Low Interest Rates Weigh on Wells Fargo’s Profits

Community Banking segment’s revenue falls 3% on back of lower other income

Source: Company's Website
Source: Company’s Website

Wells Fargo & Co. (NYSE: WFC), the largest U.S. bank by market capitalization, announced its Q2 FY16 financial results on July 15th, 2016. Headquartered in San Francisco, California, Wells Fargo provides retail, commercial, and corporate banking services to individuals, businesses, and institutions under three main segments: Community Banking, Wholesale Banking, and Wealth and Investment Management.

Wells Fargo’s Community Banking segment offers checking, savings, market rate, individual retirement, equity lines and loans, and debit and credit cards, among others. This segment also provides equipment leases, real estate and other commercial financing, as well as purchases retail installment contracts.

The Company’s Wholesale Banking segment offers commercial loans and lines of credit, letters of credit, asset-based lending, international trade facilities, foreign exchange, and treasury management. This segment also provides construction, and land acquisition and development loans; secured and unsecured lines of credit; and mortgage brokerage services.

The bank’s Wealth and Investment Management segment offers financial advisory, wealth management, brokerage, retirement, trust, and reinsurance services.

As of February 25th, 2015, Wells Fargo operated through about 8,700 locations and 12,500 ATMs & offices in 36 countries with $1.9 trillion in assets. Read more about Wells Fargo’s financial results below.

Q2 FY16 financial highlights

Source: Company's Data, WSJ
Source: Company’s Data, WSJ

Wells Fargo’s Q2 FY16 revenue grew 4% to $22.16 billion as compared to revenue of $21.32 billion in the year-ago quarter.

Taking advantage of low rates for home lending, the bank extended $63 billion in home loans during Q2 FY16 compared with $62 billion in the year-ago quarter and $44 billion in Q1 FY16. Overall, Wells Fargo’s loan disbursal continued to expand; total loans at the end of Q2 FY16 were $957.16 billion, a 7.7% increase from the year-ago quarter.

The company’s net interest margin, a key metric of how profitably the bank can lend out its customers’ deposits, fell to 2.86% from 2.90% at the end of March 2016, and 2.97% in the year-ago period. The decline was primarily due to the impact of growth in long-term debt, growth in deposits, and reduced income on investment securities.

Interest income and non-interest income

Wells Fargo’s Q2 FY16 net interest income increased by $66 million from Q1 FY16 to $11.7 billion, primarily driven by loan growth, including the full quarter benefit of the assets acquired from GE Capital that closed late in Q1 FY16. The benefit to net interest income from loan growth was partially offset by reduced income in the investment securities portfolio reflecting accelerated prepayments, primarily on mortgage-backed securities, increased interest expense from higher debt balances, and lower interest income from trading assets.

Wells Fargo’s Q2 FY16 non-interest income declined slightly to $10.4 billion from $10.5 billion in Q1 FY16, reflecting higher net gains on debt securities, trust and investment fees, net gains from trading activities, lease income, card fees and service charges on deposit accounts. These increases were partially offset by a linked-quarter reduction in other income, owing to a decline in hedge ineffectiveness income from $379 million in Q1 FY16 to $56 million in Q2 FY16. Other income in Q2 FY16 also included a $290 million gain on the sale of the health benefit services business.

Q2 FY16 trust and investment fees jumped by $162 million to $3.5 billion from the prior-year quarter, mainly due to higher investment banking fees, as well as higher retail brokerage asset-based fees and transaction activity, and trust and investment management fees. On the other hand, mortgage banking non-interest income declined by $184 million to $1.4 billion from Q1 FY16, as a $306 million increase in origination gains was more than offset by a decline in servicing revenue. Residential mortgage loan originations amounted to $63 billion in Q2 FY16, up $19 billion from the year-ago quarter. The production margin on residential held-for-sale mortgage loan originations fell slightly to 1.66%, compared with 1.68% in Q1 FY16.

Return on equity declines on low interest rates

Wells Fargo’s return on equity, a key profitability metric for bank investors, dropped to 11.7% as compared to 11.75% in Q1 FY16, and the lowest since Q4 FY10. However, Wells Fargo’s return on equity still tops that of its peers, with Citigroup Inc. (NYSE: C) reporting 7% and J.P. Morgan Chase & Co (NYSE: JPM) 10%. The bank is more dependent on consumer and commercial lending, and thereby the interest rate scenario. Despite a small European presence, Wells Fargo was affected by the market turbulence that followed Brexit, since the Federal Reserve could delay interest-rate hikes, which in turn could hamper the bank’s profitability.

In view of the continued low-rate environment, Wells Fargo purchased $38 billion in mortgage bonds and other securities, or more than seven times the amount it purchased in the first quarter, to try to eke out a better return on its excess deposits.


Total average deposits for Q2 FY16 grew 1% to $1.2 trillion as compared to Q1 FY16, driven by a $13.4 billion increase in consumer and small business. The average deposit cost for Q2 FY16 inched up 3 basis points from the year-ago period to 11 basis points, and by 1 basis point from Q1 FY16.

Non-performing Assets (NPAs) decline

On the brighter side, Wells Fargo’s NPAs during Q2 FY16 decreased by $433 million to $13.1 billion as compared to Q1 FY16. Non-accrual loans decreased by $271 million to $12.0 billion as compared to Q1 FY16, as an $809 million decrease in consumer non-accruals was partially offset by a $651 million increase in oil and gas non-accruals. Foreclosed assets of $1.1 billion declined by $162 million as compared to Q1 FY16. The bank reported higher credit losses of $924 million for Q2 FY16 compared with Q1 FY16, in part driven by $59 million of higher oil and gas portfolio losses.

Segmental highlights

Community Banking: This segment’s Q2 FY16 revenue fell 3%, or $410 million, to $12.2 billion as compared to Q1 FY16 due to lower other income (hedge ineffectiveness), mortgage banking revenue, and net interest income, partially offset by higher gains from the sale of debt securities. When compared to the year-ago quarter, revenue increased 2%, or $237 million, due to higher gains on sale of debt securities other income (hedge ineffectiveness), net interest income and card fees. Net income declined 4%, or $117 million, to $3.2 billion as compared to Q1 FY16 and decreased 1%, or $36 million, when compared to the year-ago period.

Wholesale Banking: This segment’s Q2 FY16 revenue grew 5%, or $326 million, to $7.3 billion as compared to Q1 FY16 due to the full quarter impact of the GE Capital acquisition, broad-based loan growth, strong customer accommodation trading results, and increased investment banking fees. When compared to the year-ago quarter, revenue increased 10%, or $674 million, due to strong loan growth, higher investment banking fees, and a rise in treasury management fees. Net income grew 8%, or $152 million, to $2.1 billion as compared to Q1 FY16 and decreased 5%, or $118 million, when compared to the year-ago period.

Wealth and Investment Management: This segment’s Q2 FY16 revenue grew 2%, or $65 million, to $3.9 billion as compared to Q1 FY16 due to higher asset-based fees and brokerage transaction revenue. When compared to the year-ago quarter, revenue decreased 1%, or $57 million, due to lower asset-based fees and brokerage transaction revenue, partially offset by higher net interest income. Net income jumped 14%, or $72 million, to $584 million as compared to Q1 FY16 and remained relatively flat when compared to the year-ago period.

Lastly, Wells Fargo’s net income fell 3% to $5.56 billion, or $1.01 per diluted common share, for Q2 FY16, compared with $5.72 billion, or $1.03 per share, in the year-ago period, and $5.5 billion, or $0.99 per share, in Q1 FY16.

Other highlights

Wells Fargo’s capital remained strong with a net payout ratio of 62% in Q2 FY16; the bank gave back $3.2 billion to shareholders through common stock dividends and share repurchases.

On July 18th, 2016, Wells Fargo struck a £300 million deal to buy a new building for its European headquarters in London’s financial district. This is despite the fact that Wells Fargo generates about 95% of its revenues from the U.S. market and has a low profile overseas. The building is expected to be finished by September 2017, and Wells Fargo plans to move in to the new location in 2018. The bank currently has 850 employees across London.

Outlook for Q3 FY16

Wells Fargo anticipates mortgage originations in Q3 FY16, given the bank’s current pipeline. The bank also anticipates a better lending scenario for the energy sector following an uptick in oil prices. Owing to the economic, capital markets and interest rate uncertainty, the bank’s lending activities could take a blow in the coming quarter.

Stock Performance

W3Wells Fargo’s stock stood at $48.37, gaining 0.19%, at the close on Tuesday, July 19th, 2016, having vacillated between an intraday high of $48.55 and a low of $48.05 during the session. The stock’s trading volume was at 15,981,699 for the day. The Company’s market cap was at $251.91 billion as of Tuesday’s close.

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