10-Q 1 d389180d10q.htm QUARTERLY REPORT ON FORM 10-Q Quarterly Report on Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

Commission file number 001-2979

WELLS FARGO & COMPANY

(Exact name of registrant as specified in its charter)

 

Delaware   No. 41-0449260
(State of incorporation)   (I.R.S. Employer Identification No.)

420 Montgomery Street, San Francisco, California 94163

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: 1-866-249-3302

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).

Yes þ            No ¨

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

 

Large accelerated filer   þ    Accelerated filer ¨  
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company ¨  

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.

 

    

Shares Outstanding

July 31, 2012

    
Common stock, $1-2/3 par value    5,282,185,586   


Table of Contents

FORM 10-Q

CROSS-REFERENCE INDEX

 

PART I

 

Financial Information

  

Item 1.

 

Financial Statements

     Page   
 

Consolidated Statement of Income

     53   
 

Consolidated Statement of Comprehensive Income

     54   
 

Consolidated Balance Sheet

     55   
 

Consolidated Statement of Changes in Equity

     56   
 

Consolidated Statement of Cash Flows

     58   
 

Notes to Financial Statements

  
 

  1  -  Summary of Significant Accounting Policies

     59   
 

  2  -  Business Combinations

     61   
 

  3  -   Federal Funds Sold, Securities Purchased under Resale Agreements and Other Short-Term Investments

     61   
 

  4  -  Securities Available for Sale

     62   
 

  5  -  Loans and Allowance for Credit Losses

     70   
 

  6  -  Other Assets

     91   
 

  7  -  Securitizations and Variable Interest Entities

     92   
 

  8  -  Mortgage Banking Activities

     103   
 

  9  -  Intangible Assets

     106   
 

10  -  Guarantees, Pledged Assets and Collateral

     107   
 

11  -  Legal Actions

     109   
 

12  -  Derivatives

     110   
 

13  -  Fair Values of Assets and Liabilities

     117   
 

14  -  Preferred Stock

     142   
 

15  -  Employee Benefits

     144   
 

16  -  Earnings Per Common Share

     145   
 

17  -  Other Comprehensive Income

     146   
 

18  -  Operating Segments

     148   
 

19  -  Condensed Consolidating Financial Statements

     150   
 

20  -  Regulatory and Agency Capital Requirements

     155   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Financial Review)

  
 

Summary Financial Data

     2   
 

Overview

     3   
 

Earnings Performance

     5   
 

Balance Sheet Analysis

     13   
 

Off-Balance Sheet Arrangements

     16   
 

Risk Management

     17   
 

Capital Management

     46   
 

Regulatory Reform

     49   
 

Critical Accounting Policies

     49   
 

Current Accounting Developments

     50   
 

Forward-Looking Statements

     50   
 

Risk Factors

     51   
 

Glossary of Acronyms

     156   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     42   

Item 4.

 

Controls and Procedures

     52   

PART II

 

Other Information

  

Item 1.

 

Legal Proceedings

     157   

Item 1A.

 

Risk Factors

     157   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     157   

Item 6.

 

Exhibits

     158   

Signature

       158   

Exhibit Index

       159   

 

 

 

1


Table of Contents

PART I - FINANCIAL INFORMATION

FINANCIAL REVIEW

Summary Financial Data

 

 

     Quarter ended      % Change
June 30, 2012 from
    Six months ended         
($ in millions, except per share amounts)   

June 30,

2012

   

March 31,

2012

    

June 30,

2011

    

March 31,

2012

   

June 30,

2011

   

June 30,

2012

     June 30,
2011
    

%

Change

 

 

 

For the Period

                    

Wells Fargo net income

   $             4,622        4,248         3,948         9  %      17        8,870         7,707         15  % 

Wells Fargo net income applicable to common stock

     4,403        4,022         3,728         9        18        8,425         7,298         15   

Diluted earnings per common share

     0.82        0.75         0.70         9        17        1.57         1.37         15   

Profitability ratios (annualized):

                    

Wells Fargo net income to average assets (ROA)

     1.41  %      1.31         1.27         8        11        1.36         1.25         9   

Wells Fargo net income applicable to common stock to average Wells Fargo common stockholders’ equity (ROE)

     12.86        12.14         11.92         6        8        12.51         11.95         5   

Efficiency ratio (1)

     58.2        60.1         61.2         (3     (5     59.1         61.9         (5

Total revenue

   $ 21,289        21,636         20,386         (2     4        42,925         40,715         5   

Pre-tax pre-provision profit (PTPP) (2)

     8,892        8,643         7,911         3        12        17,535         15,507         13   

Dividends declared per common share

     0.22        0.22         0.12         -        83        0.44         0.24         83   

Average common shares outstanding

     5,306.9        5,282.6         5,286.5         -        -        5,294.9         5,282.7         -   

Diluted average common shares outstanding

     5,369.9        5,337.8         5,331.7         1        1        5,354.3         5,329.9         -   

Average loans

   $ 768,223        768,582         751,253         -        2        768,403         752,657         2   

Average assets

     1,321,584        1,302,921         1,250,945         1        6        1,312,252         1,246,088         5   

Average core deposits (3)

     880,636        870,516         807,483         1        9        875,576         802,184         9   

Average retail core deposits (4)

     624,329        616,569         592,974         1        5        620,445         588,561         5   

Net interest margin

     3.91  %      3.91         4.01         -        (2     3.91         4.03         (3

At Period End

                    

Securities available for sale

   $ 226,846        230,266         186,298         (1     22        226,846         186,298         22   

Loans

     775,199        766,521         751,921         1        3        775,199         751,921         3   

Allowance for loan losses

     18,320        18,852         20,893         (3     (12     18,320         20,893         (12

Goodwill

     25,406        25,140         24,776         1        3        25,406         24,776         3   

Assets

     1,336,204        1,333,799         1,259,734         -        6        1,336,204         1,259,734         6   

Core deposits (3)

     882,137        888,711         808,970         (1     9        882,137         808,970         9   

Wells Fargo stockholders’ equity

     148,070        145,516         136,401         2        9        148,070         136,401         9   

Total equity

     149,437        146,849         137,916         2        8        149,437         137,916         8   

Tier 1 capital (5)

     117,856        117,444         113,466         -        4        117,856         113,466         4   

Total capital (5)

     149,813        150,788         149,538         (1     -        149,813         149,538         -   

Capital ratios:

                    

Total equity to assets

     11.18  %      11.01         10.95         2        2        11.18         10.95         2   

Risk-based capital (5):

                    

Tier 1 capital

     11.69        11.78         11.69         (1     -        11.69         11.69         -   

Total capital

     14.85        15.13         15.41         (2     (4     14.85         15.41         (4

Tier 1 leverage (5)

     9.25        9.35         9.43         (1     (2     9.25         9.43         (2

Tier 1 common equity (6)

     10.08        9.98         9.15         1        10        10.08         9.15         10   

Common shares outstanding

     5,275.7        5,301.5         5,278.2         -        -        5,275.7         5,278.2         -   

Book value per common share

   $ 26.06        25.45         23.84         2        9        26.06         23.84         9   

Common stock price:

                    

High

     34.59        34.59         32.63         -        6        34.59         34.25         1   

Low

     29.80        27.94         25.26         7        18        27.94         25.26         11   

Period end

     33.44        34.14         28.06         (2     19        33.44         28.06         19   

Team members (active, full-time equivalent)

     264,400        264,900         266,600         -        (1     264,400         266,600         (1

 

 

 

(1) The efficiency ratio is noninterest expense divided by total revenue (net interest income and noninterest income).
(2) Pre-tax pre-provision profit (PTPP) is total revenue less noninterest expense. Management believes that PTPP is a useful financial measure because it enables investors and others to assess the Company’s ability to generate capital to cover credit losses through a credit cycle.
(3) Core deposits are noninterest-bearing deposits, interest-bearing checking, savings certificates, certain market rate and other savings, and certain foreign deposits (Eurodollar sweep balances).
(4) Retail core deposits are total core deposits excluding Wholesale Banking core deposits and retail mortgage escrow deposits.
(5) See Note 20 (Regulatory and Agency Capital Requirements) to Financial Statements in this Report for additional information.
(6) See the “Capital Management” section in this Report for additional information.

 

2


Table of Contents

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 forward-looking statements due to several factors. Factors that could cause our actual 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” and “Regulation and Supervision” sections of our Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K).

When we refer to “Wells Fargo,” “the Company,” “we,” “our” or “us” in this Report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to the “Parent,” we mean Wells Fargo & Company. When we refer to “legacy Wells Fargo,” we mean Wells Fargo excluding Wachovia Corporation (Wachovia). See the Glossary of Acronyms at the end of this Report for terms used throughout this Report.

Financial Review

Overview

 

 

Wells Fargo & Company is a diversified financial services company with $1.3 trillion in assets. Founded in 1852 and headquartered in San Francisco, we provide banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage services and consumer and commercial finance through more than 9,000 stores, 12,000 ATMs, the internet and other distribution channels to individuals, businesses and institutions across North America and internationally. With approximately 265,000 active, full-time equivalent team members, we serve one in three households in America and ranked No. 26 on Fortune’s 2012 rankings of America’s largest corporations. We ranked fourth in assets and first in the market value of our common stock among all U.S. banks at June 30, 2012.

Our vision is to satisfy all our customers’ financial needs, help them succeed financially, be recognized as the premier financial services company in our markets and be one of America’s great companies. Our primary strategy to achieve this vision is to increase the number of our products our customers utilize and to offer them all of the financial products that fulfill their needs. Our cross-sell strategy, diversified business model and the breadth of our geographic reach facilitate growth in both strong and weak economic cycles, as we can grow by expanding the number of products our current customers have with us, gain new customers in our extended markets, and increase market share in many businesses. Our retail bank household cross-sell increased each quarter during 2011, as well as in first quarter 2012, and in May 2012 we achieved a milestone of 6.00 products per household, up from 5.82 in May 2011. We believe there is more opportunity for cross-sell as we continue to earn more business from our customers. Our goal is eight products per customer, which is approximately half of our estimate of potential demand for an average U.S. household. At May 31, 2012, one of every four of our retail banking households had eight or more products.

Our pursuit of growth and earnings performance is influenced by our belief that it is important to maintain a well controlled operating environment. We manage our credit risk by establishing what we believe are sound credit policies for underwriting new business, while monitoring and reviewing the

performance of our loan portfolio. We manage the interest rate and market risks inherent in our asset and liability balances within established ranges, while ensuring adequate liquidity and funding. We maintain strong capital levels to facilitate future growth.

Expense management is also important to us, but our efforts are not intended to adversely affect revenue. Our current company-wide expense management initiative, which we publicly announced with our second quarter 2011 results, is focused on removing unnecessary complexity and eliminating duplication as a way to improve our customers’ experience and the work process of our team members. Our expenses, however, are driven in part by our revenue opportunities. Given the continued momentum in revenue opportunities in second quarter 2012, including a record number of mortgage applications, and our continued reinvestment in our businesses, we currently expect fourth quarter 2012 noninterest expense to be higher than our previously announced target of $11.25 billion. Reflecting these higher revenue opportunities, we believe our efficiency ratio, which measures our noninterest expense as a percentage of total revenue, is a better measure of our expense management than specific dollar estimates. We have targeted an efficiency ratio of 55 to 59%, and our efficiency ratio of 58.2% in second quarter 2012 was within this target range. For the remainder of 2012, we expect noninterest expense to decline from second quarter 2012 levels and that we will operate within our targeted efficiency ratio range.

Financial Performance

We reported strong financial results in second quarter 2012 driven by a $903 million increase in total revenues and $78 million decrease in noninterest expenses as compared to second quarter 2011. Wells Fargo net income was $4.6 billion and diluted earnings per common share were $0.82 in second quarter 2012, each up 17% from the prior year. Second quarter 2012 was our tenth consecutive quarter of earnings per share growth. Total revenue was $21.3 billion in second quarter 2012, up 4% from the prior year. Credit quality trends continued to show improvement in second quarter 2012, with reductions in net losses, nonperforming assets, nonaccrual loans, and loans 90

 

 

3


Table of Contents

days or more past due and still accruing. Our return on assets of 1.41% was up 14 basis points from the prior year and our return on equity of 12.86% was up 94 basis points.

Our net income growth from second quarter 2011 was primarily driven by higher noninterest income as well as higher net interest income and lower noninterest expenses.

The 4% year-over-year increase in second quarter 2012 revenue predominantly reflects increased mortgage banking net gains on mortgage loan origination/sales activities due to higher margins and the continued low interest rate environment which contributed to higher loan applications. Net gains on mortgage loan originations/sales activities were negatively affected in second quarter 2012 by a provision of $669 million for mortgage loan repurchases losses, compared with a provision of $242 million in second quarter 2011. As a result of increased mortgage loan applications our unclosed mortgage loan pipeline at June 30, 2012, was $102 billion, the second largest in our history.

Noninterest expense of $12.4 billion in second quarter 2012 was down from $12.5 billion in second quarter 2011. Our efficiency ratio of 58.2% in second quarter 2012 improved by 300 basis points from a year ago and was at the lowest level in nine quarters. Second quarter 2012 noninterest expense included $524 million of operating losses, up from $428 million for the prior year, predominantly due to additional litigation accruals.

Our balance sheet continued to strengthen in second quarter 2012 with core loan growth and growth in average core deposits. Our non-strategic/liquidating loan portfolios decreased $5.1 billion during the quarter and, excluding the planned runoff of these loans, our core loan portfolios increased $13.8 billion. Included in our core loan growth was $6.9 billion of commercial loans acquired during the quarter in connection with the acquisition of WestLB’s subscription finance loan portfolio and BNP Paribas’s North American energy lending business. Our securities portfolios decreased $3.4 billion during second quarter 2012 as new investments were more than offset by the call of lower-yielding securities and portfolio run-off. Our average core deposits were up $10.1 billion from first quarter 2012 and up $73.2 billion, or 9%, from a year ago. We have grown deposits while reducing our deposit costs for seven consecutive quarters. Our costs on average deposits in second quarter 2012 were 19 basis points, down 9 basis points from the same quarter a year ago. Our average core deposits were 115% of average loans in second quarter 2012, up from 107% for the second quarter last year.

Credit Quality

Our key credit quality indicators continued to improve during second quarter 2012. Net charge-offs of $2.2 billion were 1.15% (annualized) of average loans, down 37 basis points from 1.52% a year ago, our lowest charge-off rate since 2007. Loans 90 days or more past due and still accruing (excluding government insured/guaranteed loans) decreased to $1.4 billion from $2.0 billion at December 31, 2011. Nonperforming assets decreased by $1.1 billion to $24.9 billion at June 30, 2012, from $26.0 billion at December 31, 2011. The year to date decrease is inclusive of the offsetting impact of our $1.7 billion reclassification of real estate 1-4 family junior lien mortgages to nonaccrual status in

first quarter 2012 in accordance with junior lien mortgage industry guidance issued by bank regulators during that quarter. The improvement in our credit portfolio was due in part to the continued decline in balances in our non-strategic/liquidating loan portfolios, which decreased $5.1 billion during the quarter, and $87.7 billion in total since the beginning of 2009, to $103.1 billion at June 30, 2012.

With the continued credit performance improvement in our loan portfolios, our $1.8 billion provision for credit losses in second quarter 2012 was $38 million less than a year ago. The provision included a release of $400 million from the allowance for credit losses (the amount by which net charge-offs exceeded the provision), compared with a release of $1.0 billion a year ago. Absent significant deterioration in the economy, we expect continued but more modest improvement in credit performance for the remainder of the year, and we continue to expect future allowance releases in 2012.

Capital

Our capital position continued to grow in second quarter 2012, as total equity increased by $2.6 billion from the prior quarter to $149.4 billion and our Tier 1 common equity ratio grew 10 basis points during the quarter to 10.08% of risk-weighted assets under Basel I.

In June 2012, the three federal banking agencies, including the Board of Governors of the Federal Reserve System (FRB), jointly published notices of proposed rulemaking, which would substantially amend the risk-based capital rules for banks. The proposed capital rules are intended to implement in the U.S. the Basel III regulatory capital reforms, comply with changes required by the Dodd-Frank Act, and replace the existing Basel I-based capital requirements. Based on our current interpretation of the proposed Basel III capital rules contained in the notices of proposed rulemaking, we estimate that our Tier 1 common equity ratio was 7.78% at June 30, 2012.

Our other regulatory capital ratios remained strong with a small decrease in the Tier 1 capital ratio to 11.69% and Tier 1 leverage ratio to 9.25% at June 30, 2012, compared with 11.78% and 9.35%, respectively, at March 31, 2012. See the “Capital Management” section in this Report for more information regarding our capital, including Tier 1 common equity.

In second quarter 2012 we repurchased approximately 53 million shares of common stock and entered into a forward repurchase contract to repurchase an estimated 11 million shares expected to settle in third quarter 2012. We also paid quarterly common stock dividends of $0.22 per share, and redeemed $2.7 billion of trust preferred securities with an average coupon of 6.33%.

 

 

4


Table of Contents

Earnings Performance

 

 

Wells Fargo net income for second quarter 2012 was $4.6 billion ($0.82 diluted earnings per common share) compared with $3.9 billion ($0.70 diluted earnings per common share) for second quarter 2011. Net income for the first half of 2012 was $8.9 billion compared with $7.7 billion for the same period a year ago. Our June 30, 2012, quarterly and six month earnings reflected strong execution of our business strategy and growth throughout many of our businesses. The key drivers of our financial performance in second quarter 2012 were continued improved credit quality, strong mortgage banking results, diversified sources of fee income, balanced net interest and fee income, and a diversified loan portfolio.

Revenue, the sum of net interest income and noninterest income, was $21.3 billion in second quarter 2012, compared with $20.4 billion in second quarter 2011. Revenue for the first half of 2012 was $42.9 billion, up 5% from a year ago. The increase in revenue for the second quarter and first half of 2012 was due to growth in noninterest income, predominantly from mortgage banking, as well as modest growth in net interest income. Mortgage banking revenue in second quarter 2012 increased 79% from a year ago with strong originations and margins reflecting some stabilization in the housing market and the low interest rate environment. Mortgage originations were $131 billion in second quarter 2012, more than double what they were a year ago. The unclosed mortgage pipeline at June 30, 2012, was very strong at $102 billion, up 100% from second quarter 2011. In addition to mortgage banking, businesses generating double-digit year-over-year revenue growth for second quarter 2012 included capital markets, commercial banking, commercial real estate, corporate trust, asset backed finance, merchant services, government and institutional banking, global remittance services and business payroll services. Net interest income was $11.0 billion in second quarter 2012, representing 52% of revenue, compared with $10.7 billion (52%) in second quarter 2011. Continued success in generating low-cost deposits enabled us to grow assets by funding loans and securities growth while reducing higher cost long-term debt.

Noninterest income was $10.3 billion in second quarter 2012, representing 48% of revenue, compared with $9.7 billion (48%) in second quarter 2011. Noninterest income was $21.0 billion for the first half of 2012 compared with $19.4 billion for the same period a year ago. The increase in noninterest income for the second quarter and first half of 2012 was driven by increases in net gains on mortgage loan origination/sales activities as well as service charges on deposit accounts.

Noninterest expense was $12.4 billion in second quarter 2012, compared with $12.5 billion in second quarter 2011. Noninterest expense was $25.4 billion for the first half of 2012 compared with $25.2 billion for the same period a year ago. The decrease in noninterest expense in second quarter 2012 from second quarter 2011 was predominantly due to lower merger-related integration expense, offset by higher revenue-based commissions and incentive compensation. Our efficiency ratio was 58.2% in second quarter 2012 compared with 61.2% in second quarter 2011, reflecting our expense management efforts and revenue growth.

Net Interest Income

Net interest income is the interest earned on debt securities, loans (including yield-related loan fees) and other interest-earning assets minus the interest paid for deposits, short-term borrowings and long-term debt. The net interest margin is the average yield on earning assets minus the average interest rate paid for deposits and our other sources of funding. Net interest income and the net interest margin are presented on a taxable-equivalent basis in Table 1 to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% federal statutory tax rate.

Net interest income and the net interest margin are significantly influenced by the mix and overall size of our earning asset portfolio and the cost of funding those assets. In addition, some sources of interest income, such as loan prepayment fees and collection of interest on nonaccrual loans, can vary from period to period. Net interest income on a taxable-equivalent basis was $11.2 billion and $22.3 billion in the second quarter and first half of 2012, compared with $10.9 billion and $21.7 billion for the same periods a year ago. The net interest margin was 3.91% for both the second quarter and first half of 2012, down from 4.01% and 4.03% for the same periods a year ago. The increase in net interest income was largely driven by loan growth, redeployment of short-term investments into available-for-sale securities, disciplined deposit pricing, debt maturities and redemptions of higher yielding trust preferred securities, which offset the impact of higher yielding loan and investment runoff. Continued runoff of higher yielding assets was the primary driver of the decline in net interest margin in second quarter 2012 compared with second quarter 2011. Pressure on our second quarter 2012 net interest margin was in part offset by variable sources of interest income, including resolution of PCI loans. We expect continued pressure on our net interest margin as the balance sheet reprices in the current low interest rate environment.

Average earning assets increased $66.4 billion and $63.1 billion in the second quarter and first half of 2012 from a year ago, as average securities available for sale increased $54.3 billion and $56.6 billion, and average mortgages held for sale increased $18.9 billion and $13.5 billion for the same periods, respectively. In addition, solid commercial loan demand offset the impact of liquidating certain loan portfolios, resulting in $17.0 billion and $15.7 billion higher average loans in the second quarter and first half of 2012 compared with a year ago. These increases in average securities available for sale, mortgages held for sale and average loans were predominantly offset by a $27.3 billion and $27.4 billion decline in average short-term investments from the second quarter and first half of 2011.

Core deposits are an important low-cost source of funding and affect both net interest income and the net interest margin. Core deposits include noninterest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). Average core deposits rose to $880.6 billion in second quarter 2012 ($875.6 billion in the first half of 2012) compared with $807.5 billion in second quarter 2011 ($802.2 billion in the first half of 2011) and funded 115% of average loans in second

 

 

5


Table of Contents

quarter 2012 (114% in the first half of 2012) compared with 107% a year ago (107% for the first half of 2011). Average core deposits increased to 76% and 77% of average earning assets in second quarter and first half of 2012, respectively, compared with 74% for each respective period a year ago. The cost of these deposits has continued to decline due to a sustained low interest rate environment and a shift in our deposit mix from higher cost certificates of deposit to lower yielding checking and savings products. About 93% of our average core deposits are in checking and savings deposits, one of the highest industry percentages.

 

 

6


Table of Contents

Earnings Performance (continued)

 

Table 1: Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis) (1)(2)

 

 

     Quarter ended June 30,  
     2012      2011  
(in millions)   

Average

balance

   

Yields/

rates

   

Interest

income/

expense

    

Average

balance

   

Yields/

rates

   

Interest

income/

expense

 

 

 

Earning assets

             

Federal funds sold, securities purchased under resale agreements and other short-term investments

   $ 71,250         0.47  %    $ 83          98,519         0.32  %    $ 80    

Trading assets

     42,614         3.27        348          38,015         3.71        352    

Securities available for sale (3):

             

Securities of U.S. Treasury and federal agencies

     1,954         1.60                2,058         2.33        12    

Securities of U.S. states and political subdivisions

     34,560         4.39        379          22,536         5.35        302    

Mortgage-backed securities:

             

Federal agencies

     95,031         3.37        800          70,891         4.76        844    

Residential and commercial

     33,870         6.97        591          29,981         8.86        664    

 

     

 

 

    

 

 

     

 

 

 

Total mortgage-backed securities

     128,901         4.32        1,391          100,872         5.98        1,508    

Other debt and equity securities

     48,915         4.39        535          34,580         5.81        502    

 

     

 

 

    

 

 

     

 

 

 

Total securities available for sale

     214,330         4.32        2,313          160,046         5.81        2,324    

Mortgages held for sale (4)

     49,528         3.86        477          30,674         4.73        362    

Loans held for sale (4)

     833         5.48        12          1,356         5.05        17    

Loans:

             

Commercial:

             

Commercial and industrial

     171,776         4.21        1,801          153,630         4.60        1,761    

Real estate mortgage

     105,509         4.60        1,208          101,437         4.16        1,051    

Real estate construction

     17,943         4.96        221          21,987         4.64        254    

Lease financing

     12,890         6.86        221          12,899         7.72        249    

Foreign

     38,917         2.57        249          36,445         2.65        241    

 

     

 

 

    

 

 

     

 

 

 

Total commercial

     347,035         4.28        3,700          326,398         4.37        3,556    

 

     

 

 

    

 

 

     

 

 

 

Consumer:

             

Real estate 1-4 family first mortgage

     230,065         4.62        2,658          224,873         4.97        2,792    

Real estate 1-4 family junior lien mortgage

     82,076         4.30        878          91,934         4.25        975    

Credit card

     22,065         12.70        697          20,954         12.97        679    

Other revolving credit and installment

     86,982         6.09        1,317          87,094         6.32        1,372    

 

     

 

 

    

 

 

     

 

 

 

Total consumer

     421,188         5.29        5,550          424,855         5.48        5,818    

 

     

 

 

    

 

 

     

 

 

 

Total loans (4)

     768,223         4.83        9,250          751,253         5.00        9,374    

Other

     4,486         4.56        51          4,997         4.10        52    

 

     

 

 

    

 

 

     

 

 

 

Total earning assets

   $ 1,151,264         4.37  %    $         12,534                  1,084,860         4.64  %    $ 12,561    

 

     

 

 

    

 

 

     

 

 

 

Funding sources

             

Deposits:

             

Interest-bearing checking

   $ 30,440         0.07  %    $         53,344         0.09  %    $ 12    

Market rate and other savings

     500,327         0.12        152          455,126         0.20        226    

Savings certificates

     60,341         1.34        200          72,100         1.42        256    

Other time deposits

     12,803         1.83        59          12,988         2.03        67    

Deposits in foreign offices

     65,587         0.17        27          57,899         0.23        33    

 

     

 

 

    

 

 

     

 

 

 

Total interest-bearing deposits

     669,498         0.27        443          651,457         0.37        594    

Short-term borrowings

     51,698         0.19        24          53,340         0.18        24    

Long-term debt

     127,660         2.48        789          145,431         2.78        1,009    

Other liabilities

     10,408         2.48        65          10,978         3.03        83    

 

     

 

 

    

 

 

     

 

 

 

Total interest-bearing liabilities

     859,264         0.62        1,321          861,206         0.80        1,710    

Portion of noninterest-bearing funding sources

     292,000         -                223,654         -          

 

     

 

 

    

 

 

     

 

 

 

Total funding sources

   $         1,151,264         0.46        1,321          1,084,860         0.63        1,710    

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Net interest margin and net interest income on a taxable-equivalent basis (5)

       3.91  %    $ 11,213            4.01  %    $         10,851    
    

 

 

      

 

 

 

Noninterest-earning assets

             

Cash and due from banks

   $ 16,200              17,373        

Goodwill

     25,332              24,773        

Other

     128,788              123,939        

 

        

 

 

     

Total noninterest-earning assets

   $ 170,320              166,085        

 

        

 

 

     

Noninterest-bearing funding sources

             

Deposits

   $ 254,442              199,339        

Other liabilities

     58,441              53,169        

Total equity

     149,437              137,231        

Noninterest-bearing funding sources used to fund earning assets

     (292,000)             (223,654)       

 

        

 

 

     

Net noninterest-bearing funding sources

   $ 170,320              166,085        

 

        

 

 

     

Total assets

   $ 1,321,584              1,250,945        

 

        

 

 

     

 

 

 

(1) Our average prime rate was 3.25% for the quarters ended June 30, 2012 and 2011, and 3.25% for the first six months of both 2012 and 2011. The average three-month London Interbank Offered Rate (LIBOR) was 0.47% and 0.26% for the quarters ended June 30, 2012 and 2011, respectively, and 0.49% and 0.29%, respectively, for the first six months of 2012 and 2011.
(2) Yield/rates and amounts include the effects of hedge and risk management activities associated with the respective asset and liability categories.
(3) Yields and rates are based on interest income/expense amounts for the period, annualized based on the accrual basis for the respective accounts. The average balance amounts represent amortized cost for the periods presented.
(4) Nonaccrual loans and related income are included in their respective loan categories.
(5) Includes taxable-equivalent adjustments of $176 million and $173 million for the quarters ended June 30, 2012 and 2011, respectively, and $346 million and $334 million for the first six months of 2012 and 2011, respectively, primarily related to tax-exempt income on certain loans and securities. The federal statutory tax rate utilized was 35% for the periods presented.

 

7


Table of Contents
     Six months ended June 30,  
     2012      2011  
(in millions)    Average
balance
    Yields/
rates
    Interest
income/
expense
     Average
balance
    Yields/
rates
    Interest
income/
expense
 

 

 

Earning assets

             

Federal funds sold, securities purchased under resale agreements and other short-term investments

   $ 63,635         0.49  %    $ 156          90,994         0.34  %    $ 152    

Trading assets

     43,190         3.39        731          37,711         3.76        708    

Securities available for sale (3):

             

Securities of U.S. Treasury and federal agencies

     3,875         1.13        22          1,804         2.56        23    

Securities of U.S. states and political subdivisions

     33,578         4.45        747          21,220         5.39        572    

Mortgage-backed securities:

             

Federal agencies

     93,165         3.43        1,597          70,656         4.74        1,676    

Residential and commercial

     34,201         6.89        1,178          30,104         9.28        1,396    

 

     

 

 

    

 

 

     

 

 

 

Total mortgage-backed securities

     127,366         4.36        2,775          100,760         6.10        3,072    

Other debt and equity securities

     49,658         4.10        1,015          34,093         5.68        967    

 

     

 

 

    

 

 

     

 

 

 

Total securities available for sale

     214,477         4.26        4,559          157,877         5.87        4,634    

Mortgages held for sale (4)

     48,218         3.88        936          34,686         4.61        799    

Loans held for sale (4)

     790         5.29        21          1,167         4.98        29    

Loans:

             

Commercial:

             

Commercial and industrial

     169,279         4.20        3,534          151,849         4.62        3,484    

Real estate mortgage

     105,750         4.33        2,280          100,621         4.04        2,018    

Real estate construction

     18,337         4.87        444          23,128         4.44        509    

Lease financing

     13,009         7.89        513          12,959         7.78        504    

Foreign

     40,042         2.54        507          35,050         2.73        476    

 

     

 

 

    

 

 

     

 

 

 

Total commercial

     346,417         4.22        7,278          323,607         4.35        6,991    

 

     

 

 

    

 

 

     

 

 

 

Consumer:

             

Real estate 1-4 family first mortgage

     229,859         4.66        5,346          227,208         4.99        5,659    

Real estate 1-4 family junior lien mortgage

     83,397         4.28        1,778          93,313         4.30        1,993    

Credit card

     22,097         12.81        1,408          21,230         13.08        1,388    

Other revolving credit and installment

     86,633         6.14        2,646          87,299         6.34        2,743    

 

     

 

 

    

 

 

     

 

 

 

Total consumer

     421,986         5.31        11,178          429,050         5.51        11,783    

 

     

 

 

    

 

 

     

 

 

 

Total loans (4)

     768,403         4.82        18,456          752,657         5.01        18,774    

Other

     4,545         4.49        103          5,111         4.00        102    

 

     

 

 

    

 

 

     

 

 

 

Total earning assets

   $         1,143,258         4.38  %    $         24,962                  1,080,203         4.69  %    $ 25,198    

 

     

 

 

    

 

 

     

 

 

 

Funding sources

             

Deposits:

             

Interest-bearing checking

   $ 31,299         0.06  %    $ 10          55,909         0.09  %    $ 26    

Market rate and other savings

     498,177         0.12        305          449,388         0.21        463    

Savings certificates

     61,515         1.35        413          73,229         1.41        511    

Other time deposits

     12,727         1.88        119          13,417         2.14        143    

Deposits in foreign offices

     65,217         0.16        53          57,687         0.23        66    

 

     

 

 

    

 

 

     

 

 

 

Total interest-bearing deposits

     668,935         0.27        900          649,630         0.38        1,209    

Short-term borrowings

     50,040         0.17        43          54,041         0.20        54    

Long-term debt

     127,599         2.54        1,619          147,774         2.86        2,113    

Other liabilities

     10,105         2.55        129          10,230         3.13        159    

 

     

 

 

    

 

 

     

 

 

 

Total interest-bearing liabilities

     856,679         0.63        2,691          861,675         0.82        3,535    

Portion of noninterest-bearing funding sources

     286,579         -                218,528         -          

 

     

 

 

    

 

 

     

 

 

 

Total funding sources

   $ 1,143,258         0.47        2,691          1,080,203         0.66        3,535    

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Net interest margin and net interest income on a taxable-equivalent basis (5)

       3.91  %    $ 22,271            4.03  %    $         21,663    
    

 

 

      

 

 

 

Noninterest-earning assets

             

Cash and due from banks

   $ 16,587              17,367        

Goodwill

     25,230              24,774        

Other

     127,177              123,744        

 

        

 

 

     

Total noninterest-earning assets

   $ 168,994              165,885        

 

        

 

 

     

Noninterest-bearing funding sources

             

Deposits

   $ 250,528              196,237        

Other liabilities

     57,821              54,237        

Total equity

     147,224              133,939        

Noninterest-bearing funding sources used to fund earning assets

     (286,579)             (218,528)       

 

        

 

 

     

Net noninterest-bearing funding sources

   $ 168,994              165,885        

 

        

 

 

     

Total assets

   $ 1,312,252              1,246,088        

 

        

 

 

     

 

 

 

8


Table of Contents

Earnings Performance (continued)

 

Noninterest Income

Table 2: Noninterest Income

 

 

     Quarter ended June 30,      %     Six months ended June 30,      %  
(in millions)    2012      2011      Change     2012      2011      Change  

 

 

Service charges on deposit accounts

   $ 1,139         1,074          6   $ 2,223         2,086          7

Trust and investment fees:

                

Trust, investment and IRA fees

     1,041         1,020          2        2,065         2,080          (1)   

Commissions and all other fees

     1,857         1,924          (3)        3,672         3,780          (3)   

 

      

 

 

    

Total trust and investment fees

     2,898         2,944          (2)        5,737         5,860          (2)   

 

      

 

 

    

Card fees

     704         1,003          (30)        1,358         1,960          (31)   

Other fees:

                

Cash network fees

     120         94          28        238         175          36   

Charges and fees on loans

     427         404          6        872         801          9   

Processing and all other fees

     587         525          12        1,119         1,036          8   

 

      

 

 

    

Total other fees

     1,134         1,023          11        2,229         2,012          11   

 

      

 

 

    

Mortgage banking:

                

Servicing income, net

     679         877          (23)        931         1,743          (47)   

Net gains on mortgage loan origination/sales activities

     2,214         742          198        4,832         1,892          155   

 

      

 

 

    

Total mortgage banking

     2,893         1,619          79        5,763         3,635          59   

 

      

 

 

    

Insurance

     522         568          (8)        1,041         1,071          (3)   

Net gains from trading activities

     263         414          (36)        903         1,026          (12)   

Net losses on debt securities available for sale

     (61)         (128)         (52)        (68)         (294)         (77)   

Net gains from equity investments

     242         724          (67)        606         1,077          (44)   

Operating leases

     120         103          17        179         180          (1)   

All other

     398         364          9        1,029         773          33   

 

      

 

 

    

Total

   $           10,252         9,708          6      $           21,000         19,386          8   

 

 

 

Noninterest income was $10.3 billion and $9.7 billion for second quarter 2012 and 2011, respectively, and $21.0 billion and $19.4 billion for the first half of 2012 and 2011, respectively. Noninterest income represented 48% of revenue for the quarter and 49% for the first half of 2012. The increase in total noninterest income in the second quarter and first half of 2012 from the same periods a year ago was due predominantly to higher net gains on mortgage loan origination/sales activities.

Our service charges on deposit accounts increased 6% in the second quarter and 7% in the first half of 2012 from the same periods a year ago. This increase was predominantly due to product and account changes including changes to service charges and fewer fee waivers, continued customer adoption of overdraft services and customer account growth.

We earn trust, investment and IRA (Individual Retirement Account) fees from managing and administering assets, including mutual funds, corporate trust, personal trust, employee benefit trust and agency assets. At June 30, 2012, these assets totaled $2.2 trillion, up 1% from a year ago. Trust, investment and IRA fees are largely based on a tiered scale relative to the market value of the assets under management or administration. These fees were $1.0 billion and $2.1 billion in the second quarter and first half of 2012, respectively, essentially flat from a year ago for both periods.

We receive commissions and other fees for providing services to full-service and discount brokerage customers as well as from investment banking activities including equity and bond underwriting. These fees were $1.9 billion and $3.7 billion in the second quarter and first half of 2012, respectively, down 3%

from a year ago for both periods. Commissions and other fees include transactional commissions, which are based on the number of transactions executed at the customer’s direction, and asset-based fees, which are based on the market value of the customer’s assets. Brokerage client assets totaled $1.2 trillion at June 30, 2012, a 2% decrease from a year ago.

Card fees decreased to $704 million in second quarter 2012, from $1.0 billion in second quarter 2011. For the first six months of 2012, these fees decreased to $1.4 billion from $2.0 billion a year ago. Card fees decreased because of lower debit card interchange rates resulting from the final FRB rules implementing the Durbin Amendment to the Dodd-Frank Act, which became effective in fourth quarter 2011 and placed limits on debit card interchange rates. The reduction in debit card interchange rates was partially offset by growth in purchase volume and new accounts.

Mortgage banking noninterest income, consisting of net servicing income and net gains on loan origination/sales activities, totaled $2.9 billion in second quarter 2012, compared with $1.6 billion a year ago and totaled $5.8 billion for the first half of 2012 compared with $3.6 billion for the same period a year ago. The increase year over year in mortgage banking noninterest income was predominantly driven by an increase in net gains on mortgage loan origination/sales activities.

Net mortgage loan servicing income includes amortization of commercial mortgage servicing rights (MSRs), changes in the fair value of residential MSRs during the period as well as changes in the value of derivatives (economic hedges) used to hedge the residential MSRs. Net servicing income for second

 

 

9


Table of Contents

quarter 2012 included a $377 million net MSR valuation gain ($1.63 billion decrease in the fair value of the MSRs offset by a $2.01 billion hedge gain) and for second quarter 2011 included a $374 million net MSR valuation gain ($1.08 billion decrease in the fair value of MSRs offset by a $1.45 billion hedge gain). For the first half of 2012, net servicing income included a $319 million net MSR valuation gain ($1.79 billion decrease in the fair value of MSRs offset by a $2.11 billion hedge gain) and for the same period of 2011, included a $753 million net MSR valuation gain ($576 million decrease in the fair value of MSRs offset by a $1.33 billion hedge gain). The $434 million decline in net MSR valuation gain results for the first half of 2012 compared with the same period last year was primarily due to a reduction in the fair value of our residential MSRs to include a discount rate increase reflecting increased capital return requirements from market participants. The valuation of our MSRs at the end of second quarter 2012 and 2011 reflected our assessment of expected future amounts of servicing and foreclosure costs. Our portfolio of loans serviced for others was $1.91 trillion at June 30, 2012, and $1.85 trillion at December 31, 2011. At June 30, 2012, the ratio of MSRs to related loans serviced for others was 0.69%, compared with 0.76% at December 31, 2011. See the “Risk Management – Mortgage Banking Interest Rate and Market Risk” section of this Report for additional information regarding our MSRs risks and hedging approach and the “Risk Management – Credit Risk Management – Risks Relating to Servicing Activities” section in this Report for information on the regulatory consent orders that we entered into relating to our mortgages servicing and foreclosure practices.

Income from mortgage loan origination/sale activities was $2.2 billion and $4.8 billion in the second quarter and first half of 2012, respectively, up from $742 million and $1.9 billion for the same periods a year ago. The year over year increases were driven by higher loan origination volume and margins. Residential real estate originations were $131 billion in second quarter 2012 compared with $64 billion a year ago and mortgage applications were $208 billion in second quarter 2012 compared with $109 billion a year ago. The 1-4 family first mortgage unclosed pipeline was $102 billion at June 30, 2012, and $51 billion a year ago. For additional information about our mortgage banking activities and results, see the “Risk Management – Mortgage Banking Interest Rate and Market Risk” section and Note 8 (Mortgage Banking Activities) and Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report.

Net gains on mortgage loan origination/sales activities include the cost of any additions to the mortgage repurchase liability. Mortgage loans are repurchased from third parties based on standard representations and warranties, and early payment default clauses in mortgage sale contracts. Additions to the mortgage repurchase liability that were charged against net gains on mortgage loan origination/sales activities during second quarter 2012 totaled $669 million (compared with $242 million for second quarter 2011), of which $597 million ($222 million for second quarter 2011) was for subsequent increases in estimated losses on prior period loan sales. Additions to the mortgage repurchase liability for the six months ended June 30, 2012, and 2011 were $1.1 billion and $491

million, respectively, of which $965 million and $436 million, respectively, were for subsequent increases in estimated losses on prior period loan sales. For additional information about mortgage loan repurchases, see the “Risk Management – Credit Risk Management – Liability for Mortgage Loan Repurchase Losses” section and Note 8 (Mortgage Banking Activities) to Financial Statements in this Report.

Net gains (losses) from trading activities, which reflect unrealized changes in fair value of our trading positions and realized gains and losses, were $263 million and $903 million in the second quarter and first half of 2012, respectively, compared with $414 million and $1.0 billion for the same periods a year ago. The year-over-year decrease for the second quarter and first half of 2012 was driven by lower gains on deferred compensation plan investments and economic hedging losses. Net gains (losses) from trading activities do not include interest income and other fees earned from related activities. Those amounts are reported within interest income from trading assets and other noninterest income, respectively, in the income statement. Net gains (losses) from trading activities are primarily from trading conducted on behalf of or driven by the needs of our customers (customer accommodation trading) and also include the results of certain economic hedging and proprietary trading activity. Proprietary trading had $1 million of net losses in the second quarter and $14 million of net gains in the first half of 2012, compared with net losses of $23 million and $9 million, respectively, for the same periods a year ago. Proprietary trading results also included interest and fees reported in their corresponding income statement line items. Proprietary trading activities are not significant to our client-focused business model. Our trading activities, customer accommodation, economic hedging and proprietary trading are further discussed in the “Asset/Liability Management – Market Risk – Trading Activities” section in this Report.

Net gains on debt and equity securities totaled $181 million for second quarter 2012 and $596 million for second quarter 2011 ($538 million and $783 million for the first half of 2012 and 2011, respectively), after other-than-temporary impairment (OTTI) write-downs of $120 million and $205 million for second quarter 2012 and 2011, respectively, and $185 million and $326 million for the first half of 2012 and 2011, respectively.

 

 

10


Table of Contents

Earnings Performance (continued)

 

Noninterest Expense

Table 3: Noninterest Expense

 

 

     Quarter ended June 30,      %     Six months
ended June 30,
     %  
(in millions)    2012      2011      Change     2012      2011      Change  

 

 

Salaries

   $ 3,705         3,584         3   $ 7,306         7,038         4

Commission and incentive compensation

     2,354         2,171         8        4,771         4,518         6   

Employee benefits

     1,049         1,164         (10     2,657         2,556         4   

Equipment

     459         528         (13     1,016         1,160         (12

Net occupancy

     698         749         (7     1,402         1,501         (7

Core deposit and other intangibles

     418         464         (10     837         947         (12

FDIC and other deposit assessments

     333         315         6        690         620         11   

Outside professional services

     658         659         -        1,252         1,239         1   

Contract services

     236         341         (31     539         710         (24

Foreclosed assets

     289         305         (5     593         713         (17

Operating losses

     524         428         22        1,001         900         11   

Postage, stationery and supplies

     195         236         (17     411         471         (13

Outside data processing

     233         232         -        449         452         (1

Travel and entertainment

     218         205         6        420         411         2   

Advertising and promotion

     144         166         (13     266         282         (6

Telecommunications

     127         132         (4     251         266         (6

Insurance

     183         201         (9     340         334         2   

Operating leases

     27         31         (13     55         55         -   

All other

     547         564         (3     1,134         1,035         10   

 

      

 

 

    

Total

   $     12,397         12,475         (1   $     25,390         25,208         1   

 

 

Noninterest expense was $12.4 billion in second quarter 2012, down 1% from $12.5 billion a year ago, predominantly due to lower merger costs in 2012 with the completion of Wachovia merger integration activities in first quarter 2012 ($484 million in second quarter 2011), partially offset by higher personnel expenses ($7.1 billion, up from $6.9 billion a year ago) and higher operating losses ($524 million, up from $428 million a year ago). For the first half of 2012, noninterest expense was up 1% from the same period a year ago.

Personnel expenses were up $189 million or 3% in second quarter 2012 compared with the same quarter last year, largely due to higher revenues generated by businesses with revenue-based compensation, such as mortgage, and severance expense related to our expense initiative. Included in personnel expense was a $115 million decline in employee benefits due primarily to lower deferred compensation expense which was offset in trading income. Personnel expenses were up $622 million, or 4%, for the first half of 2012 compared with the same period in 2011, mostly due to higher revenue-based compensation, higher severance costs, and annual salary increases and related salary taxes.

Operating losses were up 22% in second quarter 2012 compared with the same quarter last year predominantly due to additional litigation accruals, including additional accruals for our settlement with the U.S. Department of Justice (DOJ) announced on July 12, 2012, which resolved alleged claims related to our mortgage lending practices. See “Risk Management – Credit Risk Management – Other Mortgage Matters” and Note 11 (Legal Actions) to Financial Statements in this Report for additional information regarding matters related to the DOJ settlement.

The completion of Wachovia integration activities in first quarter 2012 significantly contributed to year-over-year reductions, for both the second quarter and first half of 2012, in equipment, occupancy, contract services, postage, stationery and supplies, and advertising and promotion expenses. We also have made significant progress on our expense management initiatives as evidenced by the year-over-year $903 million increase in revenues and $78 million decrease in noninterest expense. We have achieved a number of expense reduction accomplishments since fourth quarter 2010. For example, we reduced full-time equivalent (FTE) employees by 3% and net occupancy expense declined 7% as a result of significant reduction in real estate holdings. We lowered our third party expenditures through renegotiated contracts and optimization of procurement practices. We reduced organizational complexity, streamlining the number of our legal entities and satellite data centers, both by 13%.

We remain focused on continuing our expense management efforts. At the same time, our efforts are not intended to adversely affect revenue, and we have not foregone attractive revenue opportunities, such as recently completed business and loan portfolio acquisitions, in order to meet specific noninterest expense targets.

Income Tax Expense

Our effective tax rate was 33.9% in second quarter 2012, up from 33.6% in second quarter 2011. Our effective tax rate was 34.6% in the first half of 2012, up from 31.7% in the first half of 2011. The lower tax rate in 2011 reflects a tax benefit from the realization for tax purposes of a previously written down investment as well as tax benefits related to charitable donations of appreciated securities.

 

 

11


Table of Contents

Operating Segment Results

We are organized for management reporting purposes into three operating segments: Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement. These segments are defined by product type and customer segment and their results are based on our management accounting process, for which there is no comprehensive, authoritative financial accounting guidance equivalent to generally accepted accounting principles

(GAAP). In first quarter 2012, we modified internal funds transfer rates and the allocation of funding. The prior periods have been revised to reflect these changes. Table 4 and the following discussion present our results by operating segment. For a more complete description of our operating segments, including additional financial information and the underlying management accounting process, see Note 18 (Operating Segments) to Financial Statements in this Report.

 

 

Table 4: Operating Segment Results – Highlights

 

 

     Community Banking      Wholesale Banking      Wealth, Brokerage
and Retirement
 
(in billions)    2012      2011       2012      2011       2012      2011  

Quarter ended June 30,

                 

Revenue

   $ 13.1         12.6          6.1         5.6          3.0         3.1   

Net income

     2.5         2.1          1.9         1.9          0.3         0.3   

Average loans

     483.9         497.0          270.2         242.9          42.5         43.5   

Average core deposits

     586.1         552.0          220.9         190.6          134.2         125.9   

Six months ended June 30,

                 

Revenue

   $           26.5         25.3          12.2         11.0          6.0         6.2   

Net income

     4.9         4.3          3.7         3.5          0.6         0.7   

Average loans

     485.0         502.7          269.4         238.8          42.5         43.1   

Average core deposits

     580.7         550.0          220.9         187.7          134.9         125.7   

 

 

Community Banking offers a complete line of diversified financial products and services for consumers and small businesses including investment, insurance and trust services in 39 states and D.C., and mortgage and home equity loans in all 50 states and D.C. through its Regional Banking and Wells Fargo Home Mortgage business units.

Community Banking had net income of $2.5 billion, up $415 million, or 20%, from second quarter 2011, and $4.9 billion for the first half of 2012, up $583 million, or 14%, compared with the same period a year ago. Revenue of $13.1 billion increased $487 million, or 4%, from second quarter 2011 and was $26.5 billion for the first half of 2012, an increase of $1.3 billion, or 5%, compared with the same period a year ago. Revenue increased in both periods as a result of higher volume-related mortgage banking income and deposit growth, with the increase partially offset by outsized equity gains in the prior year second quarter, planned runoff of non-strategic loan balances and lower debit card revenue due to regulatory changes enacted in October 2011. Noninterest income increased $1.6 billion, or 15%, for the first half of 2012 compared with the same period a year ago, mostly due to higher volume-related mortgage banking income. Average core deposits increased $34.1 billion, or 6%, from second quarter 2011 and $30.7 billion, or 6%, from the first half of 2011. The number of consumer checking accounts grew 1.0% from May 2011 to May 2012. Noninterest expense in second quarter and for the first half of 2012 increased 2%, primarily from higher mortgage volume-related expenses and increased severance expense associated with our efficiency and cost save initiatives. The provision for credit losses decreased $343 million from second quarter 2011 and $526 million from the first half of 2011 due to a decrease in net charge-offs, offset in part by a lower allowance release. We released $725 million of allowance

in the first half of 2012, compared with $1.6 billion released in the same period a year ago.

Wholesale Banking provides financial solutions to businesses across the United States and globally with annual sales generally in excess of $20 million. Products and business segments include Middle Market Commercial Banking, Government and Institutional Banking, Corporate Banking, Commercial Real Estate, Treasury Management, Wells Fargo Capital Finance, Insurance, International, Real Estate Capital Markets, Commercial Mortgage Servicing, Corporate Trust, Equipment Finance, Wells Fargo Securities, Principal Investments, Asset Backed Finance, and Asset Management.

Wholesale Banking had net income of $1.9 billion in second quarter 2012, down $32 million, or 2%, from second quarter 2011. Net income increased to $3.7 billion for the first half of 2012 from $3.5 billion a year ago. Results for the first six months of 2012 benefited from strong revenue growth partially offset by increased noninterest expense and a higher provision for loan losses. Revenue in second quarter 2012 increased $522 million, or 9%, from second quarter 2011 and revenue in the first half of 2012 increased $1.1 billion, or 10%, from the first half of 2011 driven by broad-based business growth, primarily from acquisitions and strong loan and deposit growth. Average loans of $270.2 billion in second quarter 2012 increased 11% from second quarter 2011 driven by acquisitions and strong borrowing demand across all customer segments, with most lending areas experiencing double-digit rates of growth in loans outstanding, including in asset backed finance, capital finance, commercial banking, commercial real estate, corporate banking, international, and real estate capital markets. Average core deposits of $220.9 billion in second quarter 2012 increased 16% from second quarter 2011, reflecting continued strong customer

 

 

12


Table of Contents

Earnings Performance (continued)

 

liquidity. Noninterest expense in second quarter and for the first half of 2012 increased 13% and 11%, respectively, from the comparable periods last year, because of higher personnel expenses and higher operating losses. Despite an improvement of $40 million in net charge-offs, the provision for credit losses rose $285 million from second quarter 2011. The provision included a $25 million loan loss allowance build, compared with a $300 million loan loss allowance release a year ago.

Wealth, Brokerage and Retirement provides a full range of financial advisory services to clients using a planning approach to meet each client’s needs. Wealth Management provides affluent and high net worth clients with a complete range of wealth management solutions, including financial planning, private banking, credit, investment management and trust. Abbot Downing (formerly branded as Lowry Hill and Wells Fargo Family Wealth) meets the unique needs of ultra high net worth clients. Brokerage serves customers’ advisory, brokerage and financial needs as part of one of the largest full-service brokerage firms in the United States. Retirement is a national leader in providing institutional retirement and trust services (including 401(k) and pension plan record keeping) for businesses, retail retirement solutions for individuals, and reinsurance services for the life insurance industry.

Wealth, Brokerage and Retirement had net income of $343 million in second quarter 2012, up $6 million, or 2%, from second quarter 2011. Net income for the first half of 2012 was $639 million, down $41 million, or 6%, compared with the same period a year ago. The prior year results include the H.D. Vest Financial Services business that we divested in fourth quarter 2011. Revenue was down 4% from second quarter 2011, due to lower brokerage transaction revenue, reduced securities gains in the brokerage business and market impact on deferred compensation plan investments (offset in noninterest expense), partially offset by growth in managed account fee revenue. Revenue was down 3% from the first six months of 2011 due to lower brokerage transaction revenue and reduced securities gains in the brokerage business, partially offset by growth in managed account fee revenue. Total provision for credit losses decreased $25 million from second quarter 2011 and $22 million compared with the first half of 2011. Noninterest expense was down 4% from second quarter 2011, driven by a decline in personnel costs largely due to decreased broker commissions from lower production levels, and lower deferred compensation plan expense. Noninterest expense was down 2% for the first half of 2012, driven by a decline in personnel costs largely due to decreased broker commissions from lower production levels.

 

 

Balance Sheet Analysis

 

 

At June 30, 2012, our total assets, core deposits and total loans were up from December 31, 2011. Core deposits totaled 114% of the loan portfolio at June 30, 2012, and we have the capacity to add higher yielding earning assets to generate future revenue and earnings growth. The strength of our business model produced record earnings and continued internal capital generation as reflected in our improved capital ratios. Tier 1 capital as a percentage of total risk-weighted assets increased to 11.69%, total capital increased to 14.85%, Tier 1 leverage increased to 9.25%, and Tier 1 common equity increased to

10.08% at June 30, 2012, up from 11.33%, 14.76%, 9.03%, and 9.46%, respectively, at December 31, 2011. For additional information about our capital, see Note 20 (Regulatory and Agency Capital Requirements) to Financial Statements in this Report.

The following discussion provides additional information about the major components of our balance sheet. Information regarding our capital and changes in our asset mix is included in the “Earnings Performance – Net Interest Income” and “Capital Management” sections of this Report.

 

 

Securities Available for Sale

Table 5: Securities Available for Sale – Summary

 

 

     June 30, 2012      December 31, 2011  
(in millions)    Cost      Net
unrealized
gain
     Fair
value
     Cost      Net
unrealized
gain
     Fair
value
 

Debt securities available for sale

   $         214,870         9,129         223,999         212,642         6,554         219,196   

Marketable equity securities

     2,478         369         2,847         2,929         488         3,417   

Total securities available for sale

   $ 217,348         9,498         226,846         215,571         7,042         222,613   

 

 

Table 5 presents a summary of our securities available-for-sale portfolio, which consists of both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and long-term yield enhancement. Accordingly, this portfolio consists primarily of liquid, high quality federal agency debt and privately issued mortgage-backed securities (MBS). The total net unrealized gains on securities available for sale were $9.5 billion at June  30,

2012, up from net unrealized gains of $7.0 billion at December 31, 2011, due to a decline in long-term yields and tightening of credit spreads.

We analyze securities for OTTI quarterly or more often if a potential loss-triggering event occurs. Of the $185 million OTTI write-downs recognized in the first half of 2012, $127 million related to debt securities. There was $6 million in OTTI write-downs for marketable equity securities and $52 million in OTTI

 

 

13


Table of Contents

write-downs related to nonmarketable equity securities. For a discussion of our OTTI accounting policies and underlying considerations and analysis see Note 1 (Summary of Significant Accounting Policies – Securities) in our 2011 Form 10-K and Note 4 (Securities Available for Sale) to Financial Statements in this Report.

At June 30, 2012, debt securities available for sale included $37.3 billion of municipal bonds, of which 80% were rated “A-” or better based on external and, in some cases internal, ratings. Additionally, some of the securities in our total municipal bond portfolio are guaranteed against loss by bond insurers. These guaranteed bonds are predominantly investment grade and were generally underwritten in accordance with our own investment standards prior to the determination to purchase, without relying on the bond insurer’s guarantee in making the investment decision. Our municipal bond holdings are monitored as part of our ongoing impairment analysis of our securities available for sale.

The weighted-average expected maturity of debt securities available for sale was 5.2 years at June 30, 2012. Because 61% of this portfolio is MBS, the expected remaining maturity may differ from contractual maturity because borrowers generally have the right to prepay obligations before the underlying mortgages mature. The estimated effect of a 200 basis point increase or decrease in interest rates on the fair value and the expected remaining maturity of the MBS available for sale are shown in Table 6.

Table 6: Mortgage-Backed Securities

 

 

(in billions)   Fair
value
    Net
unrealized
gain (loss)
    Expected
remaining
maturity
(in years)
 

At June 30, 2012

     

Actual

  $     137.5        6.8        3.7   

Assuming a 200 basis point:

     

Increase in interest rates

    127.6        (3.1     5.5   

Decrease in interest rates

    140.6        9.9        3.0   

 

See Note 4 (Securities Available for Sale) to Financial Statements in this Report for securities available for sale by security type.

 

 

14


Table of Contents

Balance Sheet Analysis (continued)

 

Loan Portfolio

Total loans were $775.2 billion at June 30, 2012, up $5.6 billion from December 31, 2011. Table 7 provides a summary of total outstanding loans for our commercial and consumer loan portfolios. Excluding the runoff in the non-strategic/liquidating portfolios of $9.2 billion, loans in the core portfolio grew $14.8 billion in the first half of 2012. Included in our core loan growth was $6.9 billion of commercial loans ($5.4 billion commercial and industrial and $1.5 billion foreign) acquired during second quarter 2012 in connection with the acquisition of BNP Paribas’ North American energy lending business and WestLB’s subscription finance loan portfolio and $858 million of commercial asset-based loans acquired with the acquisition of

Burdale Financial Holdings Limited (Burdale) and the portfolio of Burdale Capital Finance Inc. in first quarter 2012. Loan growth occurred across commercial and industrial, foreign, real estate 1-4 family first mortgage, consumer auto lending and private student lending. This growth was offset by a decline in commercial real estate and continued runoff in the home equity portfolio. Additional information on the non-strategic and liquidating loan portfolios is included in Table 11 in the “Credit Risk Management” section of this Report.

 

 

Table 7: Loan Portfolios – Summary

 

 

     June 30, 2012      December 31, 2011  
(in millions)    Core      Liquidating      Total      Core      Liquidating      Total  

Commercial

   $ 349,774          4,278          354,052          339,755          5,695          345,450    

Consumer

     322,297          98,850          421,147          317,550          106,631          424,181    

Total loans

   $   672,071         103,128          775,199          657,305          112,326          769,631    

 

A discussion of the impact on net interest income and a comparative detail of average loan balances is included in “Earnings Performance – Net Interest Income” and Table 1 earlier in this Report. Additional information on total loans outstanding by portfolio segment and class of financing receivable is included in the “Credit Risk Management” section in this Report. Period-end balances and other loan related information are in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

Deposits

Deposits totaled $928.9 billion at June 30, 2012, compared with $920.1 billion at December 31, 2011. Table 8 provides additional information regarding deposits. Information regarding the impact of deposits on net interest income and a comparison of average deposit balances is provided in “Earnings Performance – Net Interest Income” and Table 1 earlier in this Report. Total core deposits were $882.1 billion at June 30, 2012, up $9.5 billion from $872.6 billion at December 31, 2011.

 

 

Table 8: Deposits

 

 

(in millions)    June 30,
2012
     % of
total
deposits
    December 31,
2011
     % of
total
deposits
    %
Change
 

 

 

Noninterest-bearing

   $ 253,997         28  %    $ 243,961         26  %      4   

Interest-bearing checking

     29,574         3        37,027         4        (20

Market rate and other savings

     496,034         53        485,534         53        2   

Savings certificates

     59,184         6        63,617         7        (7

Foreign deposits (1)

     43,348         5        42,490         5        2   

 

   

Core deposits

     882,137         95        872,629         95        1   

Other time and savings deposits

     21,788         2        20,745         2        5   

Other foreign deposits

     25,008         3        26,696         3        (6

 

   

Total deposits

   $ 928,933         100  %    $         920,070         100  %      1   

 

 

(1) Reflects Eurodollar sweep balances included in core deposits.

 

15


Table of Contents

Fair Valuation of Financial Instruments

We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. See our 2011 Form 10-K for a description of our critical accounting policy related to fair valuation of financial instruments.

We may use independent pricing services and brokers (collectively, pricing vendors) to obtain fair values (vendor prices) which are used to either record the price of an instrument or to corroborate internally developed prices. For certain securities, we may use internal traders to price instruments. Where vendor prices are utilized for recording the price of an instrument, we determine the most appropriate and relevant pricing vendor for each security class and obtain a price from that particular pricing vendor for each security.

Determination of the fair value of financial instruments using either vendor prices or internally developed prices are both subject to our internal price validation procedures, which include, but are not limited to, one or a combination of the following procedures:

   

comparison to pricing vendors (for internally developed prices) or to other pricing vendors (for vendor developed prices);

   

variance analysis of prices;

   

corroboration of pricing by reference to other independent market data such as secondary broker quotes and relevant benchmark indices;

   

review of pricing by Company personnel familiar with market liquidity and other market-related conditions; and

   

investigation of prices on a specific instrument-by-instrument basis.

For instruments where we use vendor prices to record the price of an instrument, we perform additional procedures. We evaluate pricing vendors by comparing prices from one vendor to prices of other vendors for identical or similar instruments and evaluate the consistency of prices to known market

transactions when determining the level of reliance to be placed on a particular pricing vendor. Methodologies employed and inputs used by third party pricing vendors are subject to additional review when such services are provided. This review may consist of, in part, obtaining and evaluating control reports issued and pricing methodology materials distributed.

Table 9 presents the summary of the fair value of financial instruments recorded at fair value on a recurring basis, and the amounts measured using significant Level 3 inputs (before derivative netting adjustments). The fair value of the remaining assets and liabilities were measured using valuation methodologies involving market-based or market-derived information (collectively Level 1 and 2 measurements).

Table 9: Fair Value Level 3 Summary

 

 

    June 30, 2012     December 31, 2011  
($ in billions)   Total
balance
    Level 3 (1)     Total
balance
    Level 3 (1)  

Assets carried at fair value

  $     363.8         50.0        373.0        53.3   

As a percentage of total assets

    27      4        28        4   

Liabilities carried at fair value

  $ 27.3         4.3        26.4        4.6   

As a percentage of total liabilities

        *        2        *   

 

* Less than 1%.
(1) Before derivative netting adjustments.

See Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report for additional information regarding our use of fair valuation of financial instruments, our related measurement techniques and the impact to our financial statements.

 

 

Off-Balance Sheet Arrangements

 

 

In the ordinary course of business, we engage in financial transactions that are not recorded in the balance sheet, or may be recorded in the balance sheet in amounts that are different from the full contract or notional amount of the transaction. These transactions are designed to (1) meet the financial needs of customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources, and/or (4) optimize capital.

Off-Balance Sheet Transactions with Unconsolidated Entities

We routinely enter into various types of on- and off-balance sheet transactions with special purpose entities (SPEs), which are corporations, trusts or partnerships that are established for a limited purpose. Historically, the majority of SPEs were formed in connection with securitization transactions. For more information on securitizations, including sales proceeds and cash flows from securitizations, see Note 7 (Securitizations and Variable Interest Entities) to Financial Statements in this Report.

 

 

16


Table of Contents

Risk Management

 

 

All financial institutions must manage and control a variety of business risks that can significantly affect their financial performance. Key among those are credit, asset/liability and market risk.

For more information about how we manage these risks, see the “Risk Management” section in our 2011 Form 10-K. The discussion that follows provides an update regarding these risks.

Credit Risk Management

Loans represent the largest component of our balance sheet and their related credit risk is among the most significant risks we manage. We define credit risk as the risk of loss associated with a borrower or counterparty default (failure to meet obligations in accordance with agreed upon terms). Table 10 presents our total loans outstanding by portfolio segment and class of financing receivable.

Table 10: Total Loans Outstanding by Portfolio Segment and Class of Financing Receivable

 

 

(in millions)    June 30,
2012
     Dec. 31,
2011
 

Commercial:

     

Commercial and industrial

   $ 177,646         167,216   

Real estate mortgage

     105,666         105,975   

Real estate construction

     17,594         19,382   

Lease financing

     12,729         13,117   

Foreign (1)

     40,417         39,760   

Total commercial

     354,052         345,450   

Consumer:

     

Real estate 1-4 family first mortgage

     230,263         228,894   

Real estate 1-4 family junior lien mortgage

     80,881         85,991   

Credit card

     22,706         22,836   

Other revolving credit and installment

     87,297         86,460   

Total consumer

     421,147         424,181   

Total loans

   $       775,199         769,631   

 

 

(1) Substantially all of our foreign loan portfolio is commercial loans. Loans are classified as foreign if the borrower’s primary address is outside of the United States.
 

 

17


Table of Contents

Non-Strategic and Liquidating Loan Portfolios We continually evaluate and modify our credit policies to address appropriate levels of risk. We may designate certain portfolios and loan products as non-strategic or liquidating to cease their continued origination as we actively work to limit losses and reduce our exposures.

Table 11 identifies our non-strategic and liquidating loan portfolios. They consist primarily of the Pick-a-Pay mortgage portfolio and other PCI loans acquired from Wachovia, some portfolios from legacy Wells Fargo Home Equity and Wells Fargo Financial, and our education finance government guaranteed loan portfolio. The total of outstanding balances of

our non-strategic and liquidating loan portfolios has decreased 46% since the merger with Wachovia at December 31, 2008, and decreased 8% from the end of 2011.

The home equity portfolio of loans generated through third party channels was designated as liquidating in fourth quarter 2007. Additional information regarding this portfolio is included in the “Credit Risk Management – Home Equity Portfolios” section of this Report.

Information about the liquidating PCI and Pick-a-Pay loan portfolios is provided in the discussion of loan portfolios that follows.

 

 

Table 11: Non-Strategic and Liquidating Loan Portfolios

 

 

     Outstanding balance  
(in millions)    June 30,
2012
     Dec. 31,
2011
     Dec. 31,
2010
     Dec. 31,
2009
     Dec. 31,
2008
 

Commercial:

              

Legacy Wachovia commercial and industrial, CRE and foreign PCI loans (1)

   $ 4,278         5,695         7,935         12,988         18,704   

Total commercial

     4,278         5,695         7,935         12,988         18,704   

Consumer:

              

Pick-a-Pay mortgage (1)

     62,045         65,652         74,815         85,238         95,315   

Liquidating home equity

     5,199         5,710         6,904         8,429         10,309   

Legacy Wells Fargo Financial indirect auto

     1,454         2,455         6,002         11,253         18,221   

Legacy Wells Fargo Financial debt consolidation

     15,511         16,542         19,020         22,364         25,299   

Education Finance - government guaranteed

     13,823         15,376         17,510         21,150         20,465   

Legacy Wachovia other PCI loans (1)

     818         896         1,118         1,688         2,478   

Total consumer

     98,850         106,631         125,369         150,122         172,087   

Total non-strategic and liquidating loan portfolios

   $         103,128         112,326         133,304         163,110         190,791   

 

 

(1) Net of purchase accounting adjustments related to PCI loans.

 

PURCHASED CREDIT-IMPAIRED (PCI) LOANS Loans acquired with evidence of credit deterioration since their origination and where it is probable that we will not collect all contractually required principal and interest payments are accounted for using the measurement provisions for PCI loans. PCI loans are recorded at fair value at the date of acquisition, and the historical allowance for credit losses related to these loans is not carried over. Such loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments. Substantially all of our PCI loans were acquired in the Wachovia acquisition on December 31, 2008. For additional information on PCI loans, see the “Risk Management – Credit Risk Management – Purchased Credit-Impaired Loans” section in our 2011 Form 10-K.

During the first half of 2012, we recognized as income $52 million released from the nonaccretable difference related to commercial PCI loans due to payoffs and other resolutions. We also transferred $319 million from the nonaccretable difference to the accretable yield for PCI loans with improving credit-related cash flows and absorbed $1.1 billion of losses in the nonaccretable difference from loan resolutions and write-downs. Table 12 provides an analysis of changes in the nonaccretable difference.

 

 

18


Table of Contents

Risk Management – Credit Risk Management (continued)

 

Table 12: Changes in Nonaccretable Difference for PCI Loans

 

 

(in millions)        Commercial     Pick-a-Pay    

Other

consumer

    Total  

Balance, December 31, 2008

   $ 10,410        26,485        4,069        40,964   

Addition of nonaccretable difference due to acquisitions

     188        -        -        188   

Release of nonaccretable difference due to:

        

Loans resolved by settlement with borrower (1)

     (1,345     -        -        (1,345

Loans resolved by sales to third parties (2)

     (299     -        (85     (384

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     (1,216     (2,383     (614     (4,213

Use of nonaccretable difference due to:

        

Losses from loan resolutions and write-downs (4)

     (6,809     (14,976     (2,718     (24,503

 

 

Balance, December 31, 2011

     929        9,126        652        10,707   

Addition of nonaccretable difference due to acquisitions

     -        -        -        -   

Release of nonaccretable difference due to:

        

Loans resolved by settlement with borrower (1)

     (52     -        -        (52

Loans resolved by sales to third parties (2)

     -        -        -        -   

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     (147     (45     (127     (319

Use of nonaccretable difference due to:

        

Losses from loan resolutions and write-downs (4)

     (72     (953     (85     (1,110

 

 

Balance, June 30, 2012

   $ 658        8,128        440        9,226   

 

 

 

 

Balance, March 31, 2012

   $ 748        8,621        506        9,875   

Addition of nonaccretable difference due to acquisitions

     -        -        -        -   

Release of nonaccretable difference due to:

        

Loans resolved by settlement with borrower (1)

     (24     -        -        (24

Loans resolved by sales to third parties (2)

     -        -        -        -   

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     (39     (45     -        (84

Use of nonaccretable difference due to:

        

Losses from loan resolutions and write-downs (4)

     (27     (448     (66     (541

 

 

Balance, June 30, 2012

   $ 658        8,128        440        9,226   

 

 

 

(1) Release of the nonaccretable difference for settlement with borrower, on individually accounted PCI loans, increases interest income in the period of settlement. Pick-a-Pay and Other consumer PCI loans do not reflect nonaccretable difference releases for settlements with borrowers due to pool accounting for those loans, which assumes that the amount received approximates the pool performance expectations.
(2) Release of the nonaccretable difference as a result of sales to third parties increases noninterest income in the period of the sale.
(3) Reclassification of nonaccretable difference to accretable yield for loans with increased cash flow estimates will result in increased interest income as a prospective yield adjustment over the remaining life of the loan or pool of loans.
(4) Write-downs to net realizable value of PCI loans are absorbed by the nonaccretable difference when severe delinquency (normally 180 days) or other indications of severe borrower financial stress exist that indicate there will be a loss of contractually due amounts upon final resolution of the loan.

 

19


Table of Contents

Since December 31, 2008, we have released $6.3 billion in nonaccretable difference, including $4.5 billion transferred from the nonaccretable difference to the accretable yield and $1.8 billion released to income through loan resolutions. Also, we have provided $1.8 billion for losses on certain PCI loans or pools of PCI loans that have had credit-related decreases to cash flows expected to be collected. The net result is a $4.5 billion reduction from December 31, 2008, through June 30, 2012, in our initial projected losses on all PCI loans.

At June 30, 2012, the allowance for credit losses on certain PCI loans was $212 million. The allowance is necessary to absorb credit-related decreases in cash flows expected to be collected and primarily relates to individual PCI loans. Table 13 analyzes the actual and projected loss results on PCI loans since acquisition through June 30, 2012.

For additional information on PCI loans, see Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

 

 

Table 13: Actual and Projected Loss Results on PCI Loans

 

 

(in millions)    Commercial     Pick-a-Pay      Other
consumer
    Total  

Release of nonaccretable difference due to:

         

Loans resolved by settlement with borrower (1)

   $ 1,397        -         -        1,397   

Loans resolved by sales to third parties (2)

     299        -         85        384   

Reclassification to accretable yield for loans with improving credit-related cash flows (3)

     1,363        2,428         741        4,532   

 

 

Total releases of nonaccretable difference due to better than expected losses

     3,059        2,428         826        6,313   

Provision for losses due to credit deterioration (4)

     (1,686     -         (125     (1,811

 

 

Actual and projected losses on PCI loans less than originally expected

   $ 1,373        2,428         701        4,502   

 

 

 

(1) Release of the nonaccretable difference for settlement with borrower, on individually accounted PCI loans, increases interest income in the period of settlement. Pick-a-Pay and Other consumer PCI loans do not reflect nonaccretable difference releases for settlements with borrowers due to pool accounting for those loans, which assumes that the amount received approximates the pool performance expectations.
(2) Release of the nonaccretable difference as a result of sales to third parties increases noninterest income in the period of the sale.
(3) Reclassification of nonaccretable difference to accretable yield for loans with increased cash flow estimates will result in increased interest income as a prospective yield adjustment over the remaining life of the loan or pool of loans.
(4) Provision for additional losses is recorded as a charge to income when it is estimated that the cash flows expected to be collected for a PCI loan or pool of loans may not support full realization of the carrying value.

 

Significant Portfolio Reviews 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. The following discussion provides additional characteristics and analysis of our significant portfolios. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more analysis and credit metric information.

COMMERCIAL AND INDUSTRIAL LOANS AND LEASE FINANCING For purposes of portfolio risk management, we aggregate commercial and industrial loans and lease financing according to market segmentation and standard industry codes. Table 14 summarizes commercial and industrial loans and lease financing by industry with the related nonaccrual totals. We generally subject commercial and industrial loans and lease financing to individual risk assessment using our internal borrower and collateral quality ratings. Our ratings are aligned to pass and criticized categories with our criticized categories aligned to special mention, substandard and doubtful categories as defined by bank regulatory agencies.

Across our non-PCI commercial loans and leases, the commercial and industrial loans and lease financing portfolio generally experienced credit improvement in second quarter 2012. Of the total commercial and industrial loans and lease financing non-PCI portfolio, 0.02% was 90 days or more past due and still accruing at June 30, 2012, compared with 0.09% at

December 31, 2011, 0.84% (1.22% at December 31, 2011) was nonaccruing and 10.7% (12.5% at December 31, 2011) was criticized. The net charge-off rate for this portfolio declined to 0.54% in second quarter 2012 from 0.58% for first quarter 2012 and 0.70% for the full year of 2011.

A majority of our commercial and industrial loans and lease financing portfolio is secured by short-term liquid assets, such as accounts receivable, inventory and securities, as well as long-lived assets, such as equipment and other business assets. Generally, the collateral securing this portfolio represents a secondary source of repayment. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for additional credit metric information.

During second quarter 2012, we acquired $6.9 billion of commercial loans in connection with our acquisition of BNP Paribas’ North American energy lending business and WestLB’s subscription finance loan portfolio, which added an aggregate of $5.4 billion to the commercial and industrial loan portfolio. In first quarter 2012, we also added $858 million to this portfolio when we acquired commercial asset-based loans from the Bank of Ireland in the Burdale acquisition.

 

 

20


Table of Contents

Risk Management – Credit Risk Management (continued)

 

Table 14: Commercial and Industrial Loans and Lease Financing by Industry

 

 

      June 30, 2012  
(in millions)    Nonaccrual
loans
     Outstanding
balance (1)
    % of
total
loans
 

 

 

PCI loans (1):

       

Healthcare

   $ -         44       

Technology

     -         39        *   

Aerospace and defense

     -         39        *   

Steel and metal products

     -         17        *   

Real estate lessor

     -         17        *   

Home furnishings

     -         16        *   

Other

     -         72  (2)      *   

 

 

Total PCI loans

   $ -         244       

 

 

All other loans:

       

Oil and gas

   $ 57         13,115       

Investors

     2         12,335        2   

Cyclical retailers

     31         11,038        1   

Financial institutions

     96         11,031        1   

Food and beverage

     46         10,348        1   

Industrial equipment

     19         9,133        1   

Healthcare

     55         8,890        1   

Securities firms

     34         7,681        *   

Real estate lessor

     35         6,884        *   

Technology

     21         6,852        *   

Transportation

     10         6,500        *   

Business services

     33         5,901        *   

Other

     1,153         80,423  (3)      10   

 

 

Total all other loans

   $ 1,592         190,131        25 

 

 

Total

   $ 1,592         190,375        25 

 

 

 

* Less than 1%.
(1) For PCI loans, amounts represent carrying value. PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.
(2) No other single category had loans in excess of $13.4 million.
(3) No other single category had loans in excess of $4.4 billion.

 

COMMERCIAL REAL ESTATE (CRE) The CRE portfolio, consisting of both CRE mortgage loans and CRE construction loans, totaled $123.3 billion, or 16%, of total loans at June 30, 2012. CRE construction loans totaled $17.6 billion at June 30, 2012, and CRE mortgage loans totaled $105.7 billion at June 30, 2012. Table 15 summarizes CRE loans by state and property type with the related nonaccrual totals. CRE nonaccrual loans totaled 4% of the non-PCI CRE outstanding balance at June 30, 2012. The portfolio is diversified both geographically and by property type. The largest geographic concentrations of combined CRE loans are in California and Florida, which represented 25% and 9% of the total CRE portfolio, respectively. By property type, the largest concentrations are office buildings at 26% and industrial/warehouse at 11% of the portfolio. At June 30, 2012, we had $20.5 billion of criticized non-PCI CRE mortgage loans, a decrease of 9% from December 31, 2011, and $5.3 billion of criticized non-PCI CRE construction loans, a decrease of 22% from December 31, 2011. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for additional information on criticized loans.

At June 30, 2012, the recorded investment in PCI CRE loans totaled $3.9 billion, down from $12.3 billion when they were acquired at December 31, 2008, reflecting the reduction resulting from principal payments, loan resolutions and write-downs.

 

 

21


Table of Contents

Table 15: CRE Loans by State and Property Type

 

 

     June 30, 2012  
     Real estate mortgage      Real estate construction      Total     % of  
(in millions)    Nonaccrual
loans
    

Outstanding

balance (1)

     Nonaccrual
loans
    

Outstanding

balance (1)

     Nonaccrual
loans
    

Outstanding

balance (1)

    total
loans
 

 

 

By state:

                   

PCI loans (1):

                   

New York

   $ -         509         -         164         -         673        *

Florida

     -         351         -         198         -         549        *   

California

     -         402         -         49         -         451        *   

Texas

     -         148         -         96         -         244        *   

Pennsylvania

     -         118         -         112         -         230        *   

Other

     -         1,094         -         677         -         1,771  (2)      *   

 

 

Total PCI loans

   $ -         2,622         -         1,296         -         3,918        *

 

 

All other loans:

                   

California

   $ 952         27,768         269         3,137         1,221         30,905       

Florida

     518         8,973         161         1,309         679         10,282        1   

Texas

     347         7,990         43         1,407         390         9,397        1   

New York

     34         5,665         4         966         38         6,631        *   

North Carolina

     266         4,144         154         1,006         420         5,150        *   

Arizona

     176         4,214         34         457         210         4,671        *   

Virginia

     88         2,965         33         1,213         121         4,178        *   

Georgia

     212         3,399         166         523         378         3,922        *   

Washington

     44         3,092         8         490         52         3,582        *   

Colorado

     81         2,905         19         393         100         3,298        *   

Other

     1,114         31,929         530         5,397         1,644         37,326  (3)      5   

 

 

Total all other loans

   $ 3,832         103,044         1,421         16,298         5,253         119,342        15 

 

 

Total

   $ 3,832         105,666         1,421         17,594         5,253         123,260        16 

 

 

By property:

                   

PCI loans (1):

                   

Office buildings

   $ -         966         -         123         -         1,089        *

Apartments

     -         582         -         184         -         766        *   

Retail (excluding shopping center)

     -         388         -         22         -         410        *   

1-4 family land

     -         2         -         342         -         344        *   

Shopping center

     -         207         -         136         -         343        *   

Other

     -         477         -         489         -         966        *   

 

 

Total PCI loans

   $ -         2,622         -         1,296         -         3,918        *

 

 

All other loans:

                   

Office buildings

   $ 910         29,279         98         1,559         1,008         30,838       

Industrial/warehouse

     530         12,700         26         391         556         13,091        2   

Apartments

     238         9,955         63         1,953         301         11,908        2   

Retail (excluding shopping center)

     587         11,078         48         294         635         11,372        1   

Real estate - other

     364         10,158         41         309         405         10,467        1   

Shopping center

     289         9,408         79         772         368         10,180        1   

Hotel/motel

     223         8,069         24         621         247         8,690        1   

Land (excluding 1-4 family)

     6         97         426         6,710         432         6,807        *   

Institutional

     111         2,864         -         247         111         3,111        *   

Agriculture

     175         2,556         4         19         179         2,575        *   

Other

     399         6,880         612         3,423         1,011         10,303        1   

 

 

Total all other loans

   $ 3,832         103,044         1,421         16,298         5,253         119,342        15 

 

 

Total

   $ 3,832         105,666         1,421         17,594         5,253         123,260        16 

 

 

 

* Less than 1%.
(1) For PCI loans, amounts represent carrying value. PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.
(2) Includes 34 states; no state had loans in excess of $229 million.
(3) Includes 40 states; no state had loans in excess of $3.1 billion.

 

22


Table of Contents

Risk Management – Credit Risk Management (continued)

 

FOREIGN LOANS AND EUROPEAN EXPOSURE We classify loans as foreign if the borrower’s primary address is outside of the United States. At June 30, 2012, foreign loans represented approximately 5% of our total consolidated loans outstanding and approximately 3% of our total assets.

Our foreign country risk monitoring process incorporates frequent dialogue with our foreign financial institution customers, counterparties and with regulatory agencies, enhanced by centralized monitoring of macroeconomic and capital markets conditions. We establish exposure limits for each country through a centralized oversight process based on the needs of our customers, and in consideration of relevant economic, political, social, legal, and transfer risks. We monitor exposures closely and adjust our limits in response to changing conditions.

As per bank regulatory reporting requirements, we evaluate our individual country risk exposure on an ultimate risk basis which is normally based on the country of residence of the guarantor or collateral location. Our largest foreign country exposure on an ultimate risk basis was the United Kingdom, which amounted to approximately $12.5 billion, or 1% of our total assets, and included $1.7 billion of sovereign claims. Our United Kingdom sovereign claims arise primarily from deposits we have placed with the Bank of England pursuant to regulatory requirements in support of our London branch.

At June 30, 2012, our Eurozone exposure, including cross-border claims on an ultimate risk basis, and foreign exchange and derivative products, aggregated approximately $10.9 billion, including $352 million of sovereign claims, compared with approximately $11.4 billion at December 31, 2011, which included $364 million of sovereign claims. Our Eurozone exposure is relatively small compared to our overall credit risk exposure and is diverse by country, type, and counterparty.

We conduct periodic stress tests of our significant country risk exposures, analyzing the direct and indirect impacts on the risk of loss from various macroeconomic and capital markets scenarios. We do not have significant exposure to foreign country risks because our foreign portfolio is relatively small. However, we have identified exposure to increased loss from U.S. borrowers associated with the potential indirect impact of a European downturn on the U.S. economy. We mitigate these potential impacts through our normal risk management processes which include active monitoring and, if necessary, the application of aggressive loss mitigation strategies.

Table 16 provides information regarding our exposures to European sovereign entities and institutions located within such countries, including cross-border claims on an ultimate risk basis, and foreign exchange and derivative products.

 

 

Table 16: European Exposure

 

 

    Lending (1)(2)     Securities (3)     Derivatives and other (4)     Total exposure  
(in millions)   Sovereign     Non-
sovereign
    Sovereign     Non-
sovereign
    Sovereign     Non-
sovereign
    Sovereign     Non-
sovereign (5)
    Total  

 

 

June 30, 2012

                 

Eurozone

                 

Netherlands

  $ -        2,394        -        249        -        535        -        3,178        3,178   

Germany

    59        1,848        -        241        -        202        59        2,291        2,350   

Luxembourg

    -        1,002        -        131        -        4        -        1,137        1,137   

Ireland

    100        784        -        187        -        20        100        991        1,091   

France

    73        489        -        374        -        30        73        893        966   

Spain

    -        682        -        94        -        16        -        792        792   

Italy

    -        371        -        105        -        1        -        477        477   

Austria

    100        238        -        6        -        -        100        244        344   

Belgium

    -        188        -        37        -        67        -        292        292   

Other (6)

    20        145        -        105        -        9        20        259        279   

Total Eurozone exposure

    352        8,141        -        1,529        -        884        352        10,554        10,906   

United Kingdom

    1,726        4,624        -        5,802        -        314        1,726        10,740        12,466   

Other European countries

    -        4,048        4        440        1        620        5        5,108        5,113   

Total European exposure

  $ 2,078        16,813        4        7,771        1        1,818        2,083        26,402        28,485   

 

(1) Lending exposure includes funded loans and unfunded commitments, leveraged leases, and money market placements presented on a gross basis prior to the deduction of impairment allowance and collateral received under the terms of the credit agreements.
(2) Includes $1.4 billion in PCI loans, largely to customers in Germany and United Kingdom territories, and $2.9 billion in defeased leases secured predominantly by U.S. Treasury and government agency securities, or government guaranteed.
(3) Represents issuer exposure on cross-border debt and equity securities, held in trading or available-for-sale portfolio, at fair value.
(4) Represents counterparty exposure on foreign exchange and derivative contracts, and securities resale and lending agreements. This exposure is presented net of counterparty netting adjustments and reduced by the amount of cash collateral. It includes credit default swaps (CDS) predominantly used to manage our U.S. and London-based cash credit trading businesses, which sometimes results in selling and purchasing protection on the identical reference entity. Generally, we do not use market instruments such as CDS to hedge the credit risk of our investment or loan positions, although we do use them to manage risk in our trading businesses. At June 30, 2012, the gross notional amount of our CDS sold that reference assets domiciled in Europe was $8.4 billion, which was offset by the notional amount of CDS purchased of $8.4 billion. We did not have any CDS purchased or sold where the reference asset was solely the sovereign debt of a European country. Certain CDS purchased or sold reference pools of assets that contain sovereign debt, however the amount of referenced sovereign European debt was insignificant at June 30, 2012.
(5) Total non-sovereign exposure comprises $11.0 billion exposure to financial institutions and $15.4 billion to non-financial corporations at June 30, 2012.
(6) Includes non-sovereign exposure to Greece and Portugal in the amount of $3 million and $57 million, respectively. We had no sovereign debt exposure to these countries at June 30, 2012.

 

23


Table of Contents

REAL ESTATE 1-4 FAMILY FIRST AND JUNIOR LIEN MORTGAGE LOANS Our real estate 1-4 family first and junior lien mortgage loans primarily include loans we have made to customers and retained as part of our asset liability management strategy. These loans also include the Pick-a-Pay portfolio acquired from Wachovia and the home equity portfolio, which are discussed later in this Report. In addition, these loans include other purchased loans and loans included on our balance sheet due to the adoption of consolidation accounting guidance related to variable interest entities (VIEs).

Our underwriting and periodic review of loans collateralized by residential real property includes appraisals or estimates from automated valuation models (AVMs). Additional information about AVMs and our policy for their use can be found in the “Risk Management – Credit Risk Management – Real Estate 1-4 Family Mortgage Loans” section in our 2011 Form 10-K.

Some of our real estate 1-4 family first and junior lien mortgage loans include an interest-only feature as part of the loan terms. These interest-only loans were approximately 20% of total loans at June 30, 2012, compared with 21% at December 31, 2011.

We believe we have manageable adjustable-rate mortgage (ARM) reset risk across our owned mortgage loan portfolios. We do not offer option ARM products, nor do we offer variable-rate mortgage products with fixed payment amounts, commonly referred to within the financial services industry as negative amortizing mortgage loans. Our liquidating option ARM portfolio was acquired from Wachovia.

We continue to modify real estate 1-4 family mortgage loans to assist homeowners and other borrowers in the current difficult economic cycle. For more information on our participation in the U.S. Treasury’s Making Home Affordable (MHA) programs, see the “Risk Management – Credit Risk Management – Real Estate 1-4 Family Mortgage Loans” section in our 2011 Form 10-K.

Real estate 1-4 family first and junior lien mortgage loans by state are presented in Table 17. Our real estate 1-4 family mortgage loans to borrowers in California represented approximately 13% of total loans (2% of this amount were PCI loans from Wachovia) at June 30, 2012, located mostly within the larger metropolitan areas, with no single California metropolitan area consisting of more than 3% of total loans. 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.

Part of our credit monitoring includes tracking delinquency, FICO scores and collateral values (LTV/CLTV) on the entire real estate 1-4 family mortgage loan portfolio. These metrics continued to improve in second quarter 2012 on the non-PCI mortgage portfolio. Loans 30 days or more delinquent at June 30, 2012, totaled $16.1 billion, or 6%, of total non-PCI mortgages, compared with $18.4 billion, or 6%, at December 31, 2011. Loans with FICO scores lower than 640 totaled $40.5 billion at June 30, 2012, or 14% of all non-PCI mortgages, compared with $44.1 billion, or 15%, at December 31, 2011. Mortgages with a LTV/CLTV greater than 100% totaled

$66.9 billion at June 30, 2012, or 24% of total non-PCI mortgages, compared with $74.2 billion, or 26%, at December 31, 2011. Information regarding credit risk trends can be found in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

We monitor the credit performance of our junior lien mortgage portfolio for trends and factors that influence the frequency and severity of loss. In first quarter 2012, in accordance with Interagency Supervisory Guidance on Allowance for Loan and Lease Losses Estimation Practices for Loans and Lines of Credit Secured by Junior Liens on 1-4 Family Residential Properties issued by bank regulators on January 31, 2012 (Interagency Guidance), we aligned our nonaccrual reporting so that a junior lien is reported as a nonaccrual loan if the related first lien is 120 days past due or is in the process of foreclosure. This action increased our nonperforming assets by $1.7 billion, but otherwise had minimal financial impact as the expected loss content of these loans was already considered in the allowance for loan losses. See the “Risk Management – Credit Risk Management – Nonperforming Assets” section in this report for more information.

Table 17: Real Estate 1-4 Family First and Junior Lien Mortgage Loans by State

 

     June 30, 2012  
(in millions)   Real estate
1-4 family
first
mortgage
    Real estate
1-4 family
junior lien
mortgage
    Total real
estate 1-4
family
mortgage
    % of
total
loans
 

 

 

PCI loans:

       

California

  $ 18,366        37        18,403        2  % 

Florida

    2,549        35        2,584        *   

New Jersey

    1,267        23        1,290        *   

Other (1)

    6,149        95        6,244        *   

 

 

Total PCI loans

  $ 28,331        190        28,521        4  % 

 

 

All other loans:

       

California

  $ 56,821        22,562        79,383        10  % 

Florida

    15,633        7,215        22,848        3   

New Jersey

    8,990        5,946        14,936        2   

New York

    9,676        3,399        13,075        2   

Virginia

    5,828        4,192        10,020        1   

Pennsylvania

    5,669        3,709        9,378        1   

North Carolina

    5,623        3,388        9,011        1   

Georgia

    4,600        3,172        7,772        1   

Texas

    6,456        1,212        7,668        1   

Other (2)

    54,210        25,896        80,106        10   

Government insured/guaranteed loans (3)

    28,426        -        28,426        4   

 

 

Total all other loans

  $ 201,932        80,691        282,623        36  %