratio for the four prior fiscal quarters is less than 150%. The dividend coverage ratio is expressed as a percentage and calculated by dividing the four prior fiscal quarters' GAAP net income, excluding gains (or losses) from sales of property (consistent with the National Association of Real Estate Investment Trusts definition of “funds from operations”), by the amount that would be required to pay annual dividends on the Series A and Series B preferred stock.


(3)	The carrying value of purchased credit-impaired (PCI) loans contractually 90 days or more past due is excluded. These PCI loans are considered to be accruing because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.

This Quarterly Report, including the Financial Review and the Financial Statements and related Notes, contains forward-looking statements, which may include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not unduly rely on forward-looking statements. Actual results may differ materially from our forecasts and expectations due to several factors. Factors that could cause our results to differ materially from our forward looking statements are described in this Report, including in the “Forward-Looking Statements” section, and the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2018 ( 2018 Form 10-K).

When we refer to “WFREIC,” the “Company,” “we,” “our,” and “us” in this Report, we mean Wells Fargo Real Estate Investment Corporation, and where relevant, Wells Fargo Bank, National Association, acting on our behalf; the “Bank” refers to Wells Fargo Bank, National Association; and “Wells Fargo” refers to Wells Fargo & Company.

Financial Review

OVERVIEW

The Company is engaged in acquiring, holding and managing domestic mortgage assets and other authorized investments that generate net income for distribution to our shareholders. We are classified as a real estate investment trust (REIT) for federal income tax purposes and are an indirect subsidiary of Wells Fargo and the Bank.

As of June 30, 2019, we had $33.4 billion in assets, consisting substantially of real estate loan participation interests (loans). Our interests in mortgage and other assets have been acquired from the Bank pursuant to loan participation and servicing and assignment agreements among the Bank, certain of its subsidiaries and us. The Bank originated the loans, purchased them from other financial institutions or acquired them as part of the acquisition of other financial institutions. Substantially all of our loans are serviced by the Bank.

REIT Tax Status

For the tax year ended December 31, 2018, we complied with the relevant provisions of the Internal Revenue Code of 1986, as amended (the Code) to be taxed as a REIT. These provisions for qualifying as a REIT for federal income tax purposes are complex, involving many requirements, including among others, distributing at least 90% of our REIT taxable income to shareholders and satisfying certain asset, income and stock ownership tests. To the extent we meet those provisions, we will not be subject to federal income tax on net income. We continue to monitor each of these complex tests. We believe that we continue to satisfy each of these requirements and therefore continue to qualify as a REIT.

In the event we do not continue to qualify as a REIT, earnings and cash provided by operating activities available for distribution to shareholders would be reduced by the amount of any applicable income tax obligation. Given the level of earning assets, we currently expect there would be sufficient earnings and ample cash to pay preferred dividends. The preferred and common dividends we pay as a REIT are ordinary investment income not eligible for the dividends-received deduction for corporate shareholders or for the favorable qualified dividend tax rate applicable to non-corporate taxpayers, however non-corporate shareholders may be able to deduct 20% of the preferred and common dividends as a deduction for qualified business income under the Tax Cuts and Jobs Act. If we were not a REIT, preferred and common dividends we pay generally would qualify for the dividends received deduction for corporate shareholders and the favorable qualified dividend tax rate applicable to non-corporate taxpayers.

Financial Performance

We earned net income and net income applicable to common stock of $334.9 million and $330.5 million, respectively, in second quarter 2019, or $9.71 diluted earnings per common share, compared with $307.3 million and $302.9 million, respectively, in second quarter 2018, or $8.89 diluted earnings per common share. For the first half of 2019, net income and net income applicable to common stock were $638.4 million and $629.6 million, respectively, or $18.49 diluted earnings per common share, compared with $626.3 million and $617.5 million, respectively, for the same period a year ago, or $18.13 diluted earnings per common share. The increase in net income in the second quarter and first half of 2019 was predominantly attributable to an increase in noninterest income in the second quarter of 2019 due to a $25.7 million gain on the sale of real estate 1-4 family first mortgage loans, with a carrying value of $35.1 million, to the Bank. These loans were previously written down to the fair value of the underlying collateral and are below their current recovery value. The increase in the first half of 2019 was partially offset by a decrease in pledge fees.

Loans

Total loans were $33.4 billion at June 30, 2019, compared with $35.5 billion at December 31, 2018. Loans, net of allowance for loan losses, represented 99.7% of assets at both June 30, 2019 and December 31, 2018.

Credit quality, as measured by net charge-offs, nonaccrual loans and delinquencies, remained strong during second quarter 2019. Net recoveries were $1.6 million and $2.2 million in the second quarter and first half of 2019, respectively, compared with $786 thousand and $1.3 million in the second quarter and first half of 2018. Nonaccrual loans were $158.8 million at June 30, 2019, compared with $178.9 million at December 31, 2018. Loans 90 days or more past due and still accruing were $3.5 million at June 30, 2019, compared with $6.5 million at December 31, 2018. Delinquencies remain a small percentage of our loan balances.

Reversal of provision for credit losses was $9.8 million and $8.1 million in the second quarter and first half of 2019, respectively, compared with $10.2 million and $16.1 million for the same periods in 2018. The higher reversal of provision for credit losses in 2018 reflected the improvement in our outlook for hurricane-related losses. Future allowance levels will be based on a variety of factors, including loan portfolio composition, size and performance, and the general economic environment, including housing market conditions.

Capital Distributions

Dividends declared to holders of our Series A preferred stock totaled $4.4 million and $8.8 million in the second quarter and first half, respectively, of 2019 and 2018. Dividends declared to holders of our Series B preferred stock totaled $14 thousand and $28 thousand in the second quarter and first half, respectively, of both 2019 and 2018.

Dividends declared to the holders of our common stock increased to $310.0 million from $295.0 million in the second quarter of 2019 and 2018, respectively, due to an increase in

estimated REIT taxable income for federal income tax purposes before dividends paid deduction attributable to the gain on sale of real estate 1-4 family loans in second quarter 2019. Dividends declared to the holders of our common stock decreased to $605.0 million from $620.0 million in the first half of 2019 and 2018, respectively, due to a decrease in estimated annual REIT taxable income for federal income tax purposes before dividends paid deduction.

Earnings Performance

Net Income

We earned net income of $334.9 million and $307.3 million in the second quarter of 2019 and 2018, respectively. For the first half of 2019, net income was $638.4 million, compared with $626.3 million, respectively, for the same period year ago. The increase in net income in the second quarter and first half of 2019 was attributable to an increase in noninterest income in the second quarter of 2019 due to a $25.7 million gain on the sale of real estate 1-4 family first mortgage loans, with a carrying value of $35.1 million, to the Bank. These loans were previously written down to the fair value of the underlying collateral and are below their current recovery value. The increase in the first half of 2019 was partially offset by a decrease in pledge fees.

Net Interest Income

Net interest income is the interest earned on loans and cash and cash equivalents less the interest paid on our Bank line of credit. Net interest margin is the average yield on interest-earning assets minus the average interest paid for funding. Interest-earning assets predominantly consist of loans. Net interest income was $332.6 million and $672.3 million in the second quarter and first half of 2019, respectively, compared with $333.3 million and $670.6 million for the same periods a year ago. Net interest margin was 3.92% and 3.90% in the second quarter and first half of 2019, respectively, compared with 3.90% and 3.86% for the same periods a year ago. The increase in net interest margin for the second quarter and first half of 2019 was due to an increase in yields on interest-earning assets. The increase in the first half of 2019 was partially offset by an increase in interest expense resulting from higher rates. Interest income in the second quarter and first half of 2019 included net accretion of adjustments on loans of $6.0 million and $12.8 million, respectively, compared with $5.0 million and $9.3 million a year ago.

Interest income in any one period can be affected by a variety of factors, including mix and size of the earning asset portfolio. See the “Risk Management - Asset/Liability Management - Interest Rate Risk” section in this Report for more information on interest rates and interest income.

The Company has a $5.0 billion line of credit with the Bank. Average borrowings for second quarter 2019 and 2018 were $1.6 billion and $2.0 billion, respectively, at weighted average interest rates of 3.22% and 2.42%, respectively. Average borrowings for the first half of 2019 and 2018 were $2.1 billion and $2.5 billion, respectively, at weighted average interest rates of 2.96% and 2.13%, respectively. Effective March 2019, the Company renewed the line of credit with the Bank and the interest rate increased from three-month London Interbank Offered Rate (LIBOR) plus 4.4 basis points (0.044%) to three-month LIBOR plus 65.0 basis points (0.650%). The change in interest rate was driven by an increase in term, along with a change in underwriting which aligned our credit rating with that of our direct parent rather than the Bank. It is expected that a transition away from the widespread use of LIBOR to alternative benchmark rates will occur by the end of 2021.

Table 1 presents the components of interest-earning assets and interest-bearing liabilities and related average yields to provide an analysis of year-over-year changes that influenced net interest income.

Table 1: Net Interest Income



	Quarter ended June 30,
					2019						2018
(in thousands)	Average balance		Interest income/expense		Yields/rates		Average balance		Interest income/expense		Yields/rates
Earning assets
Commercial loans	$	2,796,914	31,107		4.46	%	$	3,034,155	30,648		4.05	%
Real estate 1-4 family mortgage loans	31,126,744		314,501		4.04		31,200,725		314,559		4.03
Total interest-earning assets	$	33,923,658	345,608		4.08		$	34,234,880	345,207		4.04
Funding sources
Line of credit with Bank	$	1,615,701	12,985		3.22		$	1,968,455	11,860		2.42
Total interest-bearing liabilities	$	1,615,701	12,985		3.22		$	1,968,455	11,860		2.42
Net interest margin and net interest income			$	332,623	3.92	%			$	333,347	3.90	%
	Six months ended June 30,
					2019						2018
(in thousands)	Average balance		Interest income/expense		Yields/rates		Average balance		Interest income/expense		Yields/rates
Earning assets
Commercial loans	$	2,874,006	64,169		4.50	%	$	3,133,429	60,849		3.92	%
Real estate 1-4 family mortgage loans	31,586,649		639,552		4.05		31,644,280		636,022		4.02
Total interest-earning assets	$	34,460,655	703,721		4.09		$	34,777,709	696,871		4.01
Funding sources
Line of credit with Bank	$	2,138,911	31,372		2.96		$	2,491,852	26,262		2.13
Total interest-bearing liabilities	$	2,138,911	31,372		2.96		$	2,491,852	26,262		2.13
Net interest margin and net interest income			$	672,349	3.90	%			$	670,609	3.86	%

Reversal of Provision for Credit Losses

Reversal of provision for credit losses was $9.8 million and $8.1 million in the second quarter and first half of 2019, respectively, compared with $10.2 million and $16.1 million for the same periods a year ago. The higher reversal of provision for credit losses in 2018 reflected the improvement in our outlook for hurricane-related losses. See the “Balance Sheet Analysis” and "Risk Management – Allowance for Credit Losses” sections in this Report for additional information on the allowance for credit losses.

Noninterest Income

Noninterest income was $27.5 million and $29.2 million in the second quarter and first half of 2019, respectively, compared with $157 thousand and $6.4 million for the same periods a year ago. The increase in the second quarter and first half of 2019 was attributable to a gain on the sale of real estate 1-4 family first mortgage loans to the Bank. The increase in the first half of 2019 was partially offset by a decrease in pledge fees.

The certificate of designation for the Series A preferred stock limits our ability to pledge our loans to an aggregate amount not exceeding 80% of our total assets at any time as collateral on behalf of the Bank for the Bank’s access to secured borrowing facilities through the Federal Home Loan Banks or the discount window of Federal Reserve Banks. However, the Bank's borrowings will differ from loan balances pledged. In exchange for the pledge of our loan assets, the Bank pays us a fee that is consistent with market terms. We earned $1.4 million and $2.8 million in pledge fees in the second quarter and first half of 2019, respectively. We did not earn pledge fees in second quarter 2018. Pledge fees were $6.0 million for the first half of 2018. The decrease in the first half of 2019 was attributable to a lower average balance pledged.

See Note 5 (Transactions With Related Parties) to Financial Statements in this Report for more details.

Noninterest Expense

Noninterest expense was $34.9 million and $71.3 million in the second quarter and first half of 2019, respectively, compared with $36.4 million and $66.8 million for the same period a year ago. Noninterest expense predominantly consists of loan servicing costs, management fees, and foreclosed assets expense.

The loans in our portfolio are predominantly serviced by the Bank pursuant to the terms of participation and servicing and assignment agreements. In limited instances, the Bank has delegated servicing responsibility to third parties that are not affiliated with us or the Bank. Depending on the loan type, the monthly servicing fee charges are based in part on (a) outstanding principal balances, (b) a flat fee per month, or (c) a total loan commitment amount. Loan servicing costs in the second quarter and first half of 2019 were $21.1 million and $42.6 million, respectively, compared with $21.4 million and $43.3 million for the same period a year ago.

Management fees represent reimbursements made to the Bank for general overhead expenses, including allocations of technology support and a combination of finance and accounting, risk management and other general overhead expenses incurred on our behalf. Management fees include direct and indirect expense allocations. Indirect expenses are allocated based on ratios that use our proportion of expense activity drivers. The expense activity drivers and ratios may change from time to time. Management fees were $12.3 million and $23.0 million in the second quarter and first half of 2019, respectively, compared with $11.8 million and $18.0 million for the same periods a year ago. The increase in the first half of 2019 was driven by an increase in allocations for portfolio credit monitoring and oversight.

Foreclosed assets expense was $1.4 million and $5.3 million in the second quarter and first half of 2019, respectively, compared with $3.1 million and $5.2 million for the same periods a year ago. The decrease in second quarter 2019 was due to a decline in property taxes paid. Substantially all of our foreclosed assets consist of residential 1-4 family real estate assets.

See Note 5 (Transactions With Related Parties) to Financial Statements in this Report for more details.

Balance Sheet Analysis

Total Assets

Our assets predominantly consist of commercial and consumer loans, although we have the authority to hold assets other than loans. Total assets were $33.4 billion at June 30, 2019, and $35.5 billion at December 31, 2018.

Loans

Loans were $33.4 billion at June 30, 2019, and $35.5 billion at December 31, 2018. The decrease is attributable to net paydowns in the first half of 2019. At June 30, 2019 and December 31, 2018, consumer loans represented 92% and 91% of loans, respectively, and commercial loans represented the remaining balance of our loan portfolio.

Allowance for Loan Losses

The allowance for loan losses decreased $8.8 million to $87.9 million at June 30, 2019, from $96.7 million at December 31, 2018, reflecting more favorable economic conditions, continued portfolio improvement, and declining balances.

At June 30, 2019, the allowance for loan losses included $65.2 million for consumer loans and $22.7 million for commercial loans; however, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. See the “Risk Management – Credit Risk Management – Allowance for Credit Losses” section in this Report for a description of how management estimates the allowance for loan losses and the allowance for unfunded credit commitments.

Accounts Payable and Receivable—Affiliates, Net

Accounts payable and receivable from affiliates result from intercompany transactions in the normal course of business related to loan paydowns and payoffs, interest receipts, servicing costs, management fees and other transactions with the Bank or its affiliates.

Line of Credit with Bank

We draw upon our $5.0 billion line of credit with the Bank to finance loan acquisitions. At June 30, 2019 and December 31, 2018, we had $927.7 million and $3.1 billion outstanding, respectively.

Retained Earnings (Deficit)

We expect to distribute annually an aggregate amount of dividends with respect to outstanding capital stock equal to approximately 100% of our REIT taxable income for federal income tax purposes before dividends paid deduction. Because our net income determined under GAAP may vary from the determination of REIT taxable income, due to recognition differences for items such as loan losses and purchase accounting adjustments, periodic distributions may exceed our GAAP net income.

The retained deficit included within our balance sheet results from cumulative distributions that have exceeded GAAP net income, predominantly due to the impact on REIT taxable income of purchase accounting adjustments attributable to the Company during the years 2009 through 2013, from the 2008 acquisition of Wachovia Corporation by Wells Fargo.

For further information on the differences between taxable income before dividends paid deduction reported on our income tax returns and net income as reported in our statement of income, see the “Balance Sheet Analysis” section in our 2018 Form 10-K.

Risk Management

Our board of directors has overall responsibility for overseeing the Company’s risk management structure. This oversight is accomplished through the Audit Committee of the Board of Directors and a management-level committee that reviews the allowance for credit losses and is supplemented by certain elements of Wells Fargo’s risk management framework. For more information about how we manage risk, see the “Risk Management” section in our 2018 Form 10-K. The discussion that follows supplements our discussion of the management of certain risks contained in the "Risk Management" section in our 2018 Form 10-K.

Credit Risk Management Our assets consist predominantly of loans, and their related credit risk is among the most significant risks we manage. We define credit risk as the risk to earnings associated with a borrower or counterparty default (failure to meet obligations in accordance with agreed upon terms).

Table 2 represents loans by segment and class of financing receivable and the weighted average maturity for those loans calculated using contractual maturity dates.

Table 2: Total Loans Outstanding by Portfolio Segment and Class of Financing Receivable and Weighted Average Contractual Maturity



	Loans outstanding			Weighted average maturity in years
(in thousands)	Jun 30, 2019		Dec 31, 2018	Jun 30, 2019	Dec 31, 2018
Total commercial	$	2,758,900	3,055,423	3.2	3.2
Consumer:
Real estate 1-4 family first mortgage	29,997,941		31,769,813	24.3	24.7
Real estate 1-4 family junior lien mortgage	595,953		669,832	14.9	15.0
Total consumer	30,593,894		32,439,645	24.1	24.5
Total loans	$	33,352,794	35,495,068	22.3	22.6

The discussion that follows provides analysis of the risk elements of our various loan portfolios and our credit risk management and measurement practices. See Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more analysis and credit metric information.

In order to maintain our REIT status, the composition of our loan portfolio is highly concentrated in real estate.

We continually evaluate our credit policies and modify as necessary. Measuring and monitoring our credit risk is an ongoing process that tracks delinquencies, collateral values, FICO scores, economic trends by geographic areas, loan-level risk grading for certain portfolios (typically commercial) and other indications of credit risk. Our credit risk monitoring process is designed to enable early identification of developing risk and to support our determination of an appropriate allowance for credit losses.

LOAN PORTFOLIO BY GEOGRAPHY Table 3 is a summary of the geographical distribution of our loan portfolio for the top fifteen states by loans outstanding.

Table 3: Loan Portfolio by Geography



	June 30, 2019
(in thousands)	Commercial		Real estate 1-4 family first mortgage	Real estate 1-4 family junior lien mortgage	Total	% of total loans
California	$	1,271,869	8,005,337	6,375	9,283,581	28	%
New York	10,109		2,899,264	38,273	2,947,646	9
Washington	118,580		2,230,882	766	2,350,228	7
Virginia	47,726		1,860,298	59,383	1,967,407	6
Texas	70,485		1,266,503	6,845	1,343,833	4
Maryland	107,132		1,183,678	27,916	1,318,726	4
Massachusetts	26,668		1,234,640	2,121	1,263,429	4
Pennsylvania	19,162		1,046,696	93,073	1,158,931	3
Illinois	2,929		1,108,599	936	1,112,464	3
Florida	263,391		705,323	78,588	1,047,302	3
Georgia	26,678		966,794	39,565	1,033,037	3
Oregon	134,719		855,969	477	991,165	3
Minnesota	25,025		939,694	1,376	966,095	3
Arizona	55,629		777,586	560	833,775	2
New Jersey	85,335		404,080	134,060	623,475	2
All other states (1)	493,463		4,512,598	105,639	5,111,700	16
Total loans	$	2,758,900	29,997,941	595,953	33,352,794	100	%


(1)	No state is greater than 2% of total loans.

COMMERCIAL AND INDUSTRIAL LOANS (C&I) C&I loans were less than 1% of total loans at June 30, 2019. We believe the C&I portfolio is appropriately underwritten. Our credit risk management process for this portfolio focuses on a customer's

ability to repay the loan through their cash flows. Substantially all of the loans in our C&I portfolio were unsecured at June 30, 2019.

COMMERCIAL SECURED BY REAL ESTATE (CSRE) The CSRE portfolio consists of both mortgage loans and construction loans, where loans are secured by real estate. Table 4 summarizes CSRE loans by state and property type. To identify and manage newly emerging problem CSRE loans, we employ a high level of monitoring and regular customer interaction to

understand and manage the risks associated with these loans, including regular loan reviews and appraisal updates. We consider the creditworthiness of the customers and collateral valuations when selecting CSRE loans for acquisition.

Table 4: CSRE Loans by State and Property Type



	June 30, 2019
(in thousands)	Total CSRE loans		% of total CSRE loans
By state:
California	$	1,271,869	46	%
Florida	263,056		10
Utah	152,423		6
Oregon	134,719		5
Washington	118,580		4
Maryland	107,132		4
New Jersey	80,694		3
Texas	70,485		3
Colorado	61,696		2
Arizona	55,629		2
Missouri	52,116		2
Washington DC	49,910		2
Virginia	45,586		2
North Carolina	42,122		2
Rhode Island	33,286		1
All other states (1)	211,633		6
Total loans	$	2,750,936	100	%
By property type:
Office buildings	$	662,718	24	%
Shopping centers	497,572		18
5 + multifamily residences	450,053		16
Warehouses	367,237		13
Retail establishments (restaurants, stores)	293,469		11
Mini-storage	179,165		7
Commercial/industrial (non-residential)	102,404		4
Manufacturing plants	58,979		2
Motels/hotels	58,800		2
Research and development	29,043		1
Other	51,496		2
Total loans	$	2,750,936	100	%


(1)	No state is greater than 1% of CSRE loans.

REAL ESTATE 1-4 FAMILY MORTGAGE LOANS The concentrations of real estate 1-4 family mortgage loans by state and the related loan-to-value (LTV) ratio for real estate 1-4 family first mortgage and combined loan-to-value (CLTV) ratio for real estate 1-4 family junior lien mortgage loans are presented in combination in Table 5. CLTV means the ratio of the total loan balance of first and junior mortgages to property collateral value. We monitor changes in real estate values and underlying economic or market conditions for all geographic areas of our real estate 1-4 family mortgage portfolio as part of our credit risk management process. Our periodic review of loans secured by residential real estate collateral includes appraisals or estimates from automated valuation models (AVMs) to support property values. AVMs are computer-based tools used to estimate the market value of homes. AVMs are a lower-cost alternative to appraisals and support valuations of large numbers of properties in a short period of time using market comparables and price trends for local market areas. The primary risk associated with the use of AVMs is that the value of an individual property may vary significantly from the average

for the market area. We have processes to periodically validate AVMs and specific risk management guidelines addressing the circumstances when AVMs may be used. Additional information about AVMs and our policy for their use can be found in Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report and the “Risk Management - Credit Risk Management - Real Estate 1-4 Family Mortgage Loans” section in our 2018 Form 10-K.

We modify real estate 1-4 family mortgage loans to assist homeowners and other borrowers experiencing financial difficulties. For more information on our modification programs, see the “Risk Management – Credit Risk Management – Real Estate 1-4 Family Mortgage Loans” section in our 2018 Form 10-K.

The credit performance associated with our real estate 1-4 family mortgage portfolio remained strong in second quarter 2019, as measured through net charge-offs, nonaccrual loans and delinquencies.

Table 5: Real Estate 1-4 Family Mortgage Loans LTV/CLTV by State



	June 30, 2019
(in thousands)	Real estate 1-4 family mortgage		Current LTV\CLTV ratio
California	$	8,011,712	44	%
New York	2,937,537		57
Washington	2,231,648		51
Virginia	1,919,681		62
Texas	1,273,348		57
Massachusetts	1,236,761		59
Maryland	1,211,594		64
Pennsylvania	1,139,769		60
Illinois	1,109,535		67
Georgia	1,006,359		59
Minnesota	941,070		62
Oregon	856,446		59
Florida	783,911		51
Arizona	778,146		57
Colorado	549,515		44
All other states (1)	4,606,862		57
Total loans	$	30,593,894	54


(1)	No state is greater than 2% of real estate 1-4 family mortgage loans.

REAL ESTATE 1-4 FAMILY FIRST MORTGAGE LOANS Net charge-offs (recoveries) (annualized) as a percentage of average loans were 0.00% in both the second quarter and first half of 2019, respectively, compared with (0.02)% for the same periods a year ago. Nonaccrual loans were $125.7 million at June 30, 2019, compared with $142.3 million at December 31, 2018.

Table 6 summarizes delinquency and loss rates by state for our real estate 1-4 family first mortgage portfolio.

Table 6: Real Estate 1-4 Family First Mortgage Portfolio Performance



	Outstanding balance			% of loans 30 days or more past due			Loss (recovery) rate (annualized) quarter ended
(in thousands)	Jun 30, 2019		Dec 31, 2018	Jun 30, 2019		Dec 31, 2018	Jun 30, 2019		Mar 31, 2019		Dec 31, 2018		Sep 30, 2018		Jun 30, 2018
California	$	8,005,337	8,451,050	0.15	%	0.11	—		—		—		—		—
New York	2,898,682		3,028,854	0.44		0.54	0.02		0.01		(0.01	)	0.06		0.02
Washington	2,230,882		2,348,005	0.05		0.12	—		—		(0.01	)	(0.01	)	—
Virginia	1,859,380		1,954,719	0.38		0.47	—		0.02		0.01		(0.02	)	(0.02	)
Texas	1,266,484		1,351,937	0.49		0.34	—		—		0.01		(0.01	)	—
Massachusetts	1,234,564		1,299,185	0.10		0.22	—		—		—		(0.02	)	0.01
Maryland	1,183,444		1,237,011	0.36		0.44	—		(0.02	)	—		0.01		0.02
Illinois	1,108,599		1,185,911	0.10		0.24	(0.02	)	0.05		—		(0.04	)	—
Pennsylvania	1,045,331		1,109,930	1.89		1.93	0.02		0.04		(0.03	)	(0.12	)	0.05
Georgia	966,230		1,030,320	0.43		0.33	—		(0.02	)	(0.05	)	(0.04	)	(0.15	)
Minnesota	939,694		987,652	—		0.01	—		—		(0.01	)	(0.02	)	(0.01	)
Oregon	855,969		906,070	0.07		0.01	—		—		—		—		—
Arizona	777,586		835,533	0.26		0.21	—		—		—		—		—
Florida	704,238		777,733	1.46		1.68	0.03		(0.27	)	(0.14	)	(0.17	)	(0.24	)
Colorado	547,994		594,932	—		0.06	—		—		0.02		0.01		—
All other states (1)	4,366,558		4,663,815	1.06		1.12	(0.01	)	(0.01	)	0.03		(0.05	)	(0.08	)
Total	29,990,972		31,762,657	0.43		0.46	—		—		—		(0.02	)	(0.02	)
PCI	6,969		7,156
Total first mortgages	$	29,997,941	31,769,813


(1)	No state is greater than 1% of real estate 1-4 family first mortgage loans.

REAL ESTATE 1-4 FAMILY JUNIOR LIEN MORTGAGE LOANS Our junior lien portfolio includes real estate 1-4 family junior lien mortgage loans secured by real estate. Predominantly all of our junior lien loans are amortizing payment loans with fixed interest rates and repayment periods between 5 to 30 years. Junior lien loans with balloon payments at the end of the repayment term represent less than 1% of our junior lien loans. We frequently monitor the credit performance of our junior lien mortgage portfolio for trends and factors that influence the frequency and severity of loss. Net charge-offs (recoveries)

(annualized) as a percentage of average loans were (1.06)% and (0.62)% in the second quarter and first half of 2019, respectively, compared with 0.37% and 0.33% for the same periods a year ago. Nonaccrual loans were $31.0 million at June 30, 2019, compared with $34.6 million at December 31, 2018.

Table 7 summarizes delinquency and loss rates by state for our junior lien portfolio.

Table 7: Real Estate 1-4 Family Junior Lien Portfolio Performance



	Outstanding balance			% of loans 30 days or more past due			Loss (recovery) rate (annualized) quarter ended
(in thousands)	Jun 30, 2019		Dec 31, 2018	Jun 30, 2019		Dec 31, 2018	Jun 30, 2019		Mar 31, 2019		Dec 31, 2018		Sep 30, 2018		Jun 30, 2018
New Jersey	$	134,060	146,787	4.66	%	4.83	(0.68	)	(0.61	)	(0.53	)	1.43		2.31
Pennsylvania	93,073		104,882	3.63		4.16	(0.49	)	(0.18	)	1.50		0.92		0.43
Florida	78,588		88,122	3.37		3.21	(2.57	)	(0.44	)	(1.13	)	(0.14	)	(0.08	)
Virginia	59,383		68,551	2.69		2.94	(0.18	)	0.43		(0.88	)	0.41		(1.30	)
Georgia	39,565		45,857	1.45		2.64	(4.70	)	(2.45	)	(0.07	)	0.16		(0.07	)
North Carolina	38,946		44,343	3.75		6.36	(1.18	)	(0.41	)	(1.04	)	0.13		(0.14	)
New York	38,273		42,528	3.95		5.56	(0.16	)	2.37		0.10		(0.46	)	(0.53	)
Connecticut	29,345		32,132	2.80		4.40	0.13		1.53		(0.53	)	0.13		0.35
Maryland	27,916		31,099	3.29		4.46	(0.69	)	(1.82	)	0.60		2.34		(0.78	)
South Carolina	10,741		12,567	2.25		2.54	(0.83	)	1.93		(0.78	)	(0.26	)	(0.46	)
All other states (1)	46,063		52,964	3.50		2.44	(0.35	)	(0.20	)	0.18		(0.10	)	0.33
Total	595,953		669,832	3.53		4.05	(1.06	)	(0.21	)	(0.18	)	0.58		0.37
PCI	—		—
Total junior lien mortgages	$	595,953	669,832


(1)	No state is greater than 1% of real estate 1-4 family junior lien loans.

NONPERFORMING ASSETS (NONACCRUAL LOANS AND FORECLOSED ASSETS) Table 8 summarizes nonperforming assets (NPAs) for each of the last five quarters. For information about when we generally place loans on nonaccrual status, see

Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2018 Form 10-K.

Table 8: Nonperforming Assets (Nonaccrual Loans and Foreclosed Assets)



(in thousands)	Jun 30, 2019			Mar 31, 2019	Dec 31, 2018	Sep 30, 2018	Jun 30, 2018
Nonaccrual loans:
Total commercial	$	2,146		1,959	1,975	2,016	2,506
Consumer:
Real estate 1-4 family first mortgage	125,666			144,173	142,325	141,953	147,574
Real estate 1-4 family junior lien mortgage	31,023			33,587	34,625	35,948	37,553
Total consumer	156,689			177,760	176,950	177,901	185,127
Total nonaccrual loans (1)	158,835			179,719	178,925	179,917	187,633
Foreclosed assets	2,580			2,094	1,591	2,596	2,503
Total nonperforming assets	$	161,415		181,813	180,516	182,513	190,136
As a percentage of total loans	0.48		%	0.53	0.51	0.56	0.57


(1)	Excludes PCI loans because they continue to earn interest income from accretable yield, independent of performance in accordance with their contractual terms.

Total NPAs were $161.4 million (0.48% of total loans) at June 30, 2019, and included $158.8 million of nonaccrual loans. Total NPAs were $180.5 million (0.51% of total loans) at December 31, 2018, and included $178.9 million of nonaccrual loans. Total nonaccrual loans decreased $20.1 million to $158.8 million at June 30, 2019, from $178.9 million at December 31, 2018, largely related to the sale of real estate 1-4 family first mortgage loans to the Bank.

Typically, changes to nonaccrual loans period-over-period represent inflows for loans that are placed on nonaccrual status

in accordance with our policy, offset by reductions for loans that are paid down, charged off while on nonaccrual status, sold, transferred to foreclosed properties, or are no longer classified as nonaccrual as a result of continued performance and an improvement in the borrower’s financial condition and loan repayment capabilities. Table 9 provides an analysis of the changes in nonaccrual loans.

Table 9: Analysis of Changes in Nonaccrual Loans



	Quarter ended
(in thousands)	Jun 30, 2019			Mar 31, 2019		Dec 31, 2018		Sep 30, 2018		Jun 30, 2018
Commercial:
Balance, beginning of period	$	1,959		1,975		2,016		2,506		2,519
Inflows	200			2		46		—		241
Outflows	(13		)	(18	)	(87	)	(490	)	(254	)
Balance, end of period	2,146			1,959		1,975		2,016		2,506
Consumer:
Balance, beginning of period	177,760			176,950		177,901		185,127		194,671
Inflows	18,567			28,286		23,517		19,111		23,551
Outflows:
Returned to accruing	(9,218		)	(15,705	)	(9,954	)	(12,164	)	(14,291	)
Foreclosures	(3,166		)	(1,910	)	(2,114	)	(3,278	)	(2,326	)
Charge-offs	(952		)	(1,501	)	(2,963	)	(2,538	)	(2,277	)
Payment, sales and other (1)	(26,302		)	(8,360	)	(9,437	)	(8,357	)	(14,201	)
Total outflows	(39,638		)	(27,476	)	(24,468	)	(26,337	)	(33,095	)
Balance, end of period	156,689			177,760		176,950		177,901		185,127
Total nonaccrual loans (excluding PCI)	$	158,835		179,719		178,925		179,917		187,633


(1)	Current period includes real estate 1-4 family loans sold to the Bank.

TROUBLED DEBT RESTRUCTURINGS (TDRs) The recorded investment of loans modified in TDRs is provided in Table 10. The allowance for loan losses for TDRs was $34.6 million and $37.8 million at June 30, 2019 and December 31, 2018, respectively. See Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more information. Those loans discharged in bankruptcy and reported as TDRs have been written down to net realizable collateral value. In those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off. When we delay the timing on the repayment of a portion of principal (principal forbearance), we charge off the amount of forbearance if that amount is not considered fully collectible.

For more information on our nonaccrual policies when a restructuring is involved, see the “Risk Management – Credit Risk Management – Troubled Debt Restructurings (TDRs)” section of our 2018 Form 10-K.

Table 11 provides an analysis of the changes in TDRs. Loans modified more than once are reported as TDR inflows only in the period they are first modified. Other than resolutions such as foreclosures, we may remove loans from TDR classification, but only if they have been refinanced or restructured at market terms and qualify as a new loan.

TDRs of $321.8 million at June 30, 2019, decreased $44.5 million from first quarter 2019 largely related to the sale of real estate 1-4 family first mortgage loans to the Bank.

Table 10: Troubled Debt Restructurings (TDRs)



(in thousands)	Jun 30, 2019		Mar 31, 2019	Dec 31, 2018	Sep 30, 2018	Jun 30, 2018
Total commercial TDRs	$	2,179	2,183	1,958	2,509	3,124
Consumer:
Real estate 1-4 family first mortgage	242,762		283,651	278,459	289,563	294,171
Real estate 1-4 family junior lien mortgage	72,252		75,902	77,386	78,802	81,578
Trial modifications	4,654		4,530	5,277	5,044	5,980
Total consumer TDRs	319,668		364,083	361,122	373,409	381,729
Total TDRs	$	321,847	366,266	363,080	375,918	384,853
TDRs on nonaccrual status	$	104,131	121,279	109,713	113,893	115,672
TDRs on accrual status	217,716		244,987	253,367	262,025	269,181
Total TDRs	$	321,847	366,266	363,080	375,918	384,853

Table 11: Analysis of Changes in TDRs



	Quarter ended
(in thousands)	Jun 30, 2019			Mar 31, 2019		Dec 31, 2018		Sep 30, 2018		Jun 30, 2018
Commercial:
Balance, beginning of period	$	2,183		1,958		2,509		3,124		3,152
Inflows (1)	—			233		—		350		—
Outflows (2)	(4		)	(8	)	(551	)	(965	)	(28	)
Balance, end of period	2,179			2,183		1,958		2,509		3,124
Consumer:
Balance, beginning of period	364,083			361,122		373,409		381,729		397,428
Inflows (1)	3,269			16,238		2,978		5,872		6,476
Outflows:
Charge-offs	(478		)	(305	)	(376	)	(249	)	(388	)
Foreclosures	(1,101		)	(386	)	(486	)	(1,298	)	(2,734	)
Payments, sales and other (2)	(46,228		)	(11,839	)	(14,635	)	(11,710	)	(19,476	)
Net change in trial modifications (3)	123			(747	)	232		(935	)	423
Balance, end of period	319,668			364,083		361,122		373,409		381,729
Total TDRs	$	321,847		366,266		363,080		375,918		384,853


(1)	Inflows include loans that modify, even if they resolve, within the period as well as advances on loans that modified in a prior period.


(2)	Other outflows include normal amortization/accretion of loan basis adjustments. No loans were removed from TDR classification in the quarters ended June 30, and March 31, 2019, and December 31, September 30 and June 30, 2018, as a result of being refinanced or restructured at market terms and qualifying as new loans. Current period includes real estate 1-4 family loans sold to the Bank.


(3)	Net change in trial modifications includes: inflows of new TDRs entering the trial payment period, net of outflows for modifications that either (i) successfully perform and enter into a permanent modification, or (ii) did not successfully perform according to the terms of the trial period plan and are subsequently charged-off, foreclosed upon or otherwise resolved.

Loans 90 days or more past due and still accruing were less than 1% of loans at both June 30, 2019 and December 31, 2018.

Table 12 reflects non-PCI loans 90 days or more past due and still accruing.

Table 12: Loans 90 Days or More Past Due and Still Accruing (1)



(in thousands)	Jun 30, 2019		Mar 31, 2019	Dec 31, 2018	Sep 30, 2018	Jun 30, 2018
Total commercial	$	—	—	—	—	—
Consumer:
Real estate 1-4 family first mortgage	2,547		2,259	5,819	4,640	2,321
Real estate 1-4 family junior lien mortgage	913		759	708	1,478	320
Total consumer	3,460		3,018	6,527	6,118	2,641
Total past due (excluding PCI)	$	3,460	3,018	6,527	6,118	2,641

(1)

PCI loans of $496 thousand, $381 thousand, $373 thousand, $422 thousand and $504 thousand at June 30, and March 31, 2019, and December 31, September 30 and June 30, 2018, respectively, are excluded from this disclosure even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.

NET CHARGE-OFFS Table 13 presents net charge-offs (recoveries) for second quarter 2019 and the previous four quarters. Substantially all net charge-offs (recoveries) were in

consumer real estate. Net recoveries were $1.6 million and $786 thousand in second quarter 2019 and 2018, respectively.

Table 13: Net Charge-offs (Recoveries)



						Quarter ended
	Jun 30, 2019					Mar 31, 2019					Dec 31, 2018					Sep 30, 2018					Jun 30, 2018
(in thousands)	Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)
Total commercial	$	(38	)	(0.01	)%	$	(8	)	—	%	$	(13	)	—	%	$	(12	)	—	%	$	(13	)	—	%
Consumer:
Real estate 1-4 family first mortgage	63			—		(277		)	—		(181		)	—		(1,171		)	(0.02	)	(1,505		)	(0.02	)
Real estate 1-4 family junior lien mortgage	(1,619		)	(1.06	)	(341		)	(0.21	)	(319		)	(0.18	)	1,064			0.58		732			0.37
Total consumer	(1,556		)	(0.02	)	(618		)	(0.01	)	(500		)	(0.01	)	(107		)	—		(773		)	(0.01	)
Total	$	(1,594	)	(0.02	)%	$	(626	)	(0.01	)%	$	(513	)	(0.01	)%	$	(119	)	—	%	$	(786	)	(0.01	)%


(1)	Quarterly net charge-offs (recoveries) as a percentage of average loans are annualized.

ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses, which consists of the allowance for loan losses and the allowance for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio and unfunded credit commitments at the balance sheet date, excluding loans carried at fair value. The detail of the changes in the allowance for credit losses by portfolio segment (including charge-offs and recoveries by loan class) is in Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

We apply a disciplined process and methodology to establish our allowance for credit losses each quarter. This process takes into consideration many factors, including historical and forecasted loss trends, loan-level credit quality ratings and loan grade-specific characteristics. The process involves subjective and complex judgments. In addition, we review a variety of credit metrics and trends. These credit metrics and trends, however, do not solely determine the amount of the allowance as we use several analytical tools. Our estimation approach for the commercial portfolio reflects the estimated probability of default in accordance with the borrower's financial strength, and the severity of loss in the event of default, considering the quality of any underlying collateral. Probability of default and severity at the time of default are statistically derived through historical observations of defaults and losses after default within each credit risk rating. Our estimation approach for the consumer portfolio uses forecasted losses that represent our best estimate of inherent loss based on historical experience, quantitative and other mathematical techniques.

The ratio of the allowance for credit losses to total nonaccrual loans may fluctuate significantly from period to

period due to such factors as the mix of loan types in the portfolio, borrower credit strength and the value and marketability of collateral. Substantially all of our nonaccrual loans were real estate 1-4 family first and junior lien mortgage loans at June 30, 2019.

We believe the allowance for credit losses of $89.2 million at June 30, 2019, was appropriate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at that date. The allowance for credit losses is subject to change and reflects existing factors as of the date of determination, including economic or market conditions and ongoing internal and external examination processes. Due to the sensitivity of the allowance for credit losses to changes in the economic and business environment, it is possible that we will incur incremental credit losses not anticipated as of the balance sheet date. Future allowance levels will be based on a variety of factors, including change in loan balances, portfolio performance and general economic conditions. Our process for determining the allowance for credit losses is discussed in the “Critical Accounting Policy” section and Note 1 (Summary of Significant Accounting Policies) to Financial Statements in this Report and in our 2018 Form 10-K.

Table 14 presents an analysis of the allowance for credit losses.

Table 14: Allocation of the Allowance for Credit Losses (ACL)



	Quarter ended
	Jun 30, 2019				Mar 31, 2019				Dec 31, 2018				Sep 30, 2018				Jun 30, 2018
(in thousands)	ACL		Loans as % of total loans		ACL		Loans as % of total loans		ACL		Loans as % of total loans		ACL		Loans as % of total loans		ACL		Loans as % of total loans
Total commercial	$	24,046	8	%	$	25,220	10	%	$	26,281	10	%	$	23,722	8	%	$	25,856	9	%
Consumer:
Real estate 1-4 family first mortgage	48,733		90		55,034		89		51,894		89		59,026		90		61,702		89
Real estate 1-4 family junior lien mortgage	16,439		2		19,416		1		20,093		1		23,454		2		26,178		2
Total consumer	65,172		92		74,450		90		71,987		90		82,480		92		87,880		91
Total	$	89,218	100	%	$	99,670	100	%	$	98,268	100	%	$	106,202	100	%	$	113,736	100	%



	Quarter ended
(in thousands)	Jun 30, 2019			Mar 31, 2019	Dec 31, 2018	Sep 30, 2018	Jun 30, 2018
Components:
Allowance for loan losses	$	87,885		98,158	96,743	104,556	112,381
Allowance for unfunded credit commitments	1,333			1,512	1,525	1,646	1,355
Allowance for credit losses	$	89,218		99,670	98,268	106,202	113,736
Allowance for loan losses as a percentage of total loans	0.26		%	0.28	0.27	0.32	0.33
Allowance for loan losses as a percentage of annualized net charge-offs	NM			NM	NM	NM	NM
Allowance for credit losses as a percentage of total loans	0.27			0.29	0.28	0.33	0.34
Allowance for credit losses as a percentage of total nonaccrual loans	56.17			55.46	54.92	59.03	60.62

NM – Not meaningful

Asset/Liability Management

Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk and liquidity and funding.

INTEREST RATE RISK Interest rate risk is the sensitivity of earnings to changes in interest rates. At June 30, 2019, 11% of our loans had variable interest rates. In a declining rate environment, we may experience a reduction in interest income on our loan portfolio and a corresponding decrease in funds available to be distributed to our shareholders. The reduction in interest income may result from downward adjustment of the indices upon which the interest rates on loans are based and from prepayments of loans with fixed interest rates, resulting in reinvestment of the proceeds in lower yielding assets. To manage interest rate risk, we monitor loan paydown rates, portfolio composition, and the rate sensitivity of loans acquired. Our loan acquisition process attempts to balance desirable yields with the quality of loans acquired.

At June 30, 2019, approximately 89% of our loans had fixed interest rates. Such loans increase our interest rate risk. Our methods for evaluating interest rate risk include an analysis of interest-rate sensitivity “gap,” which is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Our interest rate-sensitive liabilities are generally limited to our line of credit with the Bank.

During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution is perfectly matched in each maturity category.

At June 30, 2019, 11% of our assets had variable interest rates, and could be expected to reprice with changes in interest rates. At June 30, 2019, our liabilities were 3% of our assets. This positive gap between our assets and liabilities indicates that an increase in interest rates would result in an increase in net interest income and a decrease in interest rates would result in a decrease in net interest income.

LIQUIDITY AND FUNDING The objective of effective liquidity management is to ensure that we can meet customer loan requests and other cash commitments efficiently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, Wells Fargo’s Corporate Asset/Liability Management Committee establishes and monitors liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets.

Proceeds received from paydowns of loans are typically sufficient to fund existing lending commitments. Depending upon the timing of the loan acquisitions, we may draw on our $5.0 billion revolving line of credit we have with the Bank as a short-term liquidity source. At June 30, 2019 there was $927.7 million outstanding on our Bank line of credit. Effective March 2019, the Company renewed the line of credit with the Bank and the interest rate increased from three-month LIBOR plus 4.4 basis points (0.044%) to three-month LIBOR plus 65.0 basis points (0.650%). The change in interest rate was driven by an increase in term, along with a change in underwriting which aligned our credit rating with that of our direct parent rather than the Bank. It is expected that a transition away from the widespread use of LIBOR to alternative benchmark rates will occur by the end of 2021.

Our primary liquidity needs are to pay operating expenses, fund our lending commitments, acquire loans to replace existing loans that mature or repay, and pay dividends. The retained deficit included within our balance sheet results from cumulative distributions that have exceeded GAAP net income, predominantly due to the impact on REIT taxable income of purchase accounting adjustments attributable to the Company during the years 2009 through 2013, from the 2008 acquisition of Wachovia Corporation by Wells Fargo. The excess dividend distributions were funded by using cash provided by investing (generally principal payments received on our loans) and financing activities (generally draws on our Bank line of credit). As the remaining purchase accounting adjustments are not expected to cause a significant variance between GAAP net income and REIT taxable income in future years, operating expenses and dividends are expected to be funded through cash generated by operations or paid-in capital. Funding commitments and the acquisition of loans are intended to be funded with the proceeds obtained from repayment of principal balances by individual borrowers and our line of credit with the Bank.

On September 8, 2016, Wells Fargo reached agreements with the Consumer Financial Protection Bureau (CFPB), the Office of the Comptroller of the Currency (OCC), and the Office of the Los Angeles City Attorney, regarding allegations that some of its retail customers received products and services they did not request. On February 2, 2018, Wells Fargo entered into a consent order with the Board of Governors of the Federal Reserve System (FRB) related to governance oversight and compliance and operational risk management that imposes an asset cap on Wells Fargo until plans to enhance governance oversight and compliance and operational risk management are approved and implemented to the satisfaction of the FRB. On April 20, 2018 Wells Fargo reached agreement on consent orders issued by the CFPB and OCC to resolve matters regarding the compliance risk management program and past practices involving certain automobile collateral protection insurance policies and certain mortgage interest rate lock extensions. On August 1, 2018, Wells Fargo announced an agreement with the U.S. Department of Justice regarding the resolution of claims related to certain 2005-2007 residential mortgage-backed securities activities. Negative publicity or public opinion resulting from the settlements, consent orders, and related matters and other instances where the Bank’s customers may have experienced financial harm as well as from the resolution of other regulatory matters, litigation, or legal actions by Wells Fargo and the Bank may increase the risk of reputational harm to the business of Wells Fargo and the Bank, including the Bank’s ability to originate loans at the same volumes as we have historically acquired. If in future periods we do not reinvest loan

paydowns at sufficient levels, management may request our board of directors to consider a return of capital to the holders of our common stock. Annually, we expect to distribute an aggregate amount of outstanding capital stock dividends equal to approximately 100% of our REIT taxable income for federal tax purposes. Such distributions may exceed net income determined under GAAP.

To the extent that we determine that additional funding is necessary or advisable, we could issue additional common or preferred stock, subject to Board of Directors approval, raise funds through debt financings, or a combination of these methods. Retention of operating cash flows does not represent a significant source of funding because any cash flow retention must be consistent with the provisions of the Investment Company Act and the Code, which requires the distribution by a REIT of at least 90% of its REIT taxable income, excluding capital gains, and must take into account taxes that would be imposed on undistributed income.

The certificate of designation for the Series A preferred stock contains a covenant in which we agree not to incur indebtedness for borrowed money, including any guarantees of indebtedness (which does not include any pledges of our assets on behalf of the Bank or our other affiliates), without the consent of the holders of two-thirds of the Series A preferred stock, voting as a separate class, provided that, we may incur indebtedness in an aggregate amount not exceeding 20% of our stockholders’ equity.

Critical Accounting Policy

Our significant accounting policies (see Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2018 Form 10-K) are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. We have identified the accounting policy covering allowance for credit losses as critical because it requires management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

Management and the audit committee of the board of directors have reviewed and approved this critical accounting policy. This policy is described in the "Critical Accounting Policy" section in our 2018 Form 10-K.

Current Accounting Developments

Table 15 provides accounting pronouncements applicable to us that have been issued by the FASB but are not yet effective.

Table 15: Current Accounting Developments - Issued Standards



Standard	Description	Effective date and financial statement impact
Accounting Standards Update (ASU or Update) 2016-13 – Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and subsequent related Updates	The Update changes the accounting for credit losses measurement on loans by requiring a current expected credit loss (CECL) measurement to estimate the allowance for credit losses (ACL). CECL requires loss estimates for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts. Also, the Update eliminates the existing guidance for PCI loans, but requires an allowance for purchased financial assets with more than insignificant deterioration since origination.	We expect to adopt the guidance in first quarter 2020. Our implementation process includes loss forecasting model development, evaluation of technical accounting topics, updates to our allowance documentation, reporting processes and related internal controls, and overall operational readiness for our adoption of the Update, which will continue throughout 2019, including parallel runs for CECL alongside our current allowance process. We are in the process of developing, validating, and implementing models used to estimate credit losses under CECL. We have completed all of our loss forecasting models, and we expect to complete the validation process for our loan models during 2019. Our current planned approach for estimating expected life-time credit losses for loans includes the following key components: • An initial forecast period of one year for all portfolio segments and off-balance-sheet credit exposures. This period reflects management’s expectation of losses based on forward-looking economic scenarios over that time. • A historical loss forecast period covering the remaining contractual life, adjusted for prepayments, by portfolio segment and class of financing receivables based on the change in key historic economic variables during representative historical expansionary and recessionary periods. • A reversion period of up to 2 years connecting the initial loss forecast to the historical loss forecast based on economic conditions at the measurement date. • We will utilize discounted cash flow (DCF) methods to measure credit impairment for loans modified in a TDR, unless they are collateral dependent and measured at the fair value of collateral. The DCF methods would obtain estimated life-time credit losses using the conceptual components described above. Based on our portfolio composition as of June 30, 2019, and the current economic environment, we currently estimate an overall decrease in our ACL for loans of approximately $30 million. The reduction reflects an expected decrease for commercial loans, given their short contractual maturities, partially offset by an expected increase for longer duration consumer loans and includes recoveries related to residential mortgage loans that were previously written down during the last credit cycle and are below their current recovery value. We will continue to evaluate and refine the results of our loss estimates throughout 2019. The ultimate effect of CECL on our ACL will depend on the size and composition of our portfolio, the portfolio's credit quality and economic conditions at the time of adoption, as well as any refinements to our models, methodology and other key assumptions. At adoption, we will have a cumulative-effect adjustment to retained earnings for our change in the ACL.

In addition to the list above, the following Updates are applicable to us but are not expected to have a material impact on our financial statements:


•	ASU 2018-13 – Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement

Forward-Looking Statements

This Report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “target,” “projects,” “outlook,” “forecast,” “will,” “may,” “could,” “should,” “can” and similar references to future periods. Examples of forward-looking statements include, but are not limited to, statements we make about: future results of WFREIC; expectations for consumer and commercial credit performance and the appropriateness of our allowance for credit losses; our expectations regarding net interest income; expectations regarding loan acquisitions and paydowns; future capital expenditures; future dividends and other capital distributions; the expected outcome and impact of legal, regulatory and legislative developments, as well as our expectations regarding compliance therewith; the outcome of contingencies, such as legal proceedings; and our plans, objectives and strategies.

Forward-looking statements are not based on historical facts but instead represent our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution, therefore, against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. While there is no assurance that any list of risks and uncertainties or risk factors is complete, important factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation:


•	economic conditions that affect the general economy, housing prices, the job market, consumer confidence and spending habits, including our borrowers’ prepayment and repayment of our loans;


•	losses related to natural disasters, including from damage or loss to our collateral for loans in our consumer and commercial loan portfolios and from the impact on the ability of our borrowers to repay their loans;


•	the effect of the interest rate environment or changes in interest rates on our net interest income;


•	the level and volatility of the capital markets, interest rates, currency values and other market indices that affect the value of our assets and liabilities;


•	the effect of political conditions and geopolitical events;


•	adverse developments in the availability of desirable investment opportunities, whether they are due to competition, regulation or otherwise;


•	the extent of loan modification efforts, as well as the effects of regulatory requirements or guidance regarding loan modifications;


•	the availability and cost of both credit and capital;


•	investor sentiment and confidence in the financial markets;

•

our reputation and the reputation of Wells Fargo and the Bank, including negative effects from the Bank's retail banking sales practices matter and other instances where the Bank’s customers may have experienced financial harm and negative effects from the resolution of regulatory matters, litigation, or other legal actions by Wells Fargo and the Bank, which may result in, among other things, additional costs, fines, penalties, restrictions on Wells Fargo’s or the Bank’s business, reputational harm or other adverse consequences;


•	financial services reform and the impact of other current, pending and future legislation, regulation and legal actions applicable to us, the Bank or Wells Fargo, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and related regulations;


•	changes in accounting standards, rules and interpretations;


•	various monetary and fiscal policies and regulations of the U.S. and foreign governments;


•	a failure in or breach of our, the Bank’s or Wells Fargo’s operational or security systems or infrastructure, or those of third party vendors and other security providers, including as a result of cyber-attacks; and


•	the other factors described in “Risk Factors” in the 2018 Form 10-K.

In addition to the above factors, we also caution that our allowance for credit losses currently may not be appropriate to cover future credit losses, especially if housing prices decline, unemployment worsens, or general economic conditions deteriorate. Increases in loan charge-offs or in the allowance for credit losses and related provision expense could materially adversely affect our financial results and condition.

Any forward-looking statement made by us in this Report speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

Risk Factors

An investment in Wells Fargo Real Estate Investment Corporation involves risk, including the possibility that the value of the investment could fall substantially and that dividends or other distributions on the investment could be reduced or eliminated. For a discussion of risk factors that could adversely affect our financial results and condition and the value of, and return on, an investment in WFREIC, refer to the “Risk Factors” section in our 2018 Form 10-K.

The following risk factor updates the risk factors described in our 2018 Form 10-K:

We may redeem the Series A preferred stock upon certain events and at any time on or after December 11, 2019.

Within 90 days of the occurrence of certain events (as described in Note 5 (Common and Preferred Stock) to Financial Statements in our 2018 Form 10-K) or at any time on or after December 11, 2019, we will have the right to redeem the Series A preferred stock in whole or in part upon notice given 30-60 days in advance of the redemption date. While the Series A preferred stock may be redeemed at our option under these circumstances, investors in the Series A preferred stock will have no right to reclaim their initial investment from us, and the Series A preferred stock may never be redeemed. Investors in the Series A preferred stock may not be able to sell their securities in the secondary market, or if such a sale occurs the sale price may not be at or above the initial price at which such shares were purchased. If we redeem the Series A preferred stock, holders may not be able to invest their redemption proceeds in securities with a dividend yield comparable to that of the Series A preferred stock.

Controls and Procedures



Disclosure Controls and Procedures

The Company's management evaluated the effectiveness, as of June 30, 2019, of the Company's disclosure controls and procedures. The Company's chief executive officer and chief financial officer participated in the evaluation. Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2019.



Internal Control Over Financial Reporting

Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles (GAAP) and includes those policies and procedures that:


•	pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the Company;


•	provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and


•	provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. No change occurred during second quarter 2019 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Financial Statements



Wells Fargo Real Estate Investment Corporation
Statement of Income (Unaudited)
	Quarter ended June 30,					Six months ended June 30,
(in thousands, except per share amounts)	2019			2018		2019		2018
Interest income	$	345,608		345,207		703,721		696,871
Interest expense	12,985			11,860		31,372		26,262
Net interest income	332,623			333,347		672,349		670,609
Provision (reversal of provision) for credit losses	(9,774		)	(10,212	)	(8,089	)	(16,066	)
Net interest income after provision for credit losses	342,397			343,559		680,438		686,675
Noninterest income
Pledge fees	1,378			—		2,789		6,037
Gain (loss) on sale of loans	25,947			(33	)	26,076		(1	)
Other	168			190		370		379
Total noninterest income	27,493			157		29,235		6,415
Noninterest expense
Loan servicing costs	21,073			21,360		42,618		43,282
Management fees	12,283			11,750		22,982		18,010
Foreclosed assets	1,410			3,121		5,335		5,174
Other	179			182		354		289
Total noninterest expense	34,945			36,413		71,289		66,755
Net income	334,945			307,303		638,384		626,335
Comprehensive income	334,945			307,303		638,384		626,335
Dividends on preferred stock	4,397			4,397		8,794		8,794
Net income applicable to common stock	$	330,548		302,906		629,590		617,541
Per common share information
Earnings per common share	$	9.71		8.89		18.49		18.13
Diluted earnings per common share	9.71			8.89		18.49		18.13
Average common shares outstanding	34,058			34,058		34,058		34,058
Diluted average common shares outstanding	34,058			34,058		34,058		34,058

The accompanying notes are an integral part of these statements.



Wells Fargo Real Estate Investment Corporation
Balance Sheet
(in thousands, except shares)	Jun 30, 2019			Dec 31, 2018
Assets	(Unaudited)
Cash and cash equivalents	$	—		—
Loans	33,352,794			35,495,068
Allowance for loan losses	(87,885		)	(96,743	)
Net loans	33,264,909			35,398,325
Accounts receivable - affiliates, net	20,353			—
Other assets	92,010			94,942
Total assets	$	33,377,272		35,493,267
Liabilities
Line of credit with Bank	$	927,697		3,054,738
Accounts payable - affiliates, net	—			13,798
Other liabilities	9,699			9,445
Total liabilities	937,396			3,077,981
Stockholders’ Equity
Preferred stock	110			110
Common stock – $0.01 par value, authorized 100,000,000 shares; issued and outstanding 34,058,028 shares	341			341
Additional paid-in capital	32,550,660			32,550,660
Retained earnings (deficit)	(111,235		)	(135,825	)
Total stockholders’ equity	32,439,876			32,415,286
Total liabilities and stockholders’ equity	$	33,377,272		35,493,267

The accompanying notes are an integral part of these statements.



Wells Fargo Real Estate Investment Corporation
Statement of Changes in Stockholders’ Equity (Unaudited)
Quarter ended June 30,
(in thousands, except per share data)	Preferred stock		Common stock	Additional paid-in capital	Retained earnings (deficit)		Total stockholders’ equity
Balance, March 31, 2019	$	110	341	32,550,660	(131,783	)	32,419,328
Net income	—		—	—	334,945		334,945
Cash dividends
Series A preferred stock at $0.40 per share	—		—	—	(4,383	)	(4,383	)
Series B preferred stock at $21.25 per share	—		—	—	(14	)	(14	)
Common stock at $9.10 per share	—		—	—	(310,000	)	(310,000	)
Balance, June 30, 2019	$	110	341	32,550,660	(111,235	)	32,439,876
Balance, March 31, 2018	$	110	341	32,550,660	(171,213	)	32,379,898
Net income	—		—	—	307,303		307,303
Cash dividends
Series A preferred stock at $0.40 per share	—		—	—	(4,383	)	(4,383	)
Series B preferred stock at $21.25 per share	—		—	—	(14	)	(14	)
Common stock at $8.66 per share	—		—	—	(295,000	)	(295,000	)
Balance, June 30, 2018	$	110	341	32,550,660	(163,307	)	32,387,804

Six months ended June 30,
(in thousands, except per share data)	Preferred stock		Common stock	Additional paid-in capital	Retained earnings (deficit)		Total stockholders’ equity
Balance, December 31, 2018	$	110	341	32,550,660	(135,825	)	32,415,286
Net income	—		—	—	638,384		638,384
Cash dividends
Series A preferred stock at $0.80 per share	—		—	—	(8,766	)	(8,766	)
Series B preferred stock at $42.50 per share	—		—	—	(28	)	(28	)
Common stock at $17.76 per share	—		—	—	(605,000	)	(605,000	)
Balance, June 30, 2019	$	110	341	32,550,660	(111,235	)	32,439,876
Balance, December 31, 2017	$	110	341	32,550,660	(160,848	)	32,390,263
Net income	—		—	—	626,335		626,335
Cash dividends
Series A preferred stock at $0.80 per share	—		—	—	(8,766	)	(8,766	)
Series B preferred stock at $42.50 per share	—		—	—	(28	)	(28	)
Common stock at $18.20 per share	—		—	—	(620,000	)	(620,000	)
Balance, June 30, 2018	$	110	341	32,550,660	(163,307	)	32,387,804

The accompanying notes are an integral part of these statements.



Wells Fargo Real Estate Investment Corporation
Statement of Cash Flows (Unaudited)
	Six months ended June 30,
(in thousands)	2019			2018
Cash flows from operating activities:
Net income	$	638,384		626,335
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of adjustments on loans	(12,755		)	(9,319	)
Provision (reversal of provision) for credit losses	(8,089		)	(16,066	)
Other operating activities, net	(4,238		)	26,616
Net cash provided by operating activities	613,302			627,566
Cash flows from investing activities:
Increase (decrease) in cash realized from
Loans:
Acquisitions	—			—
Proceeds from payments and sales	2,123,136			2,199,001
Net cash provided by investing activities	2,123,136			2,199,001
Cash flows from financing activities:
Increase (decrease) in cash realized from
Draws on line of credit with Bank	645,482			650,797
Repayments of line of credit with Bank	(2,772,523		)	(2,852,967	)
Cash dividends paid	(609,397		)	(624,397	)
Net cash used by financing activities	(2,736,438		)	(2,826,567	)
Net change in cash and cash equivalents	—			—
Cash and cash equivalents at beginning of period	—			—
Cash and cash equivalents at end of period	$	—		—
Supplemental cash flow disclosures:
Change in noncash items:
Transfers from loans to foreclosed assets	$	5,914		7,063
Preferred dividends payable	4,397			4,397
Cash paid for interest	35,458			24,577

The accompanying notes are an integral part of these statements.

Note 1: Summary of Significant Accounting Policies

Wells Fargo Real Estate Investment Corporation (the Company, we, our or us) is an indirect subsidiary of both Wells Fargo & Company (Wells Fargo) and Wells Fargo Bank, National Association (the Bank). The Company, a Delaware corporation, has operated as a real estate investment trust (REIT) since its formation in 1996.

The accounting and reporting policies of the Company are in accordance with U.S. generally accepted accounting principles (GAAP). For discussion of our significant accounting policies, see Note 1 (Summary of Significant Accounting Policies) in our Annual Report on Form 10-K for the year ended December 31, 2018 (2018 Form 10-K). There were no material changes to these policies in second quarter 2019. The preparation of the financial statements in accordance with GAAP requires management to make estimates based on assumptions about future economic and market conditions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period and the related disclosures. Although our estimates contemplate current conditions and how we expect them to change in the future, it is reasonably possible that actual future conditions could be significantly different than anticipated in those estimates, which could materially affect our results of operations and financial condition. Management has made significant estimates related to the allowance for credit losses (Note 2 (Loans and Allowance for Credit Losses)). Actual results could differ from those estimates.

These unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim financial statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with our 2018 Form 10-K.

Accounting Standards Adopted in 2019

In the first half of 2019, we did not adopt any new accounting standards.

Subsequent Events

We have evaluated the effects of events that have occurred subsequent to June 30, 2019. There were no material subsequent events requiring adjustment to the financial statements or disclosure in the Notes to Financial Statements.

Note 2: Loans and Allowance for Credit Losses

The Company acquires loans originated or purchased by the Bank. In order to maintain our status as a REIT, the composition of the loans is highly concentrated in real estate. Underlying loans are concentrated primarily in California, New York, Washington, Virginia, Texas, Maryland and Massachusetts. These markets include approximately 62% of our total loan balance at June 30, 2019.

The following table presents total loans outstanding by portfolio segment and class of financing receivable. Total reductions and additions for unamortized premiums, discounts and other adjustments were less than 1% of outstanding balances at June 30, 2019 and December 31, 2018.



(in thousands)	Jun 30, 2019		Dec 31, 2018
Total commercial	$	2,758,900	3,055,423
Consumer:
Real estate 1-4 family first mortgage	29,997,941		31,769,813
Real estate 1-4 family junior lien mortgage	595,953		669,832
Total consumer	30,593,894		32,439,645
Total loans	$	33,352,794	35,495,068

The following table summarizes the proceeds paid or received from the Bank for acquisitions and sales of loans, respectively.



	2019						2018
(in thousands)	Commercial		Consumer		Total		Commercial	Consumer		Total
Quarter ended June 30,
Loan acquisitions	$	—	—		—		—	—		—
Loan sales	—		(89,179	)	(89,179	)	—	(2,134	)	(2,134	)
Six months ended June 30,
Loan acquisitions	$	—	—		—		—	—		—
Loan sales	—		(100,861	)	(100,861	)	—	(5,775	)	(5,775	)

Commitments to Lend

The contract or notional amount of commercial loan commitments to extend credit was $440.6 million at June 30, 2019 and $462.2 million at December 31, 2018.

Pledged Loans

See Note 5 (Transactions With Related Parties) for additional details on our agreement with the Bank to pledge loans.

Allowance for Credit Losses

The following table presents the allowance for credit losses, which consists of the allowance for loan losses and the allowance for unfunded credit commitments.



	Quarter ended June 30,					Six months ended June 30,
(in thousands)	2019			2018		2019			2018
Balance, beginning of period	$	99,670		124,066		$	98,268		130,661
Provision (reversal of provision) for credit losses	(9,774		)	(10,212	)	(8,089		)	(16,066	)
Interest income on certain impaired loans (1)	(798		)	(904	)	(1,707		)	(2,151	)
Loan charge-offs:
Total commercial	—			—		—			—
Consumer:
Real estate 1-4 family first mortgage	(1,028		)	(1,662	)	(2,222		)	(2,754	)
Real estate 1-4 family junior lien mortgage	(1,024		)	(2,193	)	(2,403		)	(4,991	)
Total consumer	(2,052		)	(3,855	)	(4,625		)	(7,745	)
Total loan charge-offs	(2,052		)	(3,855	)	(4,625		)	(7,745	)
Loan recoveries:
Total commercial	38			13		46			28
Consumer:
Real estate 1-4 family first mortgage	965			3,167		2,436			5,351
Real estate 1-4 family junior lien mortgage	2,643			1,461		4,363			3,658
Total consumer	3,608			4,628		6,799			9,009
Total loan recoveries	3,646			4,641		6,845			9,037
Net loan recoveries	1,594			786		2,220			1,292
Other (2)	(1,474		)	—		(1,474		)	—
Balance, end of period	$	89,218		113,736		$	89,218		113,736
Components:
Allowance for loan losses	$	87,885		112,381		$	87,885		112,381
Allowance for unfunded credit commitments	1,333			1,355		1,333			1,355
Allowance for credit losses	$	89,218		113,736		$	89,218		113,736
Net loan (recoveries) charge-offs as a percentage of average total loans (3)	(0.02		)%	(0.01	)	(0.01		)%	(0.01	)
Allowance for loan losses as a percentage of total loans	0.26			0.33		0.26			0.33
Allowance for credit losses as a percentage of total loans	0.27			0.34		0.27			0.34


(1)	Certain impaired loans with an allowance calculated by discounting expected cash flows using the loan’s effective interest rate over the remaining life of the loan recognize changes in allowance attributable to the passage of time as interest income.


(2)	Represents allowance for real estate 1-4 family loans sold to the Bank.


(3)	Quarterly net charge-offs (recoveries) as a percentage of average total loans are annualized.

The following table summarizes the activity in the allowance for credit losses by our commercial and consumer portfolio segments.



	2019							2018
(in thousands)	Commercial			Consumer		Total		Commercial		Consumer		Total
Quarter ended June 30,
Balance, beginning of period	$	25,220		74,450		99,670		27,020		97,046		124,066
Reversal of provision for credit losses	(1,212		)	(8,562	)	(9,774	)	(1,177	)	(9,035	)	(10,212	)
Interest income on certain impaired loans	—			(798	)	(798	)	—		(904	)	(904	)

Loan charge-offs	—			(2,052	)	(2,052	)	—		(3,855	)	(3,855	)
Loan recoveries	38			3,608		3,646		13		4,628		4,641
Net loan recoveries (charge-offs)	38			1,556		1,594		13		773		786
Other (1)	—			(1,474	)	(1,474	)	—		—		—
Balance, end of period	$	24,046		65,172		89,218		25,856		87,880		113,736

Six months ended June 30,
Balance, beginning of period	$	26,281		71,987		98,268		28,085		102,576		130,661
Provision (reversal of provision) for credit losses	(2,281		)	(5,808	)	(8,089	)	(2,257	)	(13,809	)	(16,066	)
Interest income on certain impaired loans	—			(1,707	)	(1,707	)	—		(2,151	)	(2,151	)

Loan charge-offs	—			(4,625	)	(4,625	)	—		(7,745	)	(7,745	)
Loan recoveries	46			6,799		6,845		28		9,009		9,037
Net loan recoveries (charge-offs)	46			2,174		2,220		28		1,264		1,292
Other (1)	—			(1,474	)	(1,474	)	—		—		—
Balance, end of period	$	24,046		65,172		89,218		25,856		87,880		113,736


(1)	Represents allowance for real estate 1-4 family loans sold to the Bank.

The following table disaggregates our allowance for credit losses and recorded investment in loans by impairment methodology.



	Allowance for credit losses				Recorded investment in loans
(in thousands)	Commercial		Consumer	Total	Commercial	Consumer	Total
June 30, 2019
Collectively evaluated (1)	$	23,606	31,034	54,640	2,756,721	30,267,257	33,023,978
Individually evaluated (2)	440		34,138	34,578	2,179	319,668	321,847
Purchased credit-impaired (PCI) (3)	—		—	—	—	6,969	6,969
Total	$	24,046	65,172	89,218	2,758,900	30,593,894	33,352,794
December 31, 2018
Collectively evaluated (1)	$	25,839	34,581	60,420	3,053,465	32,071,367	35,124,832
Individually evaluated (2)	442		37,406	37,848	1,958	361,122	363,080
PCI (3)	—		—	—	—	7,156	7,156
Total	$	26,281	71,987	98,268	3,055,423	32,439,645	35,495,068


(1)	Represents loans collectively evaluated for impairment in accordance with Accounting Standards Codification (ASC) 450-20, Loss Contingencies, and pursuant to amendments by ASU 2010-20 regarding allowance for non-impaired loans.


(2)	Represents loans individually evaluated for impairment in accordance with ASC 310-10, Receivables, and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.


(3)	Represents the allowance and related loan carrying value determined in accordance with ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality and pursuant to amendments by ASU 2010-20 regarding allowance for PCI loans.

Credit Quality

We monitor credit quality by evaluating various attributes and utilize such information in our evaluation of the appropriateness of the allowance for credit losses. The following sections provide the credit quality indicators we most closely monitor. The credit quality indicators are generally based on information as of our financial statement date, with the exception of updated Fair Isaac Corporation (FICO) scores and updated loan-to-value (LTV)/combined LTV (CLTV). We obtain FICO scores at loan origination and the scores are generally updated at least quarterly, except in limited circumstances, including compliance with the Fair Credit Reporting Act (FCRA). Generally, the LTV and CLTV indicators are updated in the second month of each quarter, with updates no older than March 31, 2019.

COMMERCIAL CREDIT QUALITY INDICATORS In addition to monitoring commercial loan concentration risk, we manage a consistent process for assessing commercial loan credit quality. Generally commercial loans are subject to individual risk assessment using our internal borrower and collateral quality ratings. Our ratings are aligned to Pass and Criticized categories. The Criticized category includes Special Mention, Substandard, and Doubtful categories which are defined by bank regulatory agencies.

The table below provides a breakdown of outstanding commercial loans by risk category.



(in thousands)	Total
June 30, 2019
By risk category:
Pass	$	2,735,756
Criticized	23,144
Total commercial loans	$	2,758,900
December 31, 2018
By risk category:
Pass	$	3,016,328
Criticized	39,095
Total commercial loans	$	3,055,423

The following table provides past due information for commercial loans, which we monitor as part of our credit risk management practices.



(in thousands)	Total
June 30, 2019
By delinquency status:
Current-29 days past due (DPD) and still accruing	$	2,746,323
30-89 DPD and still accruing	10,431
90+ DPD and still accruing	—
Nonaccrual loans	2,146
Total commercial loans	$	2,758,900
December 31, 2018
By delinquency status:
Current-29 DPD and still accruing	$	3,044,878
30-89 DPD and still accruing	8,570
90+ DPD and still accruing	—
Nonaccrual loans	1,975
Total commercial loans	$	3,055,423

CONSUMER CREDIT QUALITY INDICATORS We have various classes of consumer loans that present unique risks. Loan delinquency, FICO credit scores and LTV/CLTV for loan types are common credit quality indicators that we monitor and utilize in our evaluation of the appropriateness of the allowance for credit losses for the consumer portfolio segment.

Many of our loss estimation techniques used for the allowance for credit losses rely on delinquency-based models; therefore, delinquency is an important indicator of credit quality and the establishment of our allowance for credit losses. The following table provides the outstanding balances of our consumer portfolio by delinquency status.



(in thousands)	Real estate 1-4 family first mortgage			Real estate 1-4 family junior lien mortgage		Total
June 30, 2019
By delinquency status:
Current-29 DPD	$	29,871,150		573,458		30,444,608
30-59 DPD	53,488			10,046		63,534
60-89 DPD	18,470			5,274		23,744
90-119 DPD	10,205			2,028		12,233
120-179 DPD	9,521			1,857		11,378
180+ DPD	39,020			5,647		44,667
Remaining PCI accounting adjustments	(3,913		)	(2,357	)	(6,270	)
Total consumer loans	$	29,997,941		595,953		30,593,894
December 31, 2018
By delinquency status:
Current-29 DPD	$	31,627,108		642,271		32,269,379
30-59 DPD	60,060			11,230		71,290
60-89 DPD	15,032			6,934		21,966
90-119 DPD	11,435			1,889		13,324
120-179 DPD	12,846			2,055		14,901
180+ DPD	47,935			8,127		56,062
Remaining PCI accounting adjustments	(4,603		)	(2,674	)	(7,277	)
Total consumer loans	$	31,769,813		669,832		32,439,645

The following table provides a breakdown of our consumer portfolio by FICO. FICO is not available for certain loan types and may not be obtained if we deem it unnecessary due to strong collateral and other borrower attributes.



(in thousands)	Real estate 1-4 family first mortgage			Real estate 1-4 family junior lien mortgage		Total
June 30, 2019
By FICO:
< 600	$	138,611		44,340		182,951
600-639	99,755			32,970		132,725
640-679	240,320			57,374		297,694
680-719	772,079			102,485		874,564
720-759	2,102,674			115,097		2,217,771
760-799	5,358,323			87,675		5,445,998
800+	21,134,384			136,024		21,270,408
No FICO available	155,708			22,345		178,053
Remaining PCI accounting adjustments	(3,913		)	(2,357	)	(6,270	)
Total consumer loans	$	29,997,941		595,953		30,593,894
December 31, 2018
By FICO:
< 600	$	154,020		54,681		208,701
600-639	109,783			39,374		149,157
640-679	264,931			67,341		332,272
680-719	883,451			114,961		998,412
720-759	2,346,168			122,706		2,468,874
760-799	5,753,691			100,921		5,854,612
800+	22,092,691			149,147		22,241,838
No FICO available	169,681			23,375		193,056
Remaining PCI accounting adjustments	(4,603		)	(2,674	)	(7,277	)
Total consumer loans	$	31,769,813		669,832		32,439,645

LTV refers to the ratio comparing the loan’s unpaid principal balance to the property’s collateral value. CLTV refers to the combination of first mortgage and junior lien mortgage ratios. LTVs and CLTVs are updated quarterly using a cascade approach which first uses values provided by automated valuation models (AVMs) for the property. If an AVM is not available, then the value is estimated using the original appraised value adjusted by the change in Home Price Index (HPI) for the property location. If an HPI is not available, the original appraised value is used. The HPI value is normally the only method considered for high value properties, generally with an original value of $1 million or more, as the AVM values have proven less accurate for these properties.

The following table shows the most updated LTV and CLTV distribution of the real estate 1-4 family first and junior lien mortgage loan portfolios. We consider the trends in residential real estate markets as we monitor credit risk and establish our allowance for credit losses. In the event of a default, any loss should be limited to the portion of the loan amount in excess of the net realizable value of the underlying real estate collateral value. Certain loans do not have an LTV or CLTV due to industry data availability and portfolios acquired from or serviced by other institutions.



(in thousands)	Real estate 1-4 family first mortgage by LTV			Real estate 1-4 family junior lien mortgage by CLTV		Total
June 30, 2019
By LTV/CLTV:
0-60%	$	18,918,843		251,809		19,170,652
60.01-80%	10,170,256			175,898		10,346,154
80.01-100%	790,543			112,177		902,720
100.01-120% (1)	75,982			41,944		117,926
> 120% (1)	34,984			15,314		50,298
No LTV/CLTV available	11,246			1,168		12,414
Remaining PCI accounting adjustments	(3,913		)	(2,357	)	(6,270	)
Total consumer loans	$	29,997,941		595,953		30,593,894
December 31, 2018
By LTV/CLTV:
0-60%	$	19,522,839		272,946		19,795,785
60.01-80%	11,273,694			196,614		11,470,308
80.01-100%	837,192			135,556		972,748
100.01-120% (1)	83,515			49,441		132,956
> 120% (1)	43,004			17,196		60,200
No LTV/CLTV available	14,172			753		14,925
Remaining PCI accounting adjustments	(4,603		)	(2,674	)	(7,277	)
Total consumer loans	$	31,769,813		669,832		32,439,645


(1)	Reflects total loan balances with LTV/CLTV amounts in excess of 100%. In the event of default, the loss content would generally be limited to only the amount in excess of 100% LTV/CLTV.

NONACCRUAL LOANS The following table provides loans on nonaccrual status. PCI loans are excluded from this table due to the existence of the accretable yield, independent of performance in accordance with their contractual terms.



(in thousands)	Jun 30, 2019		Dec 31, 2018
Total commercial	$	2,146	1,975
Consumer:
Real estate 1-4 family first mortgage	125,666		142,325
Real estate 1-4 family junior lien mortgage	31,023		34,625
Total consumer	156,689		176,950
Total nonaccrual loans (excluding PCI)	$	158,835	178,925

LOANS IN PROCESS OF FORECLOSURE Our recorded investment in consumer mortgage loans collateralized by residential real estate property that are in process of foreclosure was $39.7 million and $46.4 million at June 30, 2019 and December 31, 2018, and none of these loans are government insured/guaranteed. We commence the foreclosure process on consumer real estate loans when a borrower becomes 120 days delinquent in accordance with the Bureau of Consumer Financial Protection (formerly known as the Consumer Finance Protection Bureau) Guidelines. Foreclosure procedures and timelines vary depending on whether the property address resides in a judicial or non-judicial state. Judicial states require the foreclosure to be processed through the state’s courts while non-judicial states are processed without court intervention. Foreclosure timelines vary according to state law.

LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Certain loans 90 days or more past due as to interest or principal are still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family mortgage loans exempt under regulatory rules from being classified as nonaccrual until later delinquency, usually 120 days past due. PCI loans of $496 thousand at June 30, 2019, and $373 thousand at December 31, 2018, are excluded from this disclosure even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.

The following table shows non-PCI loans 90 days or more past due and still accruing.



(in thousands)	Jun 30, 2019		Dec 31, 2018
Total commercial	$	—	—
Consumer:
Real estate 1-4 family first mortgage	2,547		5,819
Real estate 1-4 family junior lien mortgage	913		708
Total consumer	3,460		6,527
Total past due (excluding PCI)	$	3,460	6,527

Impaired Loans The table below summarizes key information for impaired loans. Our impaired loans predominantly include loans on nonaccrual status in the commercial portfolio segment and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans generally have estimated losses which are included in the allowance for credit losses. We have impaired loans with no allowance for credit losses when loss content has been previously recognized through charge-offs and

we do not anticipate additional charge-offs or losses, or certain loans are currently performing in accordance with their terms and for which no loss has been estimated. Impaired loans exclude PCI loans. The table below includes trial modifications that totaled $4.7 million at June 30, 2019 and $5.3 million at December 31, 2018.



			Recorded investment
(in thousands)	Unpaid principal balance		Impaired loans	Impaired loans with related allowance for credit losses	Related allowance for credit losses
June 30, 2019
Total commercial	$	2,810	2,179	1,949	440
Consumer:
Real estate 1-4 family first mortgage (1)	271,172		246,178	130,057	20,999
Real estate 1-4 family junior lien mortgage	82,128		73,490	52,938	13,139
Total consumer	353,300		319,668	182,995	34,138
Total impaired loans (excluding PCI)	$	356,110	321,847	184,944	34,578
December 31, 2018
Total commercial	$	2,369	1,958	1,958	442
Consumer:
Real estate 1-4 family first mortgage	336,694		282,330	153,353	23,995
Real estate 1-4 family junior lien mortgage	87,941		78,792	59,509	13,411
Total consumer	424,635		361,122	212,862	37,406
Total impaired loans (excluding PCI)	$	427,004	363,080	214,820	37,848


(1)	Impaired loans includes reduction for loans sold to the Bank.

The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans by portfolio segment and class.



	Quarter ended June 30,						Six months ended June 30,
	2019				2018		2019		2018
(in thousands)	Average recorded investment		Recognized interest income		Average recorded investment	Recognized interest income	Average recorded investment	Recognized interest income	Average recorded investment	Recognized interest income
Total commercial	$	2,181	13		3,146	15	2,182	28	3,068	27
Consumer:
Real estate 1-4 family first mortgage	266,327		3,682		303,572	4,794	274,883	8,218	308,252	9,754
Real estate 1-4 family junior lien mortgage	75,272		1,550		85,516	1,736	76,686	3,206	87,480	3,684
Total consumer	341,599		5,232		389,088	6,530	351,569	11,424	395,732	13,438
Total impaired loans	$	343,780	5,245		392,234	6,545	353,751	11,452	398,800	13,465
Interest income:
Cash basis of accounting			$	1,606		2,010		3,603		3,907
Other (1)			3,639			4,535		7,849		9,558
Total interest income			$	5,245		6,545		11,452		13,465


(1)	Includes interest recognized on accruing TDRs, interest recognized related to certain impaired loans which have an allowance calculated using discounting, and amortization of purchase accounting adjustments related to certain impaired loans.

Troubled Debt Restructuring (TDRs) When, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession for other than an insignificant period of time to a borrower that we would not otherwise consider, the related loan is classified as a TDR, the balance of which totaled $321.8 million and $363.1 million at June 30, 2019 and December 31, 2018, respectively. We do not consider loan resolutions, such as foreclosure or short sale, to be a TDR.

We may require some consumer borrowers experiencing financial difficulty to make trial payments generally for a period of three to four months, according to the terms of a planned permanent modification, to determine if they can perform according to those terms. These arrangements represent trial modifications, which we classify and account for as TDRs. While loans are in trial payment programs, their original terms are not considered modified and they continue to advance through delinquency status and accrue interest according to their original terms.

The following table summarizes our TDR modifications for the periods presented by primary modification type and includes the financial effects of these modifications. For those loans that modify more than once, the table reflects each modification that occurred during the period. Loans that both modify and pay off within the period, as well as changes in recorded investment during the period for loans modified in prior periods, are not included in the table.




	Primary modification type (1)					Financial effects of modifications
(in thousands)	Principal (2)		Interest rate reduction	Other concessions (3)	Total	Charge- offs (4)	Weighted average interest rate reduction		Recorded investment related to interest rate reduction (5)
Quarter ended June 30, 2019
Total commercial	$	—	—	94	94	—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	1,071		8	2,593	3,672	26	1.72		608
Real estate 1-4 family junior lien mortgage	195		140	670	1,005	—	5.32		316
Trial modifications (6)	—		—	367	367	—	—		—
Total consumer	1,266		148	3,630	5,044	26	2.95		924
Total	$	1,266	148	3,724	5,138	26	2.95	%	$	924
Quarter ended June 30, 2018
Total commercial	$	—	—	—	—	—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	1,359		172	5,527	7,058	80	2.65		1,387
Real estate 1-4 family junior lien mortgage	—		255	1,718	1,973	1	2.78		255
Trial modifications (6)	—		—	597	597	—	—		—
Total consumer	1,359		427	7,842	9,628	81	2.67		1,642
Total	$	1,359	427	7,842	9,628	81	2.67	%	$	1,642



	Primary modification type (1)							Financial effects of modifications
(in thousands)	Principal (2)		Interest rate reduction	Other concessions (3)		Total		Charge- offs (4)	Weighted average interest rate reduction		Recorded investment related to interest rate reduction (5)
Six months ended June 30, 2019
Total commercial	$	—	—	94		94		—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	3,041		8	17,371		20,420		51	1.86		1,452
Real estate 1-4 family junior lien mortgage	600		188	3,384		4,172		45	3.56		726
Trial modifications (6)	—		—	(102	)	(102	)	—	—		—
Total consumer	3,641		196	20,653		24,490		96	2.42		2,178
Total	$	3,641	196	20,747		24,584		96	2.42	%	$	2,178
Six months ended June 30, 2018
Total commercial	$	—	—	2,067		2,067		—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	3,408		172	11,129		14,709		156	2.42		2,487
Real estate 1-4 family junior lien mortgage	44		337	3,695		4,076		12	2.66		337
Trial modifications (6)	—		—	(992	)	(992	)	—	—		—
Total consumer	3,452		509	13,832		17,793		168	2.45		2,824
Total	$	3,452	509	15,899		19,860		168	2.45	%	$	2,824

(1)

Amounts represent the recorded investment in loans after recognizing the effects of the TDR, if any. TDRs may have multiple types of concessions, but are presented only once in the first modification type based on the order presented in the table above. The reported amounts include loans remodified of $1.6 million and $2.6 million for the quarters ended June 30, 2019 and 2018, and $5.4 million and $6.8 million for the first half of 2019 and 2018, respectively.


(2)	Principal modifications include principal forgiveness at the time of the modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with a zero percent contractual interest rate.


(3)	Other concessions include loans discharged in bankruptcy, loan renewals, term extensions and other interest and noninterest adjustments, but exclude modifications that also forgive principal and/or reduce the interest rate.

(4)

Charge-offs include write-downs of the investment in the loan in the period it is contractually modified. The amount of charge-off will differ from the modification terms if the loan has been charged down prior to the modification based on our policies. In addition, there may be cases where we have a charge-off/down with no legal principal modification. Modifications resulted in legally forgiving principal (actual, contingent or deferred) of $194 thousand and $206 thousand for the quarters ended June 30, 2019 and 2018, and $391 thousand and $318 thousand for the first half of 2019 and 2018, respectively.


(5)	Reflects the effect of reduced interest rates on loans with an interest rate concession as one of their concession types, which includes loans reported as a principal primary modification type that also have an interest rate concession.

(6)

Trial modifications are granted a delay in payments due under the original terms during the trial payment period. However, these loans continue to advance through delinquency status and accrue interest according to their original terms. Any subsequent permanent modification generally includes interest rate related concessions; however, the exact concession type and resulting financial effect are usually not known until the loan is permanently modified. Trial modifications for the period are presented net of previously reported trial modifications that became permanent in the current period.

The table below summarizes permanent modification TDRs that have defaulted in the current period within 12 months of their permanent modification date. We report these defaulted

TDRs based on a payment default definition of 90 days past due for the commercial portfolio segment and 60 days past due for the consumer portfolio segment.



	Recorded investment of defaults
	Quarter ended June 30,			Six months ended June 30,
(in thousands)	2019		2018	2019	2018
Total commercial	$	—	1,855	—	1,855
Consumer:
Real estate 1-4 family first mortgage	1,596		387	1,946	1,117
Real estate 1-4 family junior lien mortgage	31		170	106	225
Total consumer	1,627		557	2,052	1,342
Total	$	1,627	2,412	2,052	3,197

Note 3: Fair Values of Assets and Liabilities

We use fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. We did not elect the fair value option for any financial instruments as permitted in FASB ASC 825, Financial Instruments, which allows companies to elect to carry certain financial instruments at fair value with corresponding changes in fair value reported in the results of operations. As of June 30, 2019 and December 31, 2018, assets measured at fair value on a nonrecurring basis were less than 1% of total assets. See Note 1 (Summary of Significant Accounting Policies) in our 2018 Form 10-K for additional information about our fair value measurement policies and methods.

Disclosures about Fair Value of Financial Instruments The table below is a summary of fair value estimates by level for financial instruments. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions.

We have not included assets and liabilities that are not financial instruments in our disclosure, such as other assets and other liabilities. The total of the fair value calculations presented does not represent, and should not be construed to represent, the underlying value of the Company.




	Carrying amount		Estimated fair value
(in thousands)	Carrying amount		Level 1	Level 2	Level 3	Total
June 30, 2019
Financial assets
Cash and cash equivalents (1)	$	—	—	—	—	—
Loans, net (2)	33,264,909		—	—	33,796,894	33,796,894

Financial liabilities
Line of credit with Bank (1)	927,697		—	—	927,697	927,697
December 31, 2018
Financial assets
Cash and cash equivalents (1)	$	—	—	—	—	—
Loans, net (2)	35,398,325		—	—	34,703,481	34,703,481

Financial liabilities
Line of credit with Bank (1)	3,054,738		—	—	3,054,738	3,054,738


(1)	Amounts consist of financial instruments in which carrying value approximates fair value.


(2)	Carrying amount is net of allowance for loan losses.

Note 4: Common and Preferred Stock

The following table provides details of our authorized common and preferred stock.



				June 30, 2019 and December 31, 2018
	Liquidation preference per share		Shares authorized	Shares issued and outstanding	Par value per share		Carrying value
Preferred stock:
Series A
6.375%, Cumulative, Perpetual Series A Preferred Stock	$	25	11,000,000	11,000,000	$	0.01	110,000
Series B
$85 Annual Dividend Per Share, Cumulative, Perpetual Series B Preferred Stock	1,000		1,000	667	0.01		7
Common stock			100,000,000	34,058,028	0.01		340,580
Total			111,001,000	45,058,695			$	450,587

In the event that the Company is liquidated or dissolved, the holders of the Series A and Series B preferred stock will be entitled to a liquidation preference for each security plus any authorized, declared and unpaid dividends that will be paid prior to any payments to common stockholders. With respect to the payment of dividends and liquidation preference, the Series A preferred stock ranks on parity with Series B preferred stock and senior to the Company’s common stock. The Company may issue additional shares of common stock to affiliates of Wells Fargo without further action by the Series A or Series B stockholders. Additional information related to Series A and B preferred stock, including the ability of the Company to redeem each series, is included in Note 5 (Common and Preferred Stock) to Financial Statements in our 2018 Form 10-K.

The certificate of designation for the Series A preferred stock limits our ability to pay dividends on our common stock or make any payment of interest or principal on our line of credit with the Bank if the dividend coverage ratio for the four prior fiscal quarters is less than 150%. The dividend coverage ratio, expressed as a percentage, is calculated by dividing the four prior fiscal quarters’ funds from operations, defined as GAAP net income excluding gains or losses from sales of property, by the amount that would be required to pay annual dividends on the Series A and Series B preferred stock. At June 30, 2019, the dividend coverage ratio was 7,105%.

Note 5: Transactions With Related Parties

The Company engages in various transactions and agreements with affiliated parties in the ordinary course of business. Due to the common ownership of the Company and the affiliated parties by Wells Fargo, these transactions and agreements may reflect circumstances and considerations that could differ from

those conducted with unaffiliated parties. The principal items related to transactions with affiliated parties included in the accompanying statement of income and balance sheet are described in the table and narrative below.



	Quarter ended June 30,				Six months ended June 30,
(in thousands)	2019		2018		2019	2018
Income statement data
Interest income:
Net accretion of adjustments on loans	$	5,933	5,041		12,755	9,319
Total interest income	5,933		5,041		12,755	9,319
Pledge fees	1,378		—		2,789	6,037
Gain (loss) on sale of loans	25,947		(33	)	26,076	(1	)
Interest expense	12,985		11,860		31,372	26,262
Loan servicing costs	21,073		21,360		42,618	43,282
Management fees	12,283		11,750		22,982	18,010



(in thousands)	Jun 30, 2019			Dec 31, 2018
Balance sheet related data
Cash and cash equivalents	$	—		—
Loan acquisitions (year-to-date)	—			3,747,820
Loan sales (book value) (year-to-date)	(74,785		)	(27,119	)
Pledged loans (carrying value) (1)	3,073,581			3,226,825
Foreclosed asset sales (year-to-date)	(4,925		)	(12,901	)
Line of credit with Bank	927,697			3,054,738
Accounts receivable - affiliates, net	20,353			—
Accounts payable - affiliates, net	—			13,798


(1)	The fair value of pledged loans was approximately $3.2 billion at both June 30, 2019 and December 31, 2018, respectively.

Loans We acquire and sell loans to and from the Bank. The acquisitions and sales are transacted at fair value resulting in acquisition discounts and premiums or gains and losses on sales. The net acquisition discount accretion or premium amortization is reported within interest income. Gains or losses on sales of loans are included within noninterest income.

The certificate of designation for the Series A preferred stock limits our ability to pledge loans to an aggregate amount not exceeding 80% of our total assets at any time as collateral on behalf of the Bank for the Bank’s access to secured borrowing facilities through the Federal Home Loan Banks or the discount window of Federal Reserve Banks. However, the Bank's borrowings will differ from loan balances pledged. In exchange for the pledge of our loan assets, the Bank pays us a fee that is consistent with market terms. At June 30, 2019 and June 30, 2018, the fee was equal to an annual rate of 17 basis points (0.17%) and 15 basis points (0.15%), respectively, as applied to the unpaid principal balance of pledged loans on a monthly basis. Such fee may be renegotiated by us and the Bank from time to time.

Loan Servicing Costs The loans in our portfolio are predominantly serviced by the Bank pursuant to the terms of participation and servicing and assignment agreements. In some instances, the Bank has delegated servicing responsibility to third parties that are not affiliated with us or the Bank. Depending on the loan type, the monthly servicing fee charges

are based in part on (a) outstanding principal balances, (b) a flat fee per month, or (c) a total loan commitment amount.

Management Fees We pay the Bank a management fee to reimburse for general overhead expenses, including allocations of technology support and a combination of finance and accounting, risk management and other general overhead expenses incurred on our behalf. Management fees include direct and indirect expense allocations. Indirect expenses are allocated based on ratios that use our proportion of expense activity drivers. The expense activity drivers and ratios may change from time to time. The increase in first half of 2019 was driven by an increase in allocations for portfolio credit monitoring and oversight.

Deposits Interest income earned on deposits is included in interest income. Our cash management process includes applying operating cash flows to reduce any outstanding balance on our line of credit with the Bank. Operating cash flows are settled through our affiliate accounts receivable/payable process. Upon settlement cash received is either applied to reduce our line of credit outstanding or retained as a deposit with the Bank.

Foreclosed Assets We sell foreclosed assets back to the Bank from time to time at estimated fair value.

Line of Credit We have a revolving line of credit with the Bank, pursuant to which we can borrow up to $5.0 billion. Effective March 2019, the Company renewed the line of credit with the Bank and the interest rate increased from three-month LIBOR plus 4.4 basis points (0.044%) to three-month LIBOR plus 65.0 basis points (0.650%). The change in interest rate was driven by an increase in term, along with a change in underwriting which aligned our credit rating with that of our direct parent rather than the Bank.

Accounts Payable and Receivable – Affiliates, Net Accounts payable and receivable from the Bank or its affiliates result from intercompany transactions which include net loan paydowns, interest receipts, and other transactions, including those transactions noted herein, which have not yet settled.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

WFREIC is not currently involved in nor, to our knowledge, currently threatened with any material litigation. From time to time we may become involved in routine litigation arising in the ordinary course of business. We do not believe that the eventual outcome of any such routine litigation will, in the aggregate, have a material adverse effect on our financial statements. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, could be material to our financial statements for any particular period.

Item 1A. Risk Factors

Information in response to this item can be found under the “Risk Factors” section in this Report which information is incorporated by reference into this item.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Information required by this Item 2 pursuant to Item 703 of Regulation S-K regarding issuer repurchases of equity securities is not applicable since we do not have a program providing for the repurchase of our securities.

Item 6. Exhibits

A list of exhibits to this Form 10-Q is set forth below and is incorporated herein by reference.



Exhibit No.	Description	Location

(3)(a)	Amended and Restated Certificate of Incorporation.	Incorporated by reference to Exhibit (3)(a) to WFREIC’s Annual Report on Form 10-K for the year ended December 31, 2014.

(3)(b)	Bylaws.	Incorporated by reference to Exhibit 3.3 to WFREIC’s Registration Statement on Form S-11 No. 333-198948 filed November 18, 2014.

(31)(a)	Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(31)(b)	Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(32)(a)	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(32)(b)	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(101.Ins)	Inline XBRL Instance Document	The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.

(101.Sch)	Inline XBRL Taxonomy Extension Schema Document	Filed herewith.

(101.Cal)	Inline XBRL Taxonomy Extension Calculation Linkbase Document	Filed herewith.

(101.Lab)	Inline XBRL Taxonomy Extension Label Linkbase Document	Filed herewith.

(101.Pre)	Inline XBRL Taxonomy Extension Presentation Linkbase Document	Filed herewith.

(101.Def)	Inline XBRL Taxonomy Extension Definitions Linkbase Document	Filed herewith.

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



Wells Fargo Real Estate Investment Corporation

By:		/s/ RICHARD D. LEVY
		Richard D. Levy Executive Vice President and Controller (Principal Accounting Officer)

Dated: August 5, 2019