Wells Fargo 10-Q 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
Commission file number 001-2979
WELLS FARGO & COMPANY
(Exact name of registrant as specified in its charter)
420 Montgomery Street, San Francisco, California 94163
(Address of principal executive offices) (Zip Code)
Registrants 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.
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).
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
PART I FINANCIAL INFORMATION
SUMMARY FINANCIAL DATA
This Report on Form 10-Q for the quarter ended June 30, 2010, 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. Some of these factors are described in the Financial Review and in the Financial Statements and related Notes. For a discussion of other factors, refer to the Forward-Looking Statements and Risk Factors sections in this Report and to the Risk Factors and Regulation and Supervision sections of our Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K) and the Risk Factors section of our Quarterly Report on Form 10-Q for the period ended March 31, 2010 (First Quarter Form 10-Q), filed with the Securities and Exchange Commission (SEC) and available on the SECs website at www.sec.gov.
See the Glossary of Acronyms at the end of this Report for terms used throughout the Financial Review, and Financial Statements and related Notes of this Report.
Wells Fargo & Company is a nationwide, diversified, community-based financial services company, with $1.2 trillion in assets, providing banking, insurance, trust and investments, mortgage banking, investment banking, retail banking, brokerage and consumer finance through banking stores, the internet and other distribution channels to individuals, businesses and institutions in all 50 states, the District of Columbia (D.C.) and in other countries. We ranked fourth in assets and third in the market value of our common stock among our peers at June 30, 2010. 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), which was acquired by Wells Fargo on December 31, 2008.
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 Americas great companies. Our primary strategy to achieve this vision is to increase the number of products our customers buy from us and to provide them all the financial products that will help them 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. All of our business segments contributed to earnings in second quarter 2010.
Our company earned $3.1 billion ($0.55 diluted earnings per common share) in second quarter 2010, compared with $3.2 billion ($0.57 diluted earnings per common share) in second quarter 2009. This is the fourth time since the Wachovia merger that quarterly net income was greater than $3.0 billion. Net income for the first half of 2010 was $5.6 billion ($1.00 diluted earnings per common share), compared with $6.2 billion ($1.13 diluted earnings per common share) for the first half of 2009. Despite declining loan demand since early last year and lower mortgage hedging results in second quarter, total revenue and pre-tax pre-provision profit remained strong at $21.4 billion and $8.6 billion, respectively. Year-over-year growth in the franchise was driven by our diverse businesses including commercial real estate (CRE) brokerage, wealth management, asset-based lending, merchant services, debit card and global remittance.
Significant items in second quarter 2010 included:
In the six quarters since our merger with Wachovia, we have earned cumulative profits of $17.9 billion reflecting the breadth of our business model and the power of the consolidation with Wachovia. Merger integration activities are proceeding on track and the combined company continued to produce financial results including revenue synergies better than our original expectations. We currently expect aggregate merger costs of approximately $5.7 billion ($3.0 billion in aggregate through June 30, 2010). Integration costs were $498 million in second quarter 2010. We currently project $600 million to $650 million in merger costs per quarter in the third and fourth quarters of 2010, before these costs decline in 2011. We continue to expect to achieve $5.0 billion in annual cost savings upon completing the merger integration. We have achieved approximately 80% of run-rate cost savings by the end of second quarter 2010, and expect to achieve 90% by year-end 2010.
Our cross-sell at legacy Wells Fargo set a record in second quarter 2010 with 6.06 Wells Fargo products for retail banking households. Our goal is eight products per customer, which is approximately half of our estimate of potential demand. One of every four of our legacy Wells Fargo retail banking households has eight or more products and our average middle-market commercial banking customer has almost eight products. Wachovia retail bank households had an average of 4.88 Wachovia products. We believe there is potentially significant opportunity for growth from an increase in cross-sell to Wachovia retail bank households. For legacy Wells Fargo, our average middle-market commercial banking customer had an average of 7.7 products and an average of 6.4 products for Wholesale Banking customers. Business banking cross-sell offers another potential opportunity for growth, with cross-sell of 3.88 products at legacy Wells Fargo.
We continued taking actions to build capital and further strengthen our balance sheet, including reducing previously identified non-strategic and liquidating loan portfolios (including the Wells Fargo Financial liquidating portfolio), which declined by $6.9 billion in second quarter 2010 and $40.6 billion cumulatively since the Wachovia acquisition. We significantly built capital in second quarter 2010, driven by strong earnings. Our capital ratios at June 30, 2010, were higher than they were prior to the Wachovia acquisition. Our capital ratios continued to build rapidly, with Tier 1 common reaching 7.61%, up 52 basis points from first quarter 2010, and Tier 1 capital at 10.51%, even with the May 20, 2010, purchase of $540 million of Wells Fargo warrants auctioned by the U.S. Treasury. The Tier 1 leverage ratio increased to 8.66%. See the Capital Management section in this Report for more information regarding Tier 1 common equity.
As we have stated in the past, successful companies must invest in their core businesses and maintain strong balance sheets to consistently grow over the long term. In second quarter 2010, we opened 13 retail banking stores for a retail network total of 6,445 stores. We converted 87 Wachovia banking stores in California in second quarter 2010 and Texas and Kansas store conversions took place in July 2010.
In July 2010, we announced that we will be restructuring the operations of Wells Fargo Financial and closing its store network in the U.S. Due to the restructuring of this business, we recorded $137 million in severance costs in second quarter 2010. The business will largely be realigned into existing retail,
mortgage banking and commercial business lines. The legacy Wells Fargo Financial debt consolidation portfolio is now considered to be a liquidating or non-strategic portfolio as we are exiting the business of originating non-prime portfolio mortgage loans. Wells Fargo Financials other consumer loans, such as Federal Housing Administration (FHA) home loans, auto loans and credit cards, will be consolidated with similar products within Community Banking.
Wells Fargo remained one of the largest providers of credit to the U.S. economy in second quarter 2010. We continued to lend to creditworthy customers and, during second quarter 2010, made $150 billion in new loans and commitments to consumer, small business and commercial customers, including $81 billion of residential mortgage originations. We have been an industry leader in loan modifications for homeowners, with more than half a million active and completed trial modifications between January 2009 and June 30, 2010, including 75,577 Home Affordability Modification Program (HAMP) active trial and completed modifications, and 429,466 proprietary trial and completed modifications. On March 17, 2010, we announced our participation in the governments Second-Lien Modification Program under HAMP to help struggling homeowners with a reduction in their home equity loan payments.
We believe credit quality has turned the corner, with net charge-offs declining to $4.5 billion, down 16% from first quarter 2010 and down 17% from last years peak quarter. The significant reduction in credit losses in second quarter 2010 confirmed our prior outlook that credit losses peaked in fourth quarter 2009 and provision expense peaked in third quarter 2009. Based on declining losses and across-the-board improved credit quality trends, we released $500 million in loan loss reserves in second quarter 2010. Absent significant deterioration in the economy, we currently expect the positive trend in charge-offs will continue over the coming year and expect future reductions in the allowance for loan losses.
Nonaccrual loan growth in second quarter 2010 decelerated to 2% from first quarter 2010, down significantly from prior quarters. The growth in second quarter 2010 occurred in the real estate portfolios (commercial and residential), which consist of secured loans. Nonaccrual loans in all other loan portfolios were essentially flat or down. New inflows to nonaccrual loans continued to decline (down 18% linked quarter). For additional information, see Balance Sheet Analysis Loan Portfolio and Note 5 (Loans and Allowance for Credit Losses) in this Report.
The improvement in credit quality was also evident in the portfolio of PCI loans, which have continued to perform in line with or better than original expectations at the time of the Wachovia merger. In particular, the Pick-a-Pay portfolio continued to have positive performance trends, resulting in a $1.8 billion transfer from nonaccretable difference to accretable yield in second quarter 2010. This increase in the accretable yield for the Pick-a-Pay portfolio is expected to be recognized as a yield adjustment to income over the remaining life of these loans, which is estimated to have a weighted-average life of eight years. In addition, for commercial PCI loans, due to increased payoffs and dispositions, we reduced the associated nonaccretable difference by $506 million (reflected in income in the second quarter).
The continued improvement in credit performance is a result of a slowly improving economy coupled with actions taken by us over the past several years to improve underwriting standards, mitigate losses and exit portfolios with unattractive credit metrics. We have seen the positive impact of these actions in the current quarter and in projected losses for future quarters.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) became law. The Dodd-Frank Act reshapes and restructures the supervision and regulation of the financial services industry. Although the Dodd-Frank Act became generally effective in July, many of its provisions have extended implementation periods and delayed effective dates and will require extensive
rulemaking by regulatory authorities. The ultimate impact of the Dodd-Frank Act cannot be determined. See the Risk Factors section of this Report for additional information regarding the Dodd-Frank Act.
Revenue was $21.4 billion in second quarter 2010, essentially flat from first quarter 2010, and down 5% from second quarter 2009. Revenue for the first half of 2010 was $42.8 billion, down 2% from the same period a year ago. Reflecting the breadth and growth potential of the Companys business model, many businesses had double-digit revenue growth from second quarter 2009, including commercial real estate brokerage (deal flow), asset-based lending (loan volume and syndications), merchant services (processing volume), debit cards (increased account activity) and wealth management. Mortgage banking revenues in second quarter 2010 were down 34% from the prior year due to lower origination volumes and a net increase in the mortgage loan repurchase reserve. Net interest income of $11.4 billion declined only 3% from a year ago despite the 7% decline in average loans.
Noninterest expense of $12.7 billion in second quarter 2010 was flat from a year ago. Second quarter 2010 expenses included $498 million of merger integration costs, compared with $244 million a year ago, and $137 million of severance costs related to the Wells Fargo Financial restructuring. Operating losses were $627 million in second quarter 2010, up $468 million from the prior year, predominantly due to additional litigation accruals. Our expenses reflect, in addition to merger integration and credit resolution expenses, our continued investment for long-term growth, hiring in regional and commercial banking as we apply the Wells Fargo business model throughout legacy Wachovia markets, and investing in technology to improve service across the franchise. As of second quarter 2010, we have already realized approximately 80% of our targeted projected run-rate savings from the Wachovia merger. The efficiency ratio was 59.6% in second quarter 2010 compared with 56.5% in first quarter 2010 and 56.4% in second quarter 2009, with the increase largely due to additional merger expenses, litigation accruals and Wells Fargo Financials restructuring costs.
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 to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% federal statutory tax rate.
Net interest income on a taxable-equivalent basis was $11.6 billion in second quarter 2010 and $11.9 billion in second quarter 2009, reflecting a decline in average loans, including a reduction in loans in the liquidating portfolios. Continued strong growth in consumer and commercial checking and savings accounts partially offset the impact on income from the decline in loans. The net interest margin was 4.38% in second quarter 2010 up from 4.30% a year ago, due to additional PCI loan resolution income and the benefit of lower deposit and market funding costs. Average earning assets were $1.1 trillion in second quarter 2010, flat compared with second quarter 2009. Average loans decreased to $772.5 billion in second quarter 2010 from $833.9 billion a year ago. We continued to supply significant amounts of credit to consumers and businesses in second quarter 2010, although loan demand remained soft. We continued to reduce high-risk/non-strategic loans (including Pick-a-Pay mortgage, legacy Wells Fargo Financial debt consolidation, and commercial and commercial real estate PCI loans), which were down $26.1 billion in second quarter 2010 from a year ago. Average mortgages held for sale (MHFS) were $32.2 billion in second quarter 2010, down from $43.2 billion a year ago. Average debt securities available for sale were $157.6 billion in second quarter 2010, down from $179.0 billion a year ago.
Core deposits are a low-cost source of funding and thus an important contributor to net interest income and the net interest margin. Core deposits include noninterest-bearing deposits, interest-bearing checking, savings certificates, certain market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). Average core deposits declined to $761.8 billion in second quarter 2010 from $765.7 billion in second quarter 2009, and funded 99% and 92% of average loans in the same periods, respectively. Average checking and savings deposits, typically the lowest cost deposits, represented about 88% of our average core deposits, one of the highest percentages in the industry. Average certificates of deposit (CDs) declined $63 billion from second quarter 2009, predominantly the result of $57 billion of higher-cost Wachovia CDs maturing, yet total average core deposits were down only $3.9 billion from a year ago. Of average core deposits, $672.0 billion represent transaction accounts or low-cost savings accounts from consumer and commercial customers, which increased 10% from $613.3 billion in second quarter 2009. Total average retail core deposits, which exclude Wholesale Banking core deposits and retail mortgage escrow deposits, decreased to $574.4 billion for second quarter 2010 from $596.6 billion a year ago. Average mortgage escrow deposits were $25.7 billion in second quarter 2010, compared with $32.0 billion a year ago. Average certificates of deposits decreased to $89.8 billion in second quarter 2010 from $152.4 billion a year ago. Total average interest-bearing deposits decreased to $635.4 billion in second quarter 2010 from $638.0 billion a year ago.
The following table presents the individual components of net interest income and the net interest margin.
AVERAGE BALANCES, YIELDS AND RATES PAID (TAXABLE-EQUIVALENT BASIS) (1)(2)
NM Not meaningful
Noninterest income represented 46% and 47% of total revenues for the second quarter and first half of 2010, respectively, compared with 48% and 47%, respectively, for the same periods a year ago. Noninterest income was down 7% year over year, predominantly due to lower mortgage banking hedge results.
The Federal Reserve Board (FRB) announced regulatory changes to debit card and ATM overdraft practices in fourth quarter 2009. In third quarter 2009, we also announced policy changes that should help customers limit overdraft and returned item fees. We currently estimate that the combination of these changes will reduce our 2010 fee revenue by approximately $225 million (after tax) in third quarter 2010 and $275 million in fourth quarter 2010. The actual impact in 2010 and future periods could vary due to a variety of factors, including changes in customer behavior, economic conditions and other potential offsetting factors.
We earn fees on trust, investment and IRA (Individual Retirement Account) accounts from managing and administering assets, including mutual funds, corporate trust, personal trust, employee benefit trust and agency assets. At June 30, 2010, these assets totaled $1.9 trillion, up 12% from $1.7 trillion a year ago, primarily reflecting a 12% increase in the S&P 500 over the same period. Trust, investment and IRA fees are primarily based on a tiered scale relative to the market value of the assets under management or administration. These fees increased to $1.0 billion in second quarter 2010 from $839 million a year ago.
We received commissions and other fees for providing services to full-service and discount brokerage customers of $1.7 billion in second quarter 2010 and $1.6 billion a year ago. These fees include transactional commissions, which are based on the number of transactions executed at the customers direction, and asset-based fees, which are based on the market value of the customers assets. Client assets totaled $1.1 trillion at June 30, 2010, up from $1.0 trillion a year ago. Commissions and other fees also include fees from investment banking activities including equity and bond underwriting.
Card fees were $911 million in second quarter 2010, down from $923 million a year ago. Recent legislative and regulatory changes limit our ability to increase interest rates and assess certain fees on card accounts. The anticipated net impact in third quarter 2010 related to these changes is estimated to be $30 million (after tax). The actual impact in 2010 and future periods could vary due to a variety of factors, including changes in customer behavior, economic conditions and other potential offsetting factors.
Mortgage banking noninterest income was $2.0 billion in second quarter 2010, down from $3.0 billion a year ago. The reduction in mortgage banking noninterest income is primarily driven by the decline in net gains on mortgage loan origination/sales activities of $1.4 billion to $793 million for second quarter 2010 from $2.2 billion for second quarter 2009, primarily due to lower origination volumes and a net increase in the mortgage loan repurchase reserve. Residential real estate originations were $81 billion in second quarter 2010, down 37% from $129 billion a year ago. The 1-4 family first mortgage unclosed pipeline was $68 billion at June 30, 2010, and $57 billion at December 31, 2009. For additional information, see the Risk Management Mortgage Banking Interest Rate and Market Risk section and Note 1 (Summary of Significant Accounting Policies), Note 8 (Mortgage Banking Activities) and Note 12 (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 reserve as well as adjustments of loans in the warehouse/pipeline for changes in market conditions that affect their value. Mortgage loans are repurchased based on standard representations and warranties and early payment default clauses in mortgage sale contracts. Additions to the mortgage repurchase reserve that were charged against net gains on mortgage loan origination/sales activities during second quarter 2010 were $382 million and $784 million for the first half of 2010. For additional information about mortgage loan repurchases, see the Risk Management Credit Risk Management Process Reserve for Mortgage Loan Repurchase Losses section and Note 7 (Securitizations and Variable Interest Entities) to Financial Statements in this Report.
The reduction in net gains on mortgage loan origination/sales activities was partially offset by an increase in net servicing income. Net servicing income increased $402 million from a year ago primarily due to growth in the servicing portfolio, reduced mortgage servicing rights (MSR) amortization due to lower payoffs, and lower servicing foreclosure costs due to more loan modifications and loss mitigation activities in addition to stabilization in the delinquencies in our servicing portfolio. In addition to servicing fees, net servicing income includes both changes in the fair value of MSRs during the period as well as changes in the value of derivatives (economic hedges) used to hedge the MSRs. Net servicing income for second quarter 2010 included a $626 million net MSRs valuation gain ($2.7 billion decrease in the fair value of the MSRs offsetting a $3.3 billion hedge gain) and for second quarter 2009 included a $1.0 billion net MSRs valuation gain ($2.3 billion increase in the fair value of MSRs partially offsetting a $1.3 billion hedge loss). 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. At June 30, 2010, the ratio of MSRs to related loans serviced for others was 0.76% compared with 0.91% at December 31, 2009. The average note rate was 5.53%, the lowest since we reentered the servicing business.
Income from trading activities was a $109 million gain in second quarter 2010, down from a $749 million gain a year ago. This decrease was driven by challenging market conditions and continued reductions in risk positions in this business, since the merger with Wachovia, while continuing to support customer-related activities.
Aggregate net gains on debt securities available for sale and equity securities totaled $318 million in second quarter 2010, compared with net losses of $38 million a year ago. The year-over-year
improvement was due to lower impairment write-downs of $168 million in second quarter 2010, down from $463 million a year ago. For additional information, see the Balance Sheet Analysis Securities Available for Sale section and Note 4 (Securities Available for Sale) to Financial Statements in this Report.
Operating lease income was $329 million in second quarter 2010, up $161 million from a year ago primarily due to gains on early lease terminations.
The increase in All other noninterest income to $581 million in second quarter 2010 from $476 million a year ago was due to gains on loan sales.
Noninterest expense was $12.7 billion in second quarter 2010, flat compared with $12.7 billion in second quarter 2009, and included $498 million and $244 million of merger integration costs for the same periods, respectively. Noninterest expense in second quarter 2010 also included $137 million of severance costs related to the Wells Fargo Financial restructuring. Foreclosed assets expense was $333 million in second quarter 2010, up 78% from a year ago due to a $2.5 billion increase in foreclosed assets year over year, including $1.6 billion of foreclosed loans in the PCI portfolio that are now recorded as foreclosed assets. Operating losses were $627 million, up $468 million from a year ago, predominantly due to additional litigation accruals. The $128 million increase in contract services from a year ago was merger related. Of our approximately $5.7 billion of estimated total Wachovia merger integration costs ($3.0 billion in aggregate through June 30, 2010), we expect to incur approximately $2.1 billion in 2010, of which $878 million was recorded in the first half of 2010, as we convert banking stores and lines of business, and continue to build infrastructure.
Federal Deposit Insurance Corporation (FDIC) and other deposit assessments were $295 million in second quarter 2010, down from $981 million a year ago, which included additional assessments related to the FDIC Transaction Account Guarantee Program and the FDIC special assessment of $565 million. The $95 million decline in insurance expense from second quarter 2009 was predominantly due to lower insurance reserves at our captive mortgage reinsurance operation for second quarter 2009.
In addition to merger integration, we continued to invest for long-term growth throughout the Company, hiring in regional banking and commercial banking as we apply Wells Fargos model to the eastern markets, and investing in technology to improve service across our franchise. We converted 87 Wachovia
banking stores in California in second quarter 2010 and opened 13 banking stores in the quarter for a retail network total of 6,445 stores.
INCOME TAX EXPENSE
Our effective income tax rate was 33.1% in second quarter 2010, up from 31.8% in second quarter 2009, and was 34.2% for the first half of 2010, up from 32.8% for the first half of 2009. The increase for the first half of 2010 was partly due to additional tax expense in 2010 related to the new health care legislation and fewer favorable settlements with tax authorities.
OPERATING SEGMENT RESULTS
We have three lines of business for management reporting: Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement. We define our operating segments by product and customer. Our management accounting process measures the performance of the operating segments based on our management structure and is not necessarily comparable with similar information for other financial services companies.
The table below 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 16 (Operating Segments) to Financial Statements in this Report.
OPERATING SEGMENT RESULTS HIGHLIGHTS
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.
Community Bankings net income decreased 14% to $1.8 billion in second quarter 2010 from $2.1 billion a year ago. Revenue decreased to $13.7 billion and $27.8 billion in the second quarter and first half of 2010, respectively, from $15.2 billion and $29.6 billion for the same periods a year ago. Net interest income decreased $840 million, or 9%, in second quarter 2010 from a year ago driven by the planned reduction in certain liquidating loan portfolios. Average loans decreased $26.7 billion, or 5%, in second quarter 2010 from a year ago, due to the run-off of liquidating loan portfolios and low demand. Average core deposits decreased $32.2 billion in second quarter 2010 from a year ago, primarily due to
$57 billion of higher cost Wachovia CDs maturing, partially offset by $31 billion of largely lower-cost CDs retained, and growth in customer deposits. Noninterest income decreased $671 million, or 11%, driven primarily by lower mortgage banking income. The provision for loan losses decreased $946 million, or 22%, due to lower net charge-offs and a $389 million credit reserve release in second quarter 2010 compared with a $479 million credit reserve build a year ago. Noninterest expense decreased $211 million, or 3%, due to the FDIC special assessment in second quarter 2009 and Wachovia merger-related cost savings.
Wholesale Banking provides financial solutions to businesses across the United States with annual sales generally in excess of $10 million and financial institutions globally. Products include middle market banking, corporate banking, commercial real estate, treasury management, asset-based lending, insurance brokerage, foreign exchange, correspondent banking, trade services, specialized lending, equipment finance, corporate trust, investment banking, capital markets, and asset management.
Wholesale Bankings net income of $1.4 billion in second quarter 2010 was up 32% from second quarter 2009. Net income increased to $2.6 billion for the first half of 2010 from $2.2 billion a year ago. Wholesale banking results for second quarter 2010 included $495 million in commercial PCI loan resolutions, substantially all of which was recognized in net interest income, due to success in selling or settling commercial PCI loans. Net interest income of $3.0 billion in second quarter 2010 increased 21% from $2.5 billion a year ago, due to the commercial PCI loan resolutions, offset by lower average loans. Average loans of $223.4 billion declined 14% from second quarter 2009 driven by declines across most lending areas. Average core deposits of $161.5 billion in second quarter 2010 increased 18% from $137.4 billion a year ago driven by growth in both interest-bearing and non-interest bearing deposits primarily in global financial institutions, government and institutional banking and commercial banking. The provision for credit losses declined $112 million from second quarter 2009. The decrease included a $111 million reserve release in the second quarter 2010 compared with a $162 million credit reserve build a year ago. Noninterest income of $2.7 billion in second quarter 2010 decreased 4% from $2.8 billion a year ago. The decline was driven primarily by lower capital markets related trading results as well as lower investment banking revenues. Noninterest expense of $2.8 billion in second quarter 2010 increased 1% from a year ago as higher legal and foreclosed asset expenses were partially offset by lower personnel expense and FDIC assessments.
Wealth, Brokerage and Retirement provides a full range of financial advisory services to clients using a planning approach to meet each clients 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. Family Wealth meets the unique needs of the ultra high net worth customers. Retail brokerages financial advisors serve customers advisory, brokerage and financial needs as part of one of the largest full-service brokerage firms in the U.S. 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 Retirements net income increased 5% to $270 million in second quarter 2010 from $258 million a year ago. Net income increased to $552 million in the first half of 2010, up from $434 million a year ago. Revenue increased to $2.9 billion and $5.8 billion in the second quarter and first half of 2010, respectively, from $2.8 billion and $5.3 billion a year ago. Net interest income increased 7% to $684 million from $637 million a year ago, predominantly due to higher corporate investment allocation. Average loans decreased 7% to $42.6 billion in second quarter 2010 from $46.0 billion a year ago. The provision for credit losses decreased $30 million to $81 million in second quarter 2010 from $111 million a year ago, primarily due to second quarter 2009 reserve build. Noninterest expense
increased $50 million, 2%, to $2.4 billion in second quarter 2010 from $2.3 billion a year ago predominantly due to higher broker commissions on increased production.
BALANCE SHEET ANALYSIS
During second quarter 2010, our total assets, loans and core deposits each decreased slightly from December 31, 2009, but the strength of our business model continued to produce high rates of internal capital generation as reflected in our improved capital ratios. As a percentage of total risk-weighted assets, Tier 1 capital increased to 10.5%, total capital to 14.5%, Tier 1 leverage to 8.7% and Tier 1 common equity to 7.6% at June 30, 2010, up from 9.3%, 13.3%, 7.9% and 6.5%, respectively, at December 31, 2009. The Company purchased $540 million of warrants from the U.S. Treasury during second quarter 2010, which reduced the Tier 1 common ratio by approximately 5 basis points. The loan portfolio is now predominantly funded with core deposits and we have significant capacity to add higher yielding long-term mortgage-backed securities (MBS) for future revenue and earnings growth.
The following sections provide additional information about the major components of our balance sheet. Capital is discussed in the Capital Management section of this Report.
SECURITIES AVAILABLE FOR SALE
Securities available for sale consist 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 very liquid, high-quality federal agency debt and privately issued MBS. The total net unrealized gains on securities available for sale of $8.6 billion at June 30, 2010, were up from $5.6 billion at December 31, 2009, due to a general decline in long-term yields and narrowing of credit spreads.
Comparative detail of average balances of securities available for sale is provided in the table under Earnings Performance Net Interest Income earlier in this Report.
We analyze securities for other-than-temporary impairment (OTTI) on a quarterly basis, or more often if a potential loss-triggering event occurs. The initial indication of OTTI for both debt and equity securities is a decline in the market value below the amount recorded for an investment, and the severity and duration of the decline. In determining whether an impairment is other than temporary, we consider the length of time and the extent to which the market value has been below cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions within its industry, and whether it is more likely than not that we will be required to sell the security before a recovery in value.
At June 30, 2010, we had approximately $6 billion of investments in securities, primarily municipal bonds, which are guaranteed against loss by bond insurers. These securities 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 insurers guarantee in making the investment
decision. These securities will continue to be monitored as part of our on-going impairment analysis of our securities available for sale, but are expected to perform, even if the rating agencies reduce the credit rating of the bond insurers.
The weighted-average expected maturity of debt securities available for sale was 5.0 years at June 30, 2010. Since 69% 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 the following table.
MORTGAGE-BACKED SECURITIES INTEREST RATE SENSITIVITY ANALYSIS
See Note 4 (Securities Available for Sale) to Financial Statements in this Report for securities available for sale by security type.
A discussion of average loan balances and a comparative detail of average loan balances is included in Earnings Performance Net Interest Income earlier 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.
As of December 31, 2008, certain of the loans acquired from Wachovia had evidence of credit deterioration since their origination, and it was probable that we would not collect all contractually required principal and interest payments. Such loans identified at the time of the acquisition were accounted for using the measurement provisions for PCI loans. PCI loans were recorded at fair value at the date of acquisition, and any related allowance for loan losses was not permitted to be carried over.
PCI loans were written down to an amount estimated to be collectible. Accordingly, such loans are not classified as nonaccrual, even though they may be contractually past due, because we expect to fully collect the new carrying values of such loans (that is, the new cost basis arising out of our purchase accounting).
A nonaccretable difference was established in purchase accounting for PCI loans to absorb losses expected at that time on those loans. Amounts absorbed by the nonaccretable difference do not affect the income statement or the allowance for credit losses. Substantially all of our commercial, CRE and foreign PCI loans are accounted for as individual loans. Conversely, Pick-a-Pay and other consumer PCI loans have been aggregated into several pools based on common risk characteristics. Each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Resolutions of loans may include sales of loans to third parties, receipt of payments in settlement with the borrower, or foreclosure of the collateral. Our policy is to remove an individual loan from a pool based on comparing the amount received from its resolution with its contractual amount. Any difference between these amounts is absorbed by the nonaccretable difference. This removal method assumes that the amount received from resolution approximates pool performance expectations. The remaining accretable yield balance is unaffected and any material change in remaining effective yield caused by this removal method is addressed by our quarterly cash flow evaluation process for each pool. For loans in pools that are resolved by payment in full, there is no release of the nonaccretable difference since there is no difference between the amount received at resolution and the contractual amount of the loan. In second quarter 2010, we recognized in income $506 million of nonaccretable difference related to commercial PCI loans due to payoffs and dispositions of these loans, compared with $182 million in first quarter 2010. We also transferred $1.9 billion from the nonaccretable difference to the accretable yield, of which $1.8 billion was due to sustained positive performance in the Pick-a-Pay portfolio. The increase in the accretable yield for the Pick-a-Pay portfolio had no impact on second quarter 2010 net income and is expected to be recognized as a yield adjustment to income over the remaining life of the loans, which is estimated to have a weighted-average life of eight years.
The following table provides an analysis of changes in the nonaccretable difference related to principal that is not expected to be collected for the second quarter and first half of 2010.
CHANGES IN NONACCRETABLE DIFFERENCE FOR PCI LOANS
Since the Wachovia acquisition, we have released $4.2 billion in nonaccretable difference, including $3.0 billion transferred from the nonaccretable difference to the accretable yield and $1.2 billion released through loan resolutions. We provided $1.2 billion in the allowance for credit losses in excess of the initial expected levels on certain PCI loans; the net result is a $3.0 billion improvement in our initial projected losses on PCI loans. At June 30, 2010, the allowance for credit losses in excess of initial expected levels on certain PCI loans was $225 million. The following table analyzes the actual and projected loss results on PCI loans since the acquisition of Wachovia on December 31, 2008, through June 30, 2010.
For further information on PCI loans, see Note 1 (Summary of Significant Accounting Policies Loans) to Financial Statements in the 2009 Form 10-K and Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.
Deposits totaled $815.6 billion at June 30, 2010, compared with $824.0 billion at December 31, 2009. Comparative detail of average deposit balances is provided in the table under Earnings Performance Net Interest Income earlier in this Report. Total core deposits were $758.7 billion at June 30, 2010, down from $780.7 billion at December 31, 2009.
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
In the normal course of business, we 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.
NEWLY CONSOLIDATED VIE ASSETS AND LIABILITIES
Effective January 1, 2010, we adopted new consolidation accounting guidance and, accordingly, consolidated certain VIEs that were not included in our consolidated financial statements at December 31, 2009. On January 1, 2010, we recorded the assets and liabilities of the newly consolidated variable interest entities (VIEs) and derecognized our existing interests in those VIEs. We also recorded a $183 million increase to beginning retained earnings as a cumulative effect adjustment and recorded a $173 million increase to other comprehensive income (OCI).
The following table presents the net incremental assets recorded on our balance sheet by structure type upon adoption of new consolidation accounting guidance.
In accordance with the transition provisions of the new consolidation accounting guidance, we initially recorded newly consolidated VIE assets and liabilities at a basis consistent with our accounting for respective assets at their amortized cost basis, except for those VIEs for which the fair value option was elected. The carrying amount for loans approximate the outstanding unpaid principal balance, adjusted for allowance for loan losses. Short-term borrowings and long-term debt approximate the outstanding par amount due to creditors.
Upon adoption of new consolidation accounting guidance on January 1, 2010, we elected fair value option accounting for certain nonconforming residential mortgage loan securitization VIEs. This election requires us to recognize the VIEs eligible assets and liabilities on the balance sheet at fair value with changes in fair value recognized in earnings. Such eligible assets and liabilities consisted primarily of loans and long-term debt, respectively. The fair value option was elected for those newly consolidated
VIEs for which our interests, prior to January 1, 2010, were predominantly carried at fair value with changes in fair value recorded to earnings. Accordingly, the fair value option was elected to effectively continue fair value accounting through earnings for those interests. Conversely, fair value option was not elected for those newly consolidated VIEs that did not share these characteristics. At January 1, 2010, the fair value of loans and long-term debt for which the fair value option was elected was $1.0 billion and $1.0 billion, respectively. The incremental impact of electing fair value option (compared to not electing) on the cumulative effect adjustment to retained earnings was an increase of $15 million.
All financial institutions must manage and control a variety of business risks that can significantly affect their financial performance. Key among these are credit, asset/liability and market risk.
For further discussion about how we manage these risks, see pages 5471 of our 2009 Form 10-K. The discussion that follows is intended to provide an update on these risks.
CREDIT RISK MANAGEMENT
Our credit risk management process is governed centrally, but provides for decentralized credit management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, judgmental or statistical credit underwriting, frequent and detailed risk measurement and modeling, extensive credit training programs, and a continual loan review and audit process. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes. For more information on our credit risk management process, please refer to page 54 in our 2009 Form 10-K.
Credit Quality Overview
In connection with first quarter 2010 results, we said we believed quarterly credit losses peaked in fourth quarter 2009 and provision expense peaked in third quarter 2009. The significant reduction in credit losses in second quarter 2010 confirmed our prior outlook and we have seen credit quality improve earlier and to a greater extent than we had previously expected. The continued improvement in credit performance is a result of a slowly improving economy coupled with actions taken by the Company over the past several years to improve underwriting standards, mitigate losses and exit portfolios with unattractive credit metrics.
Measuring and monitoring our credit risk is an ongoing process that tracks delinquencies, collateral values, economic trends by geographic areas, loan-level risk grading for certain portfolios (typically commercial) and other indications of risk to loss. Our credit risk monitoring process is designed to enable early identification of developing risk to loss and to support our determination of an adequate allowance for loan losses. During the current economic cycle our monitoring and resolution efforts have focused on loan portfolios exhibiting the highest levels of risk including mortgage loans supported by real estate (both consumer and commercial), junior lien, commercial, credit card and subprime portfolios. The following sections include additional information regarding each of these loan portfolios and their relevant concentrations and credit quality performance metrics.
The following table identifies our non-strategic and liquidating loan portfolios as of June 30, 2010, and December 31, 2009.
NON-STRATEGIC AND LIQUIDATING LOAN PORTFOLIOS
Commercial Real Estate (CRE)
The CRE portfolio consists of both CRE mortgages and CRE construction loans. The combined CRE loans outstanding totaled $130.5 billion at June 30, 2010, or 17% of total loans. CRE construction loans totaled $30.9 billion at June 30, 2010, or 4% of total loans. Permanent CRE loans totaled $99.6 billion at June 30, 2010, or 13% of total loans. The portfolio is diversified both geographically and by property type. The largest geographic concentrations are found in California and Florida, which represented 22% and 11% of the total CRE portfolio, respectively. By property type, the largest concentrations are office buildings at 23% and industrial/warehouse at 12% of the portfolio.
The underwriting of CRE loans primarily focuses on cash flows and creditworthiness, and not solely collateral valuations. To identify and manage newly emerging problem CRE loans, we employ a high level of surveillance and regular customer interaction to understand and manage the risks associated with these assets, including regular loan reviews and appraisal updates. As issues are identified, management is engaged and dedicated workout groups are in place to manage problem assets. At June 30, 2010, the remaining balance of PCI CRE loans totaled $7.7 billion, down from a balance of $19.3 billion at December 31, 2008, reflecting the reduction resulting from loan resolutions and write-downs.
The following table summarizes CRE loans by state and property type with the related nonaccrual totals. At June 30, 2010, the highest concentration of non-PCI CRE loans by state was $27.3 billion in California, more than double the next largest state concentration, and the related nonaccrual loans totaled about $1.7 billion, or 6.2% of CRE loans in California. Office buildings, at $27.9 billion of non-PCI loans, were the largest property type concentration, almost double the next largest, and the related nonaccrual loans totaled $1.5 billion, or 5.3% of CRE loans for office buildings. Of CRE mortgage loans (excluding CRE construction loans), 42% related to owner-occupied properties at June 30, 2010. Nonaccrual loans totaled 6.6% of the non-PCI outstanding balance at June 30, 2010.
CRE LOANS BY STATE AND PROPERTY TYPE
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Commercial Loans and Lease Financing
For purposes of portfolio risk management, we aggregate commercial loans and lease financing according to market segmentation and standard industry codes. The following table summarizes commercial loans and lease financing by industry with the related nonaccrual totals. This portfolio has experienced less credit deterioration than our CRE portfolio as evidenced by its lower nonaccrual rate of 2.5% compared with 6.2% for the CRE portfolios. We believe this portfolio is well underwritten and is diverse in its risk with relatively similar concentrations across several industries. A majority of our commercial loans and lease financing portfolio is secured by short-term assets, such as accounts receivable, inventory and securities, as well as long-lived assets, such as equipment and other business assets. Our credit risk management process for this portfolio primarily focuses on a customers ability to repay the loan through their cash flow. Generally, collateral securing this portfolio represents a secondary source of repayment.
COMMERCIAL LOANS AND LEASE FINANCING BY INDUSTRY
During the recent credit cycle, we have experienced an increase in requests for extensions of construction and commercial loans which have repayment guarantees. All extensions are granted based on a re-underwriting of the loan and our assessment of the borrowers ability to perform under the agreed-upon terms. At the time of extension, borrowers are generally performing in accordance with the contractual loan terms. Extension terms generally range from six to thirty-six months and may require that the borrower provide additional economic support in the form of partial repayment, amortization or additional collateral or guarantees. In cases where the value of collateral or financial condition of the
borrower is insufficient to repay our loan, we may rely upon the support of an outside repayment guarantee in providing the extensions. In considering the impairment status of the loan, we evaluate the collateral and future cash flows as well as the anticipated support of any repayment guarantor. When performance under a loan is not reasonably assured, including the performance of the guarantor, we charge-off all or a portion of a loan based on the fair value of the collateral securing the loan.
Our ability to seek performance under the guarantee is directly related to the guarantors creditworthiness, capacity and willingness to perform. We evaluate a guarantors capacity and willingness to perform on an annual basis, or more frequently as warranted. Our evaluation is based on the most current financial information available and is focused on various key financial metrics, including net worth, leverage, and current and future liquidity. We consider the guarantors reputation, creditworthiness, and willingness to work with us based on our analysis as well as other lenders experience with the guarantor. Our assessment of the guarantors credit strength is reflected in our loan risk ratings for such loans. The loan risk rating is an important factor in our allowance methodology for commercial and commercial real estate loans.
As part of the Wachovia acquisition, we acquired residential first mortgage and home equity loans that are very similar to the Wells Fargo core originated portfolio. We also acquired the Pick-a-Pay portfolio, which describes one of the consumer mortgage portfolios. Under purchase accounting for the Wachovia acquisition, we made purchase accounting adjustments to the Pick-a-Pay loans considered to be impaired under accounting guidance for PCI loans.
Our Pick-a-Pay portfolio had an unpaid principal balance of $97.1 billion and a carrying value of $80.2 billion at June 30, 2010. The Pick-a-Pay portfolio is a liquidating portfolio, as Wachovia ceased originating new Pick-a-Pay loans in 2008. Equity lines of credit and closed-end second liens associated with Pick-a-Pay loans are reported in the Home Equity core portfolio. The Pick-a-Pay portfolio includes loans that offer payment options (Pick-a-Pay option payment loans), loans that were originated without the option payment feature, loans that no longer offer the option feature as a result of our modification efforts since the acquisition, and loans where the customer voluntarily converted to a fixed-rate product. The following table provides balances over time related to the types of loans included in the portfolio.
PCI loans in the Pick-a-Pay portfolio had an unpaid principal balance of $51.0 billion and a carrying value of $34.9 billion at June 30, 2010. The carrying value of the PCI loans is net of purchase accounting write-downs to reflect their fair value at acquisition. Upon acquisition, we recorded a $22.4 billion write-down in purchase accounting on Pick-a-Pay loans that were impaired. Due to the sustained positive performance observed on the Pick-a-Pay portfolio compared to the original acquisition estimates, we reclassified $1.8 billion from the nonaccretable difference to the accretable yield in second quarter 2010 for a total of $2.4 billion that has been reclassified since the Wachovia merger. This improvement in the lifetime credit outlook for this portfolio is primarily attributable to the significant modification efforts and the observed emergence of performance on these modifications as well as the portfolios delinquency
stabilization over the last several months. This improvement in the credit outlook will be realized over the remaining life of the portfolio, which is estimated to have a weighted average life of approximately eight years.
Pick-a-Pay option payment loans may be adjustable or fixed rate. They are home mortgages on which the customer has the option each month to select from among four payment options: (1) a minimum payment as described below, (2) an interest-only payment, (3) a fully amortizing 15-year payment, or (4) a fully amortizing 30-year payment. The minimum monthly payment for substantially all of our Pick-a-Pay loans is reset annually. The new minimum monthly payment amount generally increases by no more than 7.5% of the prior minimum monthly payment. The minimum payment may not be sufficient to pay the monthly interest due and in those situations a loan on which the customer has made a minimum payment is subject to negative amortization, where unpaid interest is added to the principal balance of the loan. The amount of interest that has been added to a loan balance is referred to as deferred interest. Total deferred interest was $3.2 billion at June 30, 2010, down from $3.7 billion at December 31, 2009, due to loan modification efforts as well as falling interest rates resulting in the minimum payment option covering the interest and some principal on many loans. At June 30, 2010, approximately 64% of customers choosing the minimum payment option did not defer interest. In situations where the minimum payment is greater than the interest-only option, the customer has only three payment options available: (1) a minimum required payment, (2) a fully amortizing 15-year payment, or (3) a fully amortizing 30-year payment.
Deferral of interest on a Pick-a-Pay loan may continue as long as the loan balance remains below a pre-defined principal cap, which is based on the percentage that the current loan balance represents to the original loan balance. Loans with an original loan-to-value (LTV) ratio equal to or below 85% have a cap of 125% of the original loan balance, and these loans represent substantially all the Pick-a-Pay portfolio. Loans with an original LTV ratio above 85% have a cap of 110% of the original loan balance. Most of the Pick-a-Pay loans on which there is a deferred interest balance re-amortize (the monthly payment amount is recast) on the earlier of the date when the loan balance reaches its principal cap, or the 10-year anniversary of the loan. For a small population of Pick-a-Pay loans, the recast occurs at the five-year anniversary. After a recast, the customers new payment terms are reset to the amount necessary to repay the balance over the remainder of the original loan term.
Due to the terms of this Pick-a-Pay portfolio, we believe there is minimal recast risk over the next three years. Based on assumptions of a flat rate environment, if all eligible customers elect the minimum payment option 100% of the time and no balances prepay, we would expect the following balances of option payment loans to recast based on reaching the principal cap: $2 million in the remaining half of 2010, $1 million in 2011 and $3 million in 2012. In second quarter 2010, no option payment loans recast based on reaching the principal cap. In addition, we would expect the following balances of option payment loans to start fully amortizing due to reaching their recast anniversary date and also having a payment change at the recast date greater than the annual 7.5% reset: $12 million in the remaining half of 2010, $37 million in 2011 and $41 million in 2012. In second quarter 2010, the amount of option payment loans reaching their recast anniversary date and also having a payment change over the annual 7.5% reset was $12 million.
The following table reflects the geographic distribution of the Pick-a-Pay portfolio broken out between PCI loans and all other loans. In stressed housing markets with declining home prices and increasing delinquencies, the LTV ratio is a useful metric in predicting future real estate 1-4 family first mortgage loan performance, including potential charge-offs. Because PCI loans were initially recorded at fair value written down for expected credit losses, the ratio of the carrying value to the current collateral value for
acquired loans with credit impairment will be lower as compared with the LTV based on the unpaid principal. For informational purposes, we have included both ratios in the following table.
PICK-A-PAY PORTFOLIO (1)
To maximize return and allow flexibility for customers to avoid foreclosure, we have in place several loss mitigation strategies for our Pick-a-Pay loan portfolio. We contact customers who are experiencing difficulty and may in certain cases modify the terms of a loan based on a customers documented income and other circumstances.
We also have taken steps to work with customers to refinance or restructure their Pick-a-Pay loans into other loan products. For customers at risk, we offer combinations of term extensions of up to 40 years (from 30 years), interest rate reductions, forbearance of principal, interest only payments for a period of time and, in geographies with substantial property value declines, we will even offer permanent principal reductions.
In fourth quarter 2009, we rolled out the U.S. Treasury Departments HAMP to the customers in this portfolio. As of June 30, 2010, over 15,000 HAMP applications were being reviewed by our loan servicing department and an additional 13,500 loans have been approved for the HAMP trial modification. We believe a key factor to successful loss mitigation is tailoring the revised loan payment to the customers sustainable income. We continually reassess our loss mitigation strategies and may adopt additional or different strategies in the future.
In second quarter 2010, we completed 7,052 proprietary and HAMP loan modifications and have completed over 64,000 modifications since acquisition. The majority of the loan modifications were
concentrated in our PCI Pick-a-Pay loan portfolio. Approximately 5,400 modification offers were proactively sent to customers in second quarter 2010. As part of the modification process, the loans are re-underwritten, income is documented and the negative amortization feature is eliminated. Most of the modifications result in material payment reduction to the customer. Because of the write-down of the PCI loans in purchase accounting, our post merger modifications to PCI Pick-a-Pay loans have not resulted in any modification-related provision for credit losses. To the extent we modify loans not in the PCI Pick-a-Pay portfolio, we establish an impairment reserve in accordance with the applicable accounting requirements for loan restructurings.
Home Equity Portfolios
The deterioration in specific segments of the legacy Wells Fargo Home Equity portfolios, which began almost three years ago, required a targeted approach to managing these assets. In fourth quarter 2007, a liquidating portfolio was identified, consisting of home equity loans generated through the wholesale channel not behind a Wells Fargo first mortgage, and home equity loans acquired through correspondents. The liquidating portion of the Home Equity portfolio was $7.6 billion at June 30, 2010, compared with $8.4 billion at December 31, 2009. The loans in this liquidating portfolio represent about 1% of total loans outstanding at June 30, 2010, and contain some of the highest risk in our $123.0 billion Home Equity portfolio, with a loss rate of 10.90% compared with 3.54% for the core portfolio. The loans in the liquidating portfolio are largely concentrated in geographic markets that have experienced the most abrupt and steepest declines in housing prices. The core portfolio was $115.3 billion at June 30, 2010, of which 97% was originated through the retail channel and approximately 19% of the outstanding balance was in a first lien position. The following table includes the credit attributes of these two portfolios. California loans represent the largest state concentration in each of these portfolios and have experienced among the highest early-term delinquency and loss rates.
HOME EQUITY PORTFOLIOS (1)
Wells Fargo Financial
Wells Fargo Financials portfolio consists of real estate loans, substantially all of which are secured debt consolidation loans, and both prime and non-prime auto secured loans, unsecured loans and credit cards. In July 2010, we announced the restructuring of our Wells Fargo Financial division and that we are exiting the origination of non-prime portfolio mortgage loans. The remaining consumer and commercial loan products offered through Wells Fargo Financial will be realigned with those offered by our other business units and will be available through our expanded network of community banking and home mortgage stores.
Wells Fargo Financial had $23.5 billion in real estate secured loans at June 30, 2010, and $25.8 billion at December 31, 2009. Of this portfolio, $1.4 billion and $1.6 billion, respectively, was considered prime based on secondary market standards and has been priced to the customer accordingly. The remaining portfolio is non-prime but was originated with standards to reduce credit risk. These loans were originated through our retail channel with documented income, LTV limits based on credit quality and property characteristics, and risk-based pricing. In addition, the loans were originated without teaser rates, interest-only or negative amortization features. Credit losses in the portfolio have increased in the current economic environment compared with historical levels, but performance remained similar to prime portfolios in the industry with overall loss rates of 4.20% (annualized) in the first half of 2010 on the entire portfolio. At June 30, 2010, $7.8 billion of the portfolio was originated with customer FICO scores below 620, but these loans have further restrictions on LTV and debt-to-income ratios intended to limit the credit risk.
Wells Fargo Financial also had $13.4 billion in auto secured loans and leases at June 30, 2010, and $16.5 billion at December 31, 2009, of which $4.0 billion and $4.4 billion, respectively, were originated with customer FICO scores below 620. Loss rates in this portfolio were 2.76% (annualized) in the second quarter and 3.57% (annualized) in the first half of 2010 for FICO scores of 620 and above, and 3.59% (annualized) and 4.75% (annualized), respectively, for FICO scores below 620. These loans were priced based on relative risk. Of this portfolio, $8.3 billion represented loans and leases originated through its indirect auto business, a channel Wells Fargo Financial ceased using near the end of 2008.
Wells Fargo Financial had $7.2 billion in unsecured loans and credit card receivables at June 30, 2010, and $8.1 billion at December 31, 2009, of which $0.8 billion and $1.0 billion, respectively, was originated with customer FICO scores below 620. Net loss rates in this portfolio were 11.51% (annualized) in the second quarter and 11.41% (annualized) in the first half of 2010 for FICO scores of 620 and above, and 15.51% (annualized) and 15.08% (annualized), respectively, for FICO scores below 620. Wells Fargo Financial has tightened credit policies and managed credit lines to reduce exposure during the recent economic environment.
Our credit card portfolio, a portion of which is included in the Wells Fargo Financial discussion above, totaled $22.1 billion at June 30, 2010, which represented 3% of our total outstanding loans and was smaller than the credit card portfolios of each of our large bank peers. Delinquencies of 30 days or more were 5.3% of credit card outstandings at June 30, 2010, down from 5.5% at December 31, 2009. Net charge-offs were 10.45% (annualized) for second quarter 2010, down from 11.17% (annualized) in first quarter 2010, reflecting previous risk mitigation efforts that included tightened underwriting and line management changes. Enhanced underwriting criteria and line management initiatives instituted in previous quarters continued to have positive effects on loss performance.
Nonaccrual Loans and Other Nonperforming Assets
The following table shows the comparative data for nonaccrual loans and other nonperforming assets (NPAs). We generally place loans on nonaccrual status when:
Note 1 (Summary of Significant Accounting Policies Loans) to Financial Statements in our 2009 Form 10-K describes our accounting policy for nonaccrual and impaired loans.
NONACCRUAL LOANS AND OTHER NONPERFORMING ASSETS