Wells Fargo & Company (WFC) reported $5.5 billion in net income for a return on assets (ROA) of 1.21%, down 2% on a linked-quarter basis and down 6% from a year ago, according to Fitch Ratings. Earnings were impacted by an expected energy-related reserve build, and seasonally higher personnel expenses.
Partially offsetting this, WFC grew revenues both linked-quarter and from a year ago, aided by the acquisition of loans and leases from GE Capital. Although earnings declined, WFC still outperforms its large bank peers, and the quarter's results were in line with Fitch's expectations.
The regulators announced earlier this week that WFC was one of seven banks whose living wills were deemed 'not credible', nor would they facilitate an orderly resolution of the company. Fitch views this as somewhat surprising given WFC was the only bank of the 11 filers to receive conditional approval from the regulators during the last submission. WFC will have until Oct. 1, 2016 to resubmit its plan. Failure to remediate the issues can result in more stringent prudential requirements.
WFC also reported several noteworthy items in the first quarter including the sale of its crop insurance business, income from hedge ineffectiveness on the company's long-term debt, and further OTTI on energy sector debt and equity securities.
At March 31, 2016, WFC's direct exposure to energy lending is modest at approximately 2% of total loans. However, Fitch notes that its portfolio includes a much larger percentage of sub-investment grade borrowers than its peers. WFC disclosed that only 7% of outstandings were to investment grade companies, while 22% of exposure was to IG companies. WFC has built its reserves to 9.3% of funded loans, a much higher level than peers reporting to date.
During the quarter, WFC disclosed that oil and gas outstandings rose by around $400 million, though 'defensive draws' were deemed to not be a primary driver to this increase. Also contributing, $236 million of the increase was due to loans acquired from GE Capital during the quarter. WFC also noted that very little of its increased provision expense was driven by the recently completed SNC exam. WFC has completed around a quarter of its Spring borrowing base redetermination process, resulting in around 50% to 60% of those credits having a reduction in their borrowing base.
WFC reported a reserve build of $200 million during the quarter, its first reserve build since 2009. WFC, similar to the industry, has benefitted from reserve releases over the past several years, and in fact, the company has released over $11 billion in reserves since 2009. Problem assets also ticked up for the first time since the third quarter of 2012 (3Q12) reflecting $1.1 billion in higher O&G non-performing assets (NPAs).
In terms of revenue growth, spread income increased around 1% on a linked-quarter basis, primarily supported by growth in earning assets, including $30.8 billion in loans and leases from GE Capital, as well as the 25 basis points (bps) rate hike in December, of which WFC believes it has already received the full benefit of that repricing on its asset side and the cost on the liability side. Partially offsetting this, lower variable income and one less day in the quarter. WFC's margin fell 2bps due lower variable income.
Noninterest income increased 5% primarily due to $381 million in gains on the sale of WFC's crop insurance business, and $379 million of positive hedge ineffectiveness related to WFC's hedging of its long-term debt. Absent these items, noninterest income would have declined 2% sequentially as higher lease income and trading gains were more than offset by declines in trust and investment fees, and lower gains on debt and equity investments.
Expenses rose 3% on a sequential basis, primarily due to seasonally higher personnel expenses. The quarter's efficiency ratio was 58.7%, at the higher end of its targeted 55% to 59% efficiency ratio. WFC expects to operate at the higher end of that range in 2016.
Total loan losses remained manageable at 38bps during the quarter with continued deterioration in the energy portfolio offsetting improvement in residential real estate. Fitch notes that at 38bps, WFC's current losses remain well below historical averages for the company, and we expect some mean reversion for WFC and the industry over the near-to-medium term.
The estimated Common Equity Tier 1 under Basel III Standardized Approach, fully phased-in, was 10.6% at quarter-end, falling roughly 13bps on a linked-quarter basis reflecting the deployment of capital for the acquisition of certain GE Capital assets.
During the quarter, WFC also announced that it had reached an agreement in principle with the DOJ and HUD regarding the company's FHA-lending practices from 2001-2010. WFC agreed to pay $1.2 billion to resolve these issues, which lowered last year's results by $134 million. This settlement follows many of WFC's peers, and was in line with Fitch's expectations.