Wells Fargo 10-Q 2011
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, 2011
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.
Yes þ No o
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 o
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).
Yes o No þ
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 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 and Risk Factors sections, as well as in the Regulation and Supervision section of our Annual Report on Form 10-K for the year ended December 31, 2010 (2010 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.
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 banking stores, 12,000 ATMs, 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. With approximately 275,000 team members, we serve one in three households in America and ranked No. 23 on Fortunes 2011 rankings of Americas largest corporations. We ranked fourth in assets and second in the market value of our common stock among our large bank peers at June 30, 2011.
Our Vision and Strategy
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 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 combined company retail bank household cross-sell was 5.84 products per household in second quarter 2011, up from 5.64 a year ago. We believe there is more opportunity for cross-sell as we continue to earn more business from our Wachovia customers. Our goal is eight products per customer, which is approximately half of our estimate of potential demand for an average U.S. household. One of every four of our retail banking households has eight or more products. Business banking cross-sell offers another potential opportunity for growth, with cross-sell of 4.17 products in our Western footprint in second quarter
2011 (including legacy Wells Fargo and converted Wachovia customers), up from 3.88 a year ago.
Our pursuit of growth and earnings performance is influenced by our belief that it is important to maintain a well controlled operating environment as we complete the integration of the Wachovia businesses and grow the combined company. 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 important to us, but we approach this in a manner intended to help ensure our revenue is not adversely affected. Our current company-wide expense management initiative is focused on removing unnecessary complexity and eliminating duplication as a way to improve the customer experience and the work process of our team members. We are still in the early stages of this initiative and expect meaningful cost savings over time. With this initiative and the completion of merger-related activities, we are targeting to reduce quarterly noninterest expense to $11 billion by fourth quarter 2012 from $12.5 billion in second quarter 2011. The target reflects expense savings initiatives that will be executed over the next six quarters. Quarterly expense trends may vary due to cyclical or seasonal factors, particularly in the first quarter of each year when higher incentive compensation and employee benefit expenses typically occur.
Wells Fargo net income was $3.9 billion in second quarter 2011, up 29% from a year ago, and diluted earnings per common share were $0.70, up 27%. Our net income growth from a year ago included contributions from each of our three business segments: Community Banking (up 22%); Wholesale Banking (up 32%); and Wealth, Brokerage and Retirement (up 23%).
On a linked-quarter basis, total revenues, loans, deposits and capital and capital ratios increased; our credit quality improved;
and our noninterest expense decreased. On a year-over-year basis, revenue was down 5% in second quarter 2011, reflecting a decline in mortgage banking income and lower service charges on deposits due to regulatory changes, as well as a decline in average loans as we continued to reduce our non-strategic and liquidating loan portfolios. Noninterest expense was down 2% from a year ago reflecting the benefit of reduced core deposit amortization and lower litigation accruals.
Our average core deposits grew 6% from a year ago to $807.5 billion at June 30, 2011. Average core deposits were 107% of total average loans in second quarter 2011, up from 99% a year ago. We continued to attract high quality core deposits in the form of checking and savings deposits, which grew 9% to $735.4 billion in second quarter 2011, from $672.0 billion a year ago, as we added new customers and deepened our relationships with existing customers.
We continued to experience significant improvement in our credit portfolio with lower net charge-offs, lower nonperforming assets (NPAs) and improved delinquency trends from first quarter 2011. The improvement in our credit portfolio was due in part to the continued decline in our non-strategic and liquidating loan portfolios (primarily from the Wachovia acquisition), which decreased $5.1 billion in second quarter 2011, and $69.0 billion in total since the Wachovia acquisition, to $121.8 billion at June 30, 2011.
Reflecting the improved performance in our loan portfolios, the $1.8 billion provision for credit losses for second quarter 2011 was $2.2 billion less than a year ago. The provision for credit losses was $1 billion less than net charge-offs in second quarter 2011 and $500 million less than net charge-offs for the same period a year ago. Absent significant deterioration in the economy, we expect future allowance releases. Second quarter 2011 marked the sixth consecutive quarter of decline in net charge-offs and the third consecutive quarter of reduced NPAs. Net charge-offs decreased significantly to $2.8 billion in second quarter 2011 from $3.2 billion in first quarter 2011, and $4.5 billion a year ago. NPAs decreased to $27.9 billion at June 30, 2011, from $30.5 billion at March 31, 2011, and $32.8 billion a year ago. Loans 90 days or more past due and still accruing (excluding government insured/guaranteed loans) decreased to $1.8 billion at June 30, 2011, from $2.4 billion at March 31, 2011, and $3.9 billion a year ago. In addition, the portfolio of purchased credit-impaired (PCI) loans acquired in the Wachovia merger continued to perform better than expected at the time of the merger.
We continued to build capital in second quarter 2011, with total stockholders equity up $10.0 billion from year-end 2010. In second quarter 2011, our Tier 1 common equity ratio grew 22 basis points to 9.15% of risk-weighted assets under Basel I, reflecting strong internal capital generation. Under current Basel III capital proposals, we estimate that our Tier 1 common equity ratio was 7.35% at the end of second quarter 2011. Our
other regulatory capital ratios also continued to grow with the Tier 1 capital ratio reaching 11.69% and Tier 1 leverage ratio reaching 9.43% at June 30, 2011. Additional capital requirements applicable to certain global systemically important financial institutions are under consideration by the Basel Committee. See the Capital Management section in this Report for more information regarding our capital, including Tier 1 common equity.
We redeemed $3.4 billion of trust preferred securities and re-started our open market common stock repurchase program. During second quarter 2011, we repurchased 35 million shares of our common stock. We also paid a quarterly dividend of $0.12 per common share.
Wachovia Merger Integration
On December 31, 2008, Wells Fargo acquired Wachovia, one of the nations largest diversified financial services companies. Our integration progress to date is on track and on schedule, and business and revenue synergies have exceeded our expectations since the merger was announced. To date we have converted 2,215 Wachovia stores and 23.7 million customer accounts, including mortgage, deposit, trust, brokerage and credit card accounts. With our conversion of retail banking stores in Pennsylvania and Florida (completed in early July), 83% of our banking customers company-wide are now on a single deposit system. The remaining Eastern banking markets are scheduled to convert by year-end 2011.
The Wachovia merger has already proven to be a financial success, with substantially all of the originally expected savings already realized and growing revenue synergies reflecting market share gains in many businesses, including mortgage, auto dealer services and investment banking. Some examples of merger revenue synergies include the following:
As a result of PCI accounting for loans acquired in the Wachovia merger, ratios of the Company, including the growth rate in NPAs since December 31, 2008, may not be directly comparable with periods prior to the merger or with credit-related ratios of other financial institutions. In particular:
Wells Fargo net income for second quarter 2011 was $3.9 billion ($0.70 diluted per common share) with $3.7 billion applicable to common stock, compared with net income of $3.1 billion ($0.55 diluted per common share) with $2.9 billion applicable to common stock for second quarter 2010. Net income for the first half of 2011 was $7.7 billion, up 37% from the same period a year ago. Our June 30, 2011, quarter-to-date and year-to-date earnings compared with the same periods a year ago reflected strong business fundamentals with diversified sources of fee income, increased deposits, lower operating costs, improved credit quality and higher capital levels.
Revenue, the sum of net interest income and noninterest income, was $20.4 billion in second quarter 2011 compared with $21.4 billion in second quarter 2010. Revenue for the first half of 2011 was $40.7 billion, down 5% from the same period a year ago. The decline in revenue in the first half of 2011 was predominantly due to lower net interest income and lower mortgage banking revenue. However, many businesses generated year over year quarterly revenue growth, including commercial banking, corporate banking, commercial real estate, international, debit card, global remittance, retail brokerage, auto dealer services and wealth management. Net interest income of $10.7 billion in second quarter 2011 declined 7% from a year ago driven by a 37 basis point decline in the net interest margin and a 3% decline in average loans. The decline in average loans reflected continued reductions in the non-strategic/liquidating portfolios. Continued success in generating low-cost deposits enabled the Company to grow assets while reducing long-term debt since December 31, 2010, including the redemption of $3.4 billion of higher-yielding trust preferred securities.
Noninterest expense was $12.5 billion (61% of revenue) in second quarter 2011, compared with $12.7 billion (60% of revenue) a year ago. Noninterest expense was $25.2 billion for the first half of 2011 compared with $24.9 billion for the same period a year ago. The second quarter and first half of 2011 included $484 million and $924 million, respectively, of merger integration costs (down from $498 million in second quarter 2010 and up from $878 million in the first half of 2010), and $428 million and $900 million, respectively, of operating losses (down from $627 million in second quarter 2010 and up from $835 million in the first half of 2010).
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 on a taxable-equivalent basis was $10.9 billion and $21.7 billion in the second quarter and first half of 2011, compared with $11.6 billion and $22.9 billion for the same periods a year ago. The net interest margin was 4.01% and 4.03% in the second quarter and first half of 2011, respectively, down from 4.38% and 4.33% for the same periods a year ago. Net interest margin was compressed relative to second quarter and first half of 2010 as lower-yielding cash and short-term investments increased as loan balances declined. The impact of these factors was somewhat mitigated by reduced long-term debt expense and continued disciplined deposit pricing.
The mix of earning assets and their yields are important drivers of net interest income. Soft consumer loan demand and the impact of liquidating certain loan portfolios reduced average loans in second quarter 2011 to 69% (69% in the first half of 2011) of average earning assets from 72% in second quarter 2010 (73% in the first half of 2010). Average short-term investments and trading account assets were 12% of earning assets in both the second quarter and first half of 2011, up from 9% and 8%, respectively, for the same periods a year ago.
Core deposits are a low-cost source of funding and thus an important contributor to both 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 rose to $807.5 billion in second quarter 2011 ($802.2 billion in the first half of 2011) from $761.8 billion in second quarter 2010 ($760.5 billion in the first half of 2010) and funded 107% and 99% (107% and 97% for the first half of the year) of average loans, respectively. Average core deposits increased to 74% of average earning assets in the second quarter and first half of 2011 compared with 71% for each respective period a year ago, yet the cost of these deposits declined significantly as the mix shifted from higher cost certificates of deposit to checking and savings products, which were also at lower yields relative to the second quarter and first half of 2010. About 91% of our average core deposits are now in checking and savings deposits, one of the highest percentages in the industry.
Table 1: Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis) (1)(2)
Table 2: Noninterest Income
Noninterest income was $9.7 billion and $9.9 billion for second quarter 2011 and 2010, respectively, and $19.4 billion and $20.2 billion for the first half of 2011 and 2010, respectively. Noninterest income represented 48% of revenue for both periods in 2011. The decrease in total noninterest income in the second quarter and first half of 2011 from the same periods a year ago was due largely to lower mortgage banking net servicing income and lower service charges on deposit accounts.
Our service charges on deposit accounts decreased 24% in the second quarter and first half of 2011 from the same periods a year ago, primarily due to changes mandated by Regulation E and related overdraft policy changes.
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, 2011, these assets totaled $2.2 trillion, up 16% from $1.9 trillion at June 30, 2010. 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 2011, respectively, 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 increased to $1.9 billion in second
quarter 2011 from $1.7 billion a year ago and increased to $3.8 billion for the first half of 2011 from $3.3 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. Brokerage client assets totaled $1.2 trillion at June 30, 2011, up from $1.1 trillion a year ago.
Card fees increased to $1.0 billion in second quarter 2011, from $911 million in second quarter 2010. For the first six months of 2011, these fees increased to $2.0 billion from $1.8 billion a year ago. The increase is mainly due to growth in purchase volume and new accounts growth. With the final FRB rules regarding debit card interchange fees, we estimate a quarterly reduction in earnings of approximately $250 million (after tax), before the impact of any offsetting actions, starting in fourth quarter 2011. We expect to recapture at least half of this earnings reduction over time through volume and product changes.
Mortgage banking noninterest income consists of net servicing income and net gains on loan origination/sales activities and totaled $1.6 billion in second quarter 2011, compared with $2.0 billion a year ago. The first half of 2011 showed a decrease to $3.6 billion from $4.5 billion for the same period a year ago. The reduction year over year in mortgage banking noninterest income was primarily driven by a decline in net servicing income.
Net servicing income includes both changes in the fair value of mortgage servicing rights (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 2011 included a $374 million net MSR valuation gain ($1.08 billion decrease in the fair value of the MSRs offset by a $1.45 billion hedge gain) and for second quarter 2010 included a $626 million net MSR valuation gain ($2.7 billion decrease in the fair value of MSRs offset by a $3.3 billion hedge gain). For the first half of 2011, it 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) and for the same period of 2010, included a $1.6 billion net MSR valuation gain ($3.44 billion decrease in the fair value of MSRs offset by a $5.05 billion hedge gain). The valuation of our MSRs at the end of second quarter 2011 reflected our assessment of expected future levels in servicing and foreclosure costs, including the estimated impact from regulatory consent orders. See the Risk Management Credit Risk Management Risks Relating to Servicing Activities section in this Report for information on the regulatory consent orders. The $252 million and $862 million decline in net MSR valuation gain results for the second quarter and first half of 2011, respectively, compared with the same periods last year was primarily due to a decline in hedge carry income. See the Risk Management Mortgage Banking Interest Rate and Market Risk section of this Report for a detailed discussion of our MSRs risks and hedging approach. Our portfolio of loans serviced for others was $1.87 trillion at June 30, 2011, and $1.84 trillion at December 31, 2010. At June 30, 2011, the ratio of MSRs to related loans serviced for others was 0.87%, compared with 0.86% at December 31, 2010.
Income from loan origination/sale activities was $742 million in second quarter 2011 compared with $793 million a year ago. The decrease in second quarter 2011 was driven by lower loan origination volume and margins on loan originations, offset by lower provision for mortgage loan repurchase losses. Income of $1.9 billion from loan origination/sales activities for the first half of 2011 remained flat from a year ago.
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 2011 totaled $242 million (compared with $382 million for second quarter 2010), of which $222 million ($346 million for second quarter 2010) was 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 in this Report.
Residential real estate originations were $64 billion in second quarter 2011 compared with $81 billion a year ago and mortgage applications were $109 billion in second quarter 2011 compared with $143 billion a year ago. The 1-4 family first mortgage unclosed pipeline was $51 billion at June 30, 2011, and
$68 billion a year ago. For additional detail, 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 from trading activities, which reflect unrealized and realized net gains due to changes in fair value of our trading positions, were $414 million and $1.0 billion in the second quarter and first half of 2011, respectively, compared with $109 million and $646 million for the same periods a year ago. The year over year increase for the second quarter and first half of 2011 was driven by improved valuation of certain contracts utilized in some of our customer accommodation trading activity. Net gains 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 fees within noninterest income line items of the income statement. Net gains from trading activities are primarily from trading done 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. Net losses from proprietary trading totaled $23 million and $9 million in the second quarter and first half of 2011, respectively, compared with $199 million and $228 million for the same periods a year ago. These net proprietary trading losses were offset by 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 and what we consider to be 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 $596 million for second quarter 2011 and $318 million for second quarter 2010, after other-than-temporary impairment (OTTI) write-downs of $205 million and $168 million for the same periods, respectively.
Operating lease income was $103 million and $180 million in the second quarter and first half of 2011, respectively, down from $329 million and $514 million for the same periods a year ago, due to gains on early lease terminations in second quarter 2010.
Table 3: Noninterest Expense
Noninterest expense was $12.5 billion in second quarter 2011, down 2% from $12.7 billion a year ago, reflecting the benefit of reduced core deposit amortization and lower operating losses in second quarter 2011 as well as $137 million of expense in second quarter 2010 for Wells Fargo Financial severance costs. For the first half of 2011, noninterest expense was nearly flat compared with the same period a year ago.
Personnel expenses were flat for second quarter 2011 compared with the same quarter last year. They were up, however, for the first half of 2011, compared with the same period of 2010, primarily due to higher variable compensation paid in first quarter 2011 by businesses with revenue-based compensation, including brokerage. Mortgage personnel expenses declined in second quarter 2011 reflecting a decrease in mortgage loan originations.
Outside professional services included increased investments by our businesses this year in their service delivery systems.
Operating losses of $428 million in second quarter 2011 were substantially all for litigation accruals for mortgage foreclosure-related matters and were down from second quarter 2010, which was elevated predominantly due to additional accrual for litigation matters.
Merger integration costs totaled $484 million and $498 million in second quarter 2011 and 2010, respectively, and $924 million and $878 million for the first six months of 2011 and 2010, respectively. Second quarter 2011 marked further milestones in our integration of legacy Wells Fargo and Wachovia, including the conversion of retail banking stores in Pennsylvania and Florida (completed in early July), one of our largest East Coast states. After these conversions, 83% of
banking customers company-wide are on a single deposit system.
With our current expense management initiative and the completion of merger-related activities, we are targeting to reduce quarterly noninterest expense to $11 billion by fourth quarter 2012 from $12.5 billion in second quarter 2011. The target reflects expense savings initiatives that will be executed over the next six quarters. Quarterly expense trends may vary due to cyclical or seasonal factors, particularly in the first quarter of each year when higher incentive compensation and employee benefit expenses typically occur.
Income Tax Expense
Our effective tax rate was 33.6% in second quarter 2011, up from 33.1% in second quarter 2010 and 29.5% in first quarter 2011. The higher effective rate in second quarter 2011 reflected the tax cost associated with accruals for mortgage foreclosure related matters. Our effective tax rate was 31.7% in the first half of 2011, down from 34.2% in the first half of 2010. The decrease for the first half of 2011 from the first half of 2010 was primarily related to a tax benefit recognized in first quarter 2011 associated with the realization for tax purposes of a previously written down investment. Our current estimate for the full year 2011 effective tax rate is approximately 32.5%.
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 guidance equivalent to generally accepted accounting principles (GAAP) for financial accounting. In fourth quarter 2010, we aligned certain lending businesses into Wholesale Banking from Community Banking to
reflect our previously announced restructuring of Wells Fargo Financial. In first quarter 2011, we realigned a private equity business into Wholesale Banking from Community Banking. 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 17 (Operating Segments) to Financial Statements in this Report.
Table 4: 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. through its Regional Banking and Wells Fargo Home Mortgage business units.
Community Banking reported net income of $2.1 billion and revenue of $12.6 billion in second quarter 2011. Revenue declined $1.0 billion from second quarter 2010, driven primarily by a decrease in mortgage banking income from lower originations/sales activities and hedge valuations, and by lower interest income primarily attributed to reductions in the home equity loan portfolio. These declines were partially mitigated by gains on equity sales as well as lower deposit costs. Net interest income decreased $1.4 billion, or 9%, for the first half of 2011 compared with the same period a year ago, mostly due to lower average loans (down $38.3 billion) as a result of intentional run-off within the portfolios (including Home Equity and Pick-A-Pay) combined with softer loan demand, and a shift in earning assets mix towards lower-yielding investment securities portfolios. This decline in interest income was mitigated by continued low funding cost. Average core deposits increased $19.4 billion, or 4%, as growth in liquid deposits more than offset planned certificates of deposit run-off. We generated strong growth in the number of consumer checking accounts (up a net 7% from second quarter 2010). Non-interest expense decreased $260 million from second quarter 2010 due to reduced personnel costs (lower mortgage sales-related incentives and second quarter 2010 Wells Fargo Financial exit expense accruals), a decrease in software license expense, lower
litigation-related operating losses, and reduced intangible amortization. The provision for credit losses decreased $1.4 billion from second quarter 2010 and credit quality indicators in most of our consumer and business loan portfolios continued to improve. Net credit losses declined in almost all portfolios, which resulted in the release of $700 million in allowance for loan losses in second quarter 2011, compared with $389 million released a year ago. The provision for credit losses declined $3.9 billion for the first half of 2011 compared with the first half of 2010. Charge-offs decreased $2.7 billion, showing improvement primarily in the Home Equity, Credit Card, and Dealer Services portfolios. Additionally, we released $1.6 billion of the allowance in the first half of 2011, compared with $389 million released a year ago.
Wholesale Banking provides financial solutions across the U.S. and globally to middle market and large corporate customers with annual revenue generally in excess of $20 million. Products and businesses include commercial banking, investment banking and capital markets, securities investment, government and institutional banking, corporate banking, commercial real estate, treasury management, capital finance, international, insurance, real estate capital markets, commercial mortgage servicing, corporate trust, equipment finance, asset backed finance, and asset management.
Wholesale Banking reported net income of $1.9 billion in second quarter 2011, up $469 million, or 32%, from second quarter 2010. Net income increased to $3.6 billion for the first half of 2011 from $2.7 billion a year ago. The year over year increases in net income for the second quarter and first six
months were the result of decreases in the provision for credit losses and noninterest expenses more than offsetting decreases in revenues. Revenue in second quarter 2011 decreased $143 million, or 2%, from second quarter 2010 as strong growth across most businesses, including loan and deposit growth, was more than offset by lower PCI-related resolutions and other gains. Average loans of $243.1 billion in second quarter 2011 increased 7% from second quarter 2010 driven by increases across most lending areas. Average core deposits of $190.6 billion in second quarter 2011 increased 17% from second quarter 2010, reflecting continued strong customer liquidity. Noninterest expense in second quarter 2011 decreased $107 million, or 4%, from second quarter 2010 related to lower litigation and foreclosed asset expenses. The provision for credit losses in second quarter 2011 declined $732 million from second quarter 2010, and included a $300 million allowance release compared with a $111 million release a year ago along with a $543 million improvement in net credit losses.
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. 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 earned net income of $333 million in second quarter 2011, up $63 million, or 23%, from second quarter 2010. Revenue of $3.1 billion predominantly consisted of brokerage commissions, asset-based fees and net interest income. Net interest income was up $7 million, or 1%, compared with second quarter 2010 as higher investment income was driven by higher deposits and loan growth offset by lower yields. Noninterest income increased $212 million, or 10%, and $420 million, or 9%, from the second quarter 2010 and first half of 2010, respectively, as higher asset-based fees and securities gains in the brokerage business were partially offset by lower brokerage transaction revenue. Noninterest expense was up $137 million, or 6%, and $306 million, or 6%, from second quarter 2010 and the first half of 2010, respectively, primarily due to growth in personnel cost driven by higher broker commissions.
Balance Sheet Analysis
At June 30, 2011, our total loans were down slightly from December 31, 2010 while our core deposits were up over the same period. At June 30, 2011, core deposits funded 108% of the loan portfolio, and we have significant capacity to add loans and higher yielding long-term MBS to generate future revenue and earnings growth. The strength of our business model produced record earnings and high rates of internal capital generation as reflected in our improved capital ratios. Tier 1 capital increased to 11.69% as a percentage of total risk-weighted assets, total
capital to 15.41%, Tier 1 leverage to 9.43% and Tier 1 common equity to 9.15% at June 30, 2011, up from 11.16%, 15.01%, 9.19% and 8.30%, respectively, at December 31, 2010.
The following discussion provides additional information about the major components of our balance sheet. Information about changes in our asset mix and about our capital 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
Table 5 presents a summary of our securities available-for-sale portfolio. 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 were $9.3 billion at June 30, 2011, up from net unrealized gains of $8.3 billion at December 31, 2010, primarily due to lower interest rates and narrowing of credit spreads.
We analyze securities for OTTI quarterly or more often if a potential loss-triggering event occurs. Of the $326 million OTTI write-downs recognized in the first half of 2011, $269 million
related to debt securities. There were no OTTI write-downs for marketable equity securities and there were $57 million in OTTI 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 2010 Form 10-K and Note 4 (Securities Available for Sale) to Financial Statements in this Report.
We apply the cost recovery method for debt securities available for sale where future cash flows cannot be reliably estimated. Under this method, cash flows received are applied against the amortized cost basis, and interest income is not recognized until such basis has been fully recovered. The respective cost basis and fair value of these securities was $71 million and $255 million at June 30, 2011, and $96 million and $296 million at December 31, 2010.
At June 30, 2011, debt securities available for sale included $24 billion of municipal bonds, of which 82% were rated A- or better based on external, and in some cases internal, ratings. Additionally, some of these bonds are guaranteed against loss by bond insurers. These 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 insurers guarantee in making the investment decision. These municipal bonds will continue to be 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 6.4 years at June 30, 2011. 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
See Note 4 (Securities Available for Sale) to Financial Statements in this Report for securities available for sale by security type.
Balance Sheet Analysis (continued)
Total loans were $751.9 billion at June 30, 2011, down $5.3 billion from December 31, 2010. Increased balances in many commercial loan portfolios offset most of the continued planned reduction in the non-strategic and liquidating portfolios, which have declined $11.6 billion since December 31,
2010. Additional information on the non-strategic and liquidating portfolios is included in Table 11 in the Credit Risk Management section of this Report.
Table 7: Loan Portfolios
A discussion of average loan balances and a comparative detail of average loan balances is included in Table 1 under Earnings Performance Net Interest Income 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 totaled $853.6 billion at June 30, 2011, compared with $847.9 billion at December 31, 2010. Table 8 provides additional detail regarding deposits. Comparative detail of average deposit balances is provided in Table 1 under
Earnings Performance Net Interest Income earlier in this Report. Total core deposits were $809.0 billion at June 30, 2011, up $10.8 billion from $798.2 billion at December 31, 2010.
Table 8: Deposits
Balance Sheet Analysis (continued)
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 2010 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 to obtain fair values based on quoted prices. We determine the most appropriate and relevant pricing service for each security class and generally obtain one quoted price for each security. For certain securities, we may use internal traders to obtain estimated fair values, which are subject to our internal price verification procedures. We validate prices received using a variety of methods, including, but not limited to, comparison to pricing services, corroboration of pricing by reference to other independent market data such as secondary broker quotes and relevant benchmark indices, and review of pricing by Company personnel familiar with market liquidity and other market-related conditions.
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
See Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report for a complete discussion on 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.
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 2010 Form 10-K. The discussion that follows is intended to provide an update on these risks.
Credit Risk Management
Table 10: Total Loans Outstanding by Portfolio Segment and Class of Financing Receivable
We employ various credit risk management and monitoring activities to mitigate risks associated with multiple risk factors affecting loans we hold or could acquire or originate including:
Our credit risk management process is governed centrally, but provides for decentralized management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, disciplined credit underwriting, frequent and detailed risk measurement and modeling, extensive credit training programs, and a continual loan review and audit process. The Credit Committee of our Board of Directors (Board) receives reports from management,
including our Chief Risk Officer and Chief Credit Officer, and its responsibilities include oversight of the administration and effectiveness of, and compliance with, our credit policies and the adequacy of the allowance for credit losses. In addition, banking regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes.
A key to our credit risk management is adhering to a well controlled underwriting process, which we believe is appropriate for the needs of our customers as well as investors who purchase the loans or securities collateralized by the loans.
Non-Strategic and Liquidating Portfolios We continually evaluate and modify our credit policies to address appropriate levels of risk. Accordingly, from time to time, we designate certain portfolios and loan products as non-strategic or high risk to limit or 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 non Pick-a-Pay PCI loans acquired from Wachovia as well as some portfolios from legacy Wells Fargo Home Equity and Wells Fargo Financial. Effective first quarter
2011, we added our education finance government guaranteed loan portfolio to the non-strategic and liquidating portfolios as there is no longer a U.S. Government guaranteed student loan program available to private financial institutions pursuant to legislation in 2010. The non-strategic and liquidating loan portfolios have decreased 36% since the merger with Wachovia at December 31, 2008, and decreased 9% from the end of 2010. The loss rate was 2.24% on these portfolios for the first half of 2011.
Table 11: Non-Strategic and Liquidating Loan Portfolios
The legacy Wells Fargo Financial debt consolidation portfolio included $1.2 billion of loans at both June 30, 2011, and December 31, 2010, which were considered prime based on secondary market standards. The remainder is non-prime but was originated with standards to reduce credit risk. Legacy Wells Fargo Financial ceased originating loans and leases through its indirect auto business channel by the end of 2008.
The home equity liquidating portfolio was designated in fourth quarter 2007 from loans generated through third party channels. This portfolio is discussed in more detail below 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.
Risk Management Credit Risk Management (continued)
PURCHASED CREDIT-IMPAIRED (PCI) LOANS 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 in the acquisition using the measurement provisions for PCI loans and are liquidating portfolios. PCI loans were recorded at fair value at the date of acquisition, and the historical allowance for credit losses related to these loans was 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.
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 commercial and industrial, 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 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 accretable yield percentage is unaffected by the resolution and any changes in the effective yield for the remaining loans in the pool are addressed by our quarterly cash flow evaluation process for each pool. For loans that are resolved by payment in full, there is no release of the nonaccretable difference for the pool because there is no difference between the amount received at resolution and the contractual amount of the loan. Modified PCI loans are not removed from a pool even if those loans would otherwise be deemed TDRs. Modified PCI loans that are accounted for individually are considered TDRs, and removed from PCI accounting, if there has been a concession granted in excess of the original nonaccretable difference. We include these TDRs in our impaired loans.
In the first six months of 2011, we recognized in income $114 million released from nonaccretable difference related to commercial PCI loans due to payoffs and dispositions of these loans. We also transferred $210 million from the nonaccretable difference to the accretable yield and $1.0 billion of losses from loan resolutions and write-downs were absorbed by the nonaccretable difference. Table 12 provides an analysis of changes in the nonaccretable difference.
Table 12: Changes in Nonaccretable Difference for PCI Loans
Risk Management Credit Risk Management (continued)
Since the Wachovia acquisition, we have released $5.6 billion in nonaccretable difference for certain PCI loans and pools of PCI loans, including $4.0 billion transferred from the nonaccretable difference to the accretable yield and $1.6 billion released to income through loan resolutions. We have provided $1.7 billion in the allowance for credit losses for 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 $3.9 billion reduction from December 31, 2008, through June 30, 2011, in our initial expected losses on all PCI loans.
At June 30, 2011, the allowance for credit losses in excess of nonaccretable difference on certain PCI loans was $273 million. The allowance is necessary to absorb credit-related decreases since acquisition 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, 2011.
Table 13: Actual and Projected Loss Results on PCI Loans
For further detail on PCI loans, see Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.
Significant Credit Concentrations and 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 adequate allowance for credit losses. The following analysis reviews the relevant concentrations and certain credit metrics 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 REAL ESTATE (CRE) The CRE portfolio consists of both CRE mortgage loans and CRE construction loans. The combined CRE loans outstanding at June 30, 2011, represented 16% of total loans. CRE construction loans totaled $21.4 billion at June 30, 2011, or 3% of total loans. CRE mortgage loans totaled $101.5 billion at June 30, 2011, or 13% of total loans, of which over 36% was to owner-occupants. Table 14 summarizes CRE loans by state and property type with the related nonaccrual totals. CRE nonaccrual loans totaled 6% of the non-PCI CRE outstanding balance at June 30, 2011, a decline of 10% from the prior quarter. 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 10% of the total CRE portfolio, respectively. By property type, the largest concentrations are office buildings at 25% and industrial/warehouse at 11% of the portfolio. The quarter ended with $26.8 billion of criticized CRE mortgage and $10.6 billion of criticized construction loans. Criticized CRE mortgage loans decreased 6% and criticized CRE construction loans decreased 24% since December 31, 2010. Total criticized CRE loans remained relatively high as a result of the current conditions in the real estate market. CRE delinquencies totaled $1.9 billion or 2% of total non-PCI CRE loans at quarter end. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for further detail on criticized loans.
The underwriting of CRE loans primarily focuses on cash flows and creditworthiness of the customer, in addition to 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 loans, including regular loan reviews and appraisal updates. As issues are identified, management is engaged and dedicated workout groups are in place to manage problem loans. At June 30, 2011, the recorded investment in PCI CRE loans totaled $5.0 billion, down from $12.3 billion at December 31, 2008, reflecting the reduction resulting from loan resolutions and write-downs.
Risk Management Credit Risk Management (continued)
Table 14: CRE Loans by State and Property Type
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 15 summarizes commercial and industrial loans and lease financing by industry with the related nonaccrual totals. Across our non-PCI commercial loans and leases, the commercial and industrial loans and lease financing portfolios experienced less credit deterioration than our CRE portfolios in the second quarter 2011. Of the total commercial and industrial loans and lease financing non-PCI portfolios, 0.06% was 90 days or more past due and still accruing, 1.46% was nonaccruing and 13.8% were criticized. In comparison, of the total non-PCI CRE portfolio, 0.19% was 90 days or more past due and still accruing, 5.71% was nonaccruing and 28.1% was criticized. See Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report. Also, the annualized net-charge off rate for both portfolios declined from second quarter 2010. We believe this portfolio is well underwritten and is diverse in its risk with relatively even concentrations across several industries. Our credit risk management process for this portfolio primarily focuses on a customers ability to repay the loan through their cash flow. Generally, the collateral securing this portfolio represents a secondary source of repayment.
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.
Table 15: Commercial and Industrial Loans and Lease Financing by Industry
Risk Management Credit Risk Management (continued)
During the recent credit cycle, we have experienced an increase in loans requiring risk mitigation activities including the restructuring of loan terms and requests for extensions of commercial and industrial and CRE loans. All actions are based on a re-underwriting of the loan and our assessment of the borrowers ability to perform under the agreed-upon terms. For loans that are granted an 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, 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 extension. 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. In many cases the strength of the guarantor provides sufficient assurance that full repayment of the loan is expected. When full and timely collection of the loan becomes uncertain, including the performance of the guarantor, we place the loan on nonaccrual status and we charge-off all or a portion of the loan based on the fair value of the collateral securing the loan, if any.
Our ability to seek performance under a guarantee is directly related to the guarantors creditworthiness, capacity and willingness to perform, which is evaluated 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 and accruing status are important factors in our allowance methodology for commercial and industrial and CRE loans.
FOREIGN LOANS At June 30, 2011, foreign loans represented approximately 5% of our total consolidated loans outstanding and approximately 3% of our total assets. The United Kingdom was the only individual foreign country with cross-border outstandings, defined to include loans, acceptances, interest-bearing deposits with other banks, other interest bearing investments and any other monetary assets that exceeded 0.75% of our consolidated assets at June 30, 2011. The United Kingdom cross-border outstandings amounted to approximately $9.5 billion, or 0.75% of our consolidated assets, and included $1.7 billion of sovereign claims. Recently, there has been increased focus on the exposure of U.S. banks to Greece, Ireland, Italy, Portugal and Spain, which have experienced credit deterioration due to economic weakness and their respective fiscal situations. At June 30, 2011, our gross outside exposure to these five countries, including cross-border claims on an ultimate risk basis, and foreign exchange and derivative products, aggregated approximately $3.2 billion. Of this amount, we held approximately $100 million in sovereign claims, substantially all for Ireland, and no sovereign claims for Greece, Portugal and Spain. We did not have any sovereign credit default swaps that we have written or received associated with Greece, Ireland, Italy, Portugal and Spain.
Our foreign country risk monitoring process incorporates frequent dialogue with our foreign financial institution customers, counterparties and regulatory agencies, enhanced by centralized monitoring of macroeconomic and capital markets conditions. We establish exposure limits for each country via 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.
Risk Management Credit Risk Management (continued)
REAL ESTATE 1-4 FAMILY MORTGAGE LOANS Our real estate 1-4 family mortgage loans primarily include loans that 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 below. 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 VIEs.
Our underwriting of loans collateralized by residential real property includes appraisals or estimates from automated valuation models (AVMs) to support property values. AVMs are computer-based tools used to estimate the market value of homes. AVMs are a lower-cost alternative to appraisals and support valuations of large numbers of properties in a short period of time using market comparables and price trends for local market areas. The primary risk associated with the use of AVMs is that the value of an individual property may vary significantly from the average for the market area. We have processes to periodically validate AVMs and specific risk management guidelines addressing the circumstances when AVMs may be used. AVMs are generally used in underwriting to support property values on loan originations only where the loan amount is under $250,000. We generally require property visitation appraisals by a qualified independent appraiser for larger residential property loans.
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 25% of total loans at both June 30, 2011 and December 31, 2010. Substantially all of these interest-only loans at origination were considered to be prime or near prime.
We believe we have manageable adjustable-rate mortgage (ARM) reset risk across our Wells Fargo 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 option ARM portfolio was acquired in the Wachovia acquisition.
We continue to modify real estate 1-4 family mortgage loans to assist homeowners and other borrowers in the current difficult economic cycle. Loans are underwritten at the time of the modification in accordance with underwriting guidelines established for governmental and proprietary loan modification programs. As a participant in the U.S. Treasurys Making Home Affordable (MHA) programs, we are focused on helping customers stay in their homes. The MHA programs create a standardization of modification terms including incentives paid to borrowers, servicers, and investors. MHA includes the Home Affordable Modification Program (HAMP) for first lien loans and the Second Lien Modification Program (2MP) for junior lien loans. Under both our proprietary programs and the MHA programs, we may provide concessions such as interest rate reductions, forbearance of principal, and in some cases, principal forgiveness. These programs generally include trial periods of three months, and after successful completion and compliance with terms during this period, the loan is considered to be modified. See the Allowance for Credit Losses section in this Report for discussion on how we determine the allowance attributable to our modified residential real estate portfolios.
The concentrations of real estate 1-4 family first and junior lien mortgage loans by state are presented in Table 16. Our real estate 1-4 family mortgage loans to borrowers in California represented approximately 14% of total loans (3% of this amount were PCI loans from Wachovia) at June 30, 2011, mostly within the larger metropolitan areas, with no single California metropolitan area consisting of more than 3% of total loans. We continuously 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. All three credit risk metrics showed improvement in second quarter 2011, on the non-PCI mortgage portfolio. Loans 30 days or more delinquent at June 30, 2011, totaled $18.4 billion, or 7%, of total non-PCI mortgages, down 9% from December 31, 2010. Loans with FICO scores lower than 640 totaled $47.0 billion at June 30, 2011 or 17% of all non-PCI mortgages, a decline of 8% from year-end. Mortgages with a LTV/CLTV greater than 100% totaled $79.4 billion at June 30, 2011 or 28% of total non-PCI mortgages, a 7% decline from year-end. Information regarding credit risk trends can be found in Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.
Table 16: Real Estate 1-4 Family Mortgage Loans by State
Risk Management Credit Risk Management (continued)
PICK-A-PAY PORTFOLIO The Pick-a-Pay portfolio was one of the consumer residential first mortgage portfolios we acquired from Wachovia. We considered a majority of the Pick-a-Pay loans to be PCI loans. The Pick-a-Pay portfolio is a liquidating portfolio, as Wachovia ceased originating new Pick-a-Pay loans in 2008.
The Pick-a-Pay portfolio includes loans that offer payment options (Pick-a-Pay option payment loans), and also includes 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 Pick-a-Pay portfolio is included in the consumer real estate 1-4 family first mortgage class of loans throughout this Report. Real estate 1-4 family junior lien mortgages and lines of credit associated with Pick-a-Pay loans are reported in the Home Equity portfolio. Table 17 provides balances over time related to the types of loans included in the portfolio since acquisition.
Table 17: Pick-a-Pay Portfolio Balances Over Time