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spk01: Good morning. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the Wells Fargo Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Please note that today's call is being recorded. I would now like to turn the call over to John Campbell, Director of Investor Relations. Sir, you may begin the conference.
spk08: Thank you, Regina. Good morning, everyone. Thank you for joining our call today where our CEO, Charlie Scharf, and our CFO, John Trusbury, will discuss second quarter results and answer your questions. This call is being recorded. Before we get started, I would like to remind you that our second quarter earnings release and quarterly supplement are available on our website at wellsfargo.com. I'd also like to caution you that we may make forward-looking statements during today's call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings, including the Form 8K file today containing our earnings release and quarterly supplement. Information about any non-GAAP financial measures referenced, including a reconciliation of those measures to GAAP measures, can also be found in our SEC filings in the earnings release and in the quarterly supplement available on our website. I will now turn the call over to Charlie.
spk04: Good morning, everyone. Thank you, John. I'm going to open the call by reviewing what is clearly a very poor quarter for us. I will review the drivers of our results, make some comments about the environment, and discuss the rationale for the intended dividend reduction. I'll then turn the call over to John to review second quarter results in more detail. Our view of the length and severity of the downturn deteriorated considerably from our assumptions at the end of the first quarter, and this, as well as the knock-on impacts from COVID, substantially impacted our results this quarter. We added $8.4 billion to the allowance for credit losses. Charge-offs increased $204 million from the prior quarter to $1.1 billion. Net interest income was down 13% from the prior quarter, driven primarily by lower rates. The constraints of operating under the asset cap has limited our ability to offset lower rates with balance sheet growth, and we actually took actions during the quarter to limit loan and deposit growth, which John will highlight. Expenses included approximately $400 million related to decisions we made due to COVID, most of which we do not expect to be permanent, but was the right thing to do for employees and to improve the safety of our facilities. About $350 million of deferred comp with an offset in fee revenue. $1.2 billion of operating losses, primarily for customer remediation accruals, related to our ongoing work to remediate the historical issues in community banking as we took another look at outstanding matters. This accrual will enable us to do the right thing for our customers while resolving these matters as quickly as possible. Revenues were lower by about $295 million due to COVID-related fee and interest waivers for certain products. In addition, a strong quarter of mortgage production revenue was partially offset by a $531 million write-down of our mortgage servicing rights asset due to higher projected defaults and faster prepayment assumptions. And while it's a smaller part of the company, we did have record revenues this quarter in our corporate and investment bank. Even with the loss this quarter, our CET1 ratio increased to .9% from .7% last quarter and is well above our regulatory minimum of 9%. As a reminder, our regulatory minimum reflects our expected stress capital buffer of .5% the minimum possible. As you know, Wells Fargo is predominantly a U.S. bank that takes deposits and makes loans. Our balance sheet composition is 80% cash, loans, and our investment portfolio. When consumers, small businesses, middle market companies, and corporate suffer, we do as well. As the economic environment brought on by COVID negatively impacts our customers and clients, it will filter through to our results primarily in the form of outsized credit losses and compressed net interest margins. Additionally, given we operate with a balance sheet cap, we must prioritize balance sheet capacity, both assets and deposits, and there is certainly an opportunity cost for us in an environment like this. In addition, given the uncertainty of the recovery, we must manage the balance sheet to a level where we can remain below the asset cap even if there is another period of material loan drawdowns or upward pressure on our deposit base. Having said that, we are responsible for the position we're in. The balance sheet cap exists because leadership failed to both oversee and build the appropriate infrastructure of the company, and our financial underperformance is because leadership didn't make the difficult decisions necessary. We are focused on both of these. We still have much to do to build the right risk and control foundation, which is what our regulators expect, and nothing can or will stand in the way of those activities. It is our highest priority, but we also recognize that we've been extremely inefficient for too long, and we will begin to take decisive actions, none of which will impact our risk and regulatory work to increase our margins. To the first point, we continue to make meaningful changes to improve the foundation of the company. In the second quarter, we announced corporate risk organizational structure to provide greater oversight of all risk-taking activities and a more comprehensive view of risk across the company. Our new risk model will have five line of business chief risk officers to complement the teams and leaders by risk type. During the quarter, we hired a new chief operational risk officer, a new chief risk officer for consumer lending, and a chief control executive. We continue to add additional talent to the senior leadership team. Since I joined the company nine months ago, I've announced six new members to the operating committee, all coming from outside of Wells Fargo with strong and relevant industry experience. Over two-thirds of our operating committee have joined Wells Fargo since 2018. All of our business line CEOs are now in place, including Mike Weinbach, who joined Wells Fargo in May as CEO of consumer lending, and Barry Summers, who joined at the end of June as CEO of wealth and investment management. Lester Owens will be joining us next week in a newly created role as head of operations. Lester has more than 30 years of experience in the financial services industry and senior operations roles. He will be responsible for building a more integrated approach to Wells Fargo's business operations functions. He has a proven track record in delivering a better customer experience while driving substantial efficiencies at the same time. We also made significant hires and roles won down from our operating committee, including a new head of government relations, corporate communications and corporate responsibility, as well as chief administrative officer and new head of our home lending businesses. We continue to have over 200,000 employees working from home, and we plan to have employees who are currently working from home continue to do so until at least September. It is too early to determine exactly when we will ultimately return to a more traditional work environment, but we will be cautious about bringing people back into the office. While I do believe there are meaningful benefits of people working physically together, we will move forward when we are comfortable that the health risks are manageable. Where there is a specific need, we will do so with the appropriate safety precautions in place, and we will make these decisions by geography, by facility. We have done this since the beginning of the crisis, and we will continue to do so and serve our customers and communities. We've made significant accommodations for our customers. Through the end of June, we have helped more than 2.7 million consumer and small business customers by deferring payments and waiving fees. This includes over 2.5 million payment deferrals, representing more than $5 billion in principal and interest, including $3.2 billion in mortgage loans serviced for others. We've provided approximately 6 million fee waivers for consumer and small business customers, exceeding $200 million. For our commercial clients, we've processed approximately 246,000 deferrals, representing more than $1.5 billion of principal and interest payments. In addition, for commercial distribution and auto-finance customers, we provided maturity date extensions, representing approximately $6.6 billion of outstanding principal and interest. Through the end of June, we have funded 179,000 PPP loans, totaling $10.1 billion, with an average loan size of $6,000. 60% of those were for loan amounts of less than $25,000. 84% of those were for companies that had fewer than 10 employees. 90% have less than 2 million in annual revenues, and 41% were to companies in low and moderate income areas for at least 50% minority census tracts. And we announced last week our Open for Business Fund. We have committed to donating approximately $400 million in gross processing fees earned from the Payroll Protection Plan to help support businesses impacted by the COVID-19 pandemic, and we will work with nonprofit organizations to provide capital, technical support, and long-term resiliency programs to small businesses with an emphasis on serving minority-owned businesses. Customer deposits have continued to increase, reflecting unprecedented government stimulus programs, lower spending, and customers converting investments into cash, while commercial deposits declined, reflecting actions we took to manage under the asset cap, which John will describe in more detail. In March, our commercial customers utilized over $80 billion of their loan commitments during the market turbulence at the onset of the pandemic, and almost all of those loans were paid down in the second quarter. Debit card spend started to increase in April and returned to pre-COVID levels in May, and in the last full week of June, were up approximately 10% from the same week a year ago. Consumer credit card spend improved steadily starting in mid-April, but was still down approximately 10% from a year ago as of the end of June. Commercial card spend remained significantly lower throughout the second quarter and was still down over 30% in the last full week of June compared to the same week a year ago with declines across industry segments. We continue to monitor our consumer and commercial customer spending trends as the nation goes through the various stages of reopening. Trends in digital usage are strong. Mobile deposit dollar volume was up over 100% in the second quarter compared with the year ago. In the second quarter, digital logins were up 21% from a year ago. Let me turn to the dividend now. Today we announced that our board expects to reduce our dividend for the third quarter to $0.10 per share. The Federal Reserve has authorized banks to pay common stock dividends that do not exceed an amount equal to the average of the bank's net income for the four preceding calendar quarters. Based on these instructions, we previously announced this limitation would cause us to reduce the dividend from the current level of $0.51 a share. In addition, while this requirement currently applies to the third quarter, the Federal Reserve stated it reserves the right to extend the limitations as it learns more about the evolution of the COVID event. Separately from this, our board has been reviewing the level of the dividend and I've discussed the way in which we would approach evaluating the right go-forward level. We first would look at our capital position. As I said, our capital position remains quite strong, so our current capital level is not the driving factor in our decision. Having said that, as we look forward, we do not pretend to have a deeper understanding of the path of the recovery than others. Using our economic assumptions, our capital levels remain above the minimum required and our CCAR results confirm the strength of our capital position, but we believe it's prudent to note that our assumptions are just that, so we felt it was appropriate to factor this uncertainty into our thinking around the appropriate dividend level in this environment. After evaluating our capital position, we considered our current and expected earnings level. We expect the impact of COVID to continue to negatively impact our earnings until we see a clear trend of meaningful improvements in unemployment and GDP. This will result in continued lower levels of NII and certain economically sensitive fee revenues, as well as potentially unforeseen expenses to operate in this environment. In addition, while our ACL is intended to cover expected losses based on our current economic assumptions, we're mindful of the uncertainty and the need to reevaluate these assumptions continually. And I will discuss this more, but while we have actively begun to address the fact that our expenses are significantly too high, it takes some time to see the impact of our actions in our results. Putting this all together, it is critical in these uncertain times that our common stock dividend reflects current earnings capacity, assuming a continued difficult operating environment, evolving regulatory guidance, and protects our capital position if economic conditions were to further deteriorate. Given this, we believe it's prudent to be extremely cautious until we see a clear path to broad economic improvement. We're confident that this eventual economic improvement combined with our actions to increase our margins will allow our wonderful franchise to support a higher dividend in the future. We're extremely disappointed to take this action and do understand that many rely on this stream of income. However, we must be prudent in this environment. I have acknowledged in the past that our expenses are too high and that we're building roadmaps to improve our efficiency ratio. To repeat, there's nothing structurally different about Wells Fargo that should prevent us from being as efficient as our large peers, but we are far from it. For us to bring our level of efficiency close to our peers, the math would tell you we need to eliminate over $10 billion of expenses. While our work is not yet complete to commit to specific numbers and timeframes, we expect to take a series of actions beginning in the second half of the year to begin to reduce our expense base and bring our expenses in line with the size and composition of our businesses. This will be a multiyear effort for sure, but we'd like to see a reduction in expenses next year. We now have a centralized team driving the effort across the enterprise and our lines of business and functional areas have dedicated resources stacked against this. This work did not start in the last few months, but the extremely challenging operating environment and uncertain outlook has accelerated our sense of urgency. It is important to note that I deeply believe that this exercise is about making us a better and more efficient company, not just about reducing expenses. We have too many management layers, spans of controls for managers are too narrow, and we have resources dedicated to activities that are not a priority today. This cannot continue. We also have the opportunity to apply lessons we have learned since the onset of the pandemic to drive efficiency across the company. Over the medium term, we have the opportunity to materially reduce our expense, including increasing digital adoption for retail and commercial clients, reducing third-party spend, consolidating locations, including branches, field offices, and corporate sites, and applying technology differently. In addition, the opportunity to consolidate our operational platforms is still meaningful. As a financial company, and specifically a GSIB, we must be strong financially to serve our customers and support our communities, but also to provide growing opportunities for our employees. And while our balance sheet is strong, our margins are too narrow. To ensure we're that source of strength, we need to begin to take action to improve ourselves. As I've said, and I'll say it again, we will not do anything that will impact the work we have underway to build out our risk and control environment. The opportunity to become more efficient exists elsewhere in the organization, and we will protect this work at all costs. I will continue to share more specifics about our plans as they develop, and we will be talking more about this next quarter. While there remains much economic uncertainty, many market and liquidity trends are strong as Fed programs continue to effectively support the smooth functioning of the capital markets. While still wide to pre-crisis levels, market spreads have continued to improve since the peak of the dislocation, and have retraced 70 to 90 percent of their mid-March widening. Liquidity and treasury and interest rate swap markets returned to pre-crisis levels, and the Fed's open market purchase program has stabilized mortgage basis valuations and improved liquidity. HQLA bid ask, a measure of the cost to transfer risk, has retraced to pre-crisis levels while measures of volatility are now below pre-crisis levels. However, the economic recovery will not be smooth. Much of the economy is still essentially closed or just beginning to open, and additional restrictions are being implemented as the spread of the virus continues to increase in many areas of the world. While consumer spending has increased from levels at the end of the first quarter, it is still down from a year ago with significant declines in areas like travel, entertainment, and restaurants. And while government stimulus programs have provided a safety net for many, they are scheduled to run off, raising the possibility of more economic hardship ahead. Having said all of this, cities, communities, people, and businesses are all learning what it takes to reopen safely, and there is progress on vaccines and therapeutics. We will do what we can to support the fastest recovery possible, but we will be cautious in our outlook until we see the facts. I want to conclude my comments today by discussing an important topic, racial injustice. In my conversations with different groups over the past months, the pain and frustration with the lack of progress within both our country and Wells Fargo is clear. Inequality and discrimination has been clearly exposed and must not continue. Wells Fargo has been effective in creating diversity or a consistently inclusive environment. I have outlined a number of actions we are taking around race to change the outcomes, including creating a new role in the community, which will have a broad mandate of driving diversity and inclusion in both the workplace, but also our business. We will be evaluating operating committee members based upon their progress in improving diverse representation and inclusion in their area of responsibility, and it will have a direct impact on year-end compensation decisions. And we've announced the donation of these gross processing fees for PPP, estimated to be approximately $400 million. This is just the beginning of the work needed to address this crisis and to meaningful contribute to the change that is necessary, but I believe that this is a watershed moment, and we will be part of making sure this time is different. Finally, I want to thank all of the employees at Wells Fargo who continue to work tirelessly to serve our customers and successfully execute on our priorities. I will now turn the call over to John.
spk02: John O'Brien Thanks, Charlie. Good morning, everyone. Charlie's comments covered most of the information on page two of the supplement, including the largest driver of our reported loss, which was the $8.4 billion increase in the allowance for credit losses in the second quarter. So let me highlight just a couple of things here. First, our income taxes in the second quarter reflected the impact of annual income tax benefits, primarily tax credits, driven by our reported pretax loss. As a result, we currently expect our effective income tax rate for the remainder of the year to be approximately 26 percent, excluding the impact of any discrete items. Also, deferred compensation plan investment results increase net gains from equity securities by $346 million and increased personnel expense by $349 million. As we've highlighted many times, while these hedges are largely P&L neutral, they can result in large swings in our reported revenue and expense trends. In late May, we entered into arrangements to transition these economic hedges from equity securities to derivatives in the form of total return swaps. As a result of this change, starting the third quarter, our reporting for this item will be less volatile since most of the accounting impacts from deferred comp hedges will be reported in personnel expense. Turning to page three, Charlie covered the support we're providing to our customers and communities during the pandemic, but let me just highlight that the approximately $400 million donation for small business recovery efforts we announced last week through the new Open for Business Fund will be donated when the fees are recognized in revenue. Turning to page four, while our earnings in the second quarter were significantly impacted by the economic environment, our capital and liquidity continued to be strong with both our CET1 ratio and LCR increasing from the first quarter. Our CET1 ratio increased to 10.9 percent, 190 basis points above our current regulatory minimum of 9 percent. We expect our stress capital buffer to be 2.5 percent, which is the lowest possible under the new framework and would result in the regulatory minimum for our CET1 ratio remaining at 9 percent. Even with the large increases in our allowance over the past two quarters, our CET1 level was $23.7 billion above the regulatory minimum. Our LCR increased to 129 percent, 29 percentage points above our regulatory minimum, and our primary unencumbered sources of liquidity were approximately $511 billion. Turning to loans, on page five, similar to industry trends, period-end consumer and commercial loans outstanding declined in the second quarter, but average balances grew, reflecting increases in outstanding balances late in the first quarter. I'll explain the drivers of consumer and commercial period-end loan balances in more detail starting with consumer on page six. Consumer loans were down $20.1 billion, or 5 percent, from the first quarter. This decline includes the reclassification of $10.4 billion of conforming first mortgage loans held for sale status to provide flexibility to manage our balance sheet under the asset cap. The economic slowdown from COVID-19 reduced consumer spending and was reflected in lower credit card balances, lower auto originations, and other revolving and installment loan balances. In addition, we took actions during the second quarter to tighten credit standards given the current economic environment and to manage to the constraints of the asset cap. These actions included no longer purchasing jumbo mortgage loans through our correspondent mortgage business and not accepting home equity and personal line of credit applications. In the auto business, we've taken actions to mitigate future loss exposure, and our spreads on new originations improved to their highest levels since 2016. That said, as states began to reopen later in the quarter, we saw increased loan demand, including higher credit card spending and higher auto loan originations. Turning to commercial loans on page seven, C&I loans declined $54.9 billion, or 14 percent, from the first quarter, driven by paydowns of revolving loans following increased loan draws in the first quarter during the market turbulence at the onset of the pandemic. As Charlie highlighted, almost all of the $80 billion of loan draws in March were paid down during the second quarter. These paydowns were partially driven by strengthened capital markets and helped drive record revenues in the second quarter in our corporate and investment bank. Commercial real estate loans increased $2.1 billion from the first quarter with growth in both commercial real estate mortgage and in construction loans. Turning to deposits on page eight, the industry has experienced very strong growth, but due to our asset cap constraint, we've worked to manage growth of certain lower liquidity value deposit categories. However, even after these actions, average deposits grew 9 percent from a year ago and 4 percent from the first quarter. The linked quarter growth was driven by non-interest bearing deposits, which were up 18 percent, while interest bearing deposits declined 1 percent. Period end consumer and small business banking deposits grew $78.6 billion from the first quarter. This strong growth reflected COVID-19 related impacts, including customers' preference for liquidity, loan and tax payment deferrals, which otherwise would have reduced deposits, stimulus checks, and lower consumer spending. Wholesale banking deposits declined $32.1 billion, reflecting actions we took to manage under the asset cap, including an emphasis on reducing certain non-operational deposits. Average deposit costs declined to 17 basis points, down 35 basis points from the first quarter, with declines across all of our lines of business. While wholesale banking deposit costs declined the most, reflecting higher deposit betas, both WIM and retail banking deposit costs also declined. We currently have no active retail banking promotions, and we expect deposit costs will continue to decline in the second half of this year and reach the single-digit lows realized in 2015 and 2016. Net interest income declined $1.4 billion, or 13 percent, from the first quarter due to balance sheet repricing driven by the impact of a lower interest rate environment, $275 million less favorable hedge ineffectiveness accounting results driven by large interest rate changes, $187 million of higher MVS premium amortization due to higher prepayment rates, and these declines were partially offset by a shift to a lower cost mix of funding. Net interest income was down 13 percent for the first half of the year, and as I discussed in June, we currently expect net interest income to be in the $41 to $42 billion range for the full year 2020, which would be down 11 to 13 percent from the full year of 2019. This decline reflects the lower interest rate environment and the constraints the asset cap places on our ability to grow the size of our balance sheet, as well as higher MVS premium amortization, which we expect to persist for the remainder of the year. Turning to page 10, non-interest income increased $1.6 billion, or 24 percent from the first quarter, driven by a $1.9 billion increase in net gains from equity securities, reflecting lower securities impairment and higher deferred compensation plan investment results. I'll explain some of these drivers in more detail. Deposit service charges were down $279 million from the first quarter, driven by -19-related impacts, including lower overdrafts as customers have reduced debit card transactions and increased deposit balances, as well as higher fee waivers. Trust and investment fees declined $223 million from the first quarter. Investment banking had a strong quarter, with revenue increasing $156 million, or 40 percent, driven by strength in debt and equity capital markets. This growth was more than offset by both lower retail brokerage advisory fees, which were priced at the beginning of the second quarter, when market levels for advisory assets were, pricing were lower, and decline in brokerage transactional revenue. Mortgage banking revenue was relatively stable-linked quarter, with strong growth in mortgage loan originations, more than offset by declines in servicing income. Total residential -for-sale originations increased 30 percent from the first quarter to $43 billion, primarily driven by lower mortgage interest rates. Lower interest rates drove strong industry volume, with second quarter estimated to be the largest origination market since the third quarter of 2003. As we managed our application pipeline to handle this strong demand, our margins increased. In the second quarter, our production margin on residential -for-sale mortgage loans was 204 basis points, up from 108 basis points in the first quarter. We've continued to add capacity and expect originations to increase in the third quarter, if rates remain low, and we would expect margins to be relatively stable with second quarter levels. Servicing revenue declined $960 million from the first quarter. The decline was driven by a lower valuation of our MSR asset as a result of updated assumptions, including higher prepayment assumptions and higher expected servicing costs due to an increase in projected defaults. Servicing fees were also lower due to payment deferrals and fee waivers provided to our customers in response to the pandemic. Finally, net gains from trading activities increased $743 million from higher trading volumes across many products, increased volatility leading to wider bid-offer spreads, and substantial spread and price improvement in certain capital markets. Turning to expenses, expenses on page 11, as Charlie highlighted, our expenses are too high and we're beginning to take further action to improve our efficiency. The $1.5 billion increase in our expenses from the first quarter was driven by higher operating losses as well as higher personnel expense, reflecting a $947 million increase in deferred comp expense. Charlie described the $1.2 billion of operating losses, which included $765 million of customer remediation accruals for a variety of matters, as well as higher litigation accruals. The $597 million increase in personnel expense included the increase in deferred compensation, which is P&L neutral, and $231 million of COVID-19 related employee expenses, including premium pay for those who had to come into the office and payments for backup child care. Most of the COVID-19 related employee expenses have now expired. We also had $133 million of higher COVID-19 related occupancy expense to make our properties safer for our employees and customers, including enhanced cleaning, additional supplies, and workstation modifications. These costs will likely remain elevated until the pandemic ends. The impact of COVID-19 also reduced some of our expenses, including travel and entertainment and advertising and promotion expense. Turning to our business segments, starting on page 12, as Charlie highlighted, we now have the leadership for our five business segments in place, and we will transition to reporting our segments in accordance with the structure starting in the third quarter. Community banking reported a net loss of $331 million driven by an increase in provision expense. On page 13, we provide our community banking metrics. We had 31.1 million digital active customers, up 4% from a year ago. While the number of digital customers remains stable from the first quarter, these customers are doing more digitally, with the logins up 10% from the first quarter, and the number of checks deposited using a mobile device reaching a record high in the second quarter up 32% from the first quarter. Approximately 20% of our branches are temporarily closed due to COVID-19. As a result of fewer branches being opened and increased digital usage, teller and ATM transactions were down 19% from the first quarter and 28% from a year ago. However, we still have approximately 1 million teller transactions occurring at our branches every business day. Our customers' demand for cash has decreased by approximately 20% compared to a year ago. This decrease was reflected in lower demand for cash in our branches. While ATM transaction volume was down, the amount of cash withdrawn at our ATMs has increased, reflecting higher levels of cash per withdrawal, in part driven by higher ATM withdrawal limits we implemented in the first quarter. Charlie highlighted the improving trends we experienced during the second quarter for debit and credit card spend. Higher debit card spend later in the quarter resulted in total second quarter spend being flat compared with a year ago. However, transaction volume was down 13% from a year ago, with customers spending more per transaction. As a reminder, debit card fees are based on transaction volume, not dollar volume. Turning to page 14, wholesale banking reported a net loss of $2.1 billion as revenue growth was more than offset by an increase in provision for credit losses. I've already discussed the drivers of loans and deposits, so let me highlight a few other business drivers. Corporate and investment banking capital markets had record revenue in the second quarter, driven by the trading revenue increases I described earlier and record investment grade debt issuance. Wells Fargo Capital Finance was the number one book runner of asset-based loans with -to-date market share increasing to 20%. We maintained our leadership position in this market by providing an important source of liquidity to our customers during a very challenging time. Wealth and investment management earned $180 million in the second quarter, down 61% from the first quarter, primarily driven by an increase in the allowance for credit losses, the lower interest rate environment, and lower market valuations at the beginning of the quarter. We continued to experience strong demand from clients for liquidity products with growth and deposits and money market funds in our asset management business. Wells Fargo Asset Management achieved a record high $578 billion in assets under management in the second quarter, up 12% from the first quarter, driven by continued momentum in the money market business, higher market valuations, and fixed income net inflows. While advisory assets in our brokerage business increased 14% during the quarter, we had lower retail brokerage advisory fees since their price at the beginning of the quarter when market valuations were lower. These fees will benefit from the stronger markets at the beginning of the third quarter. Turning to credit results for the company on page 16, our net charge off rate was up eight basis points from the first quarter to 46 basis points, which is still an low level, particularly during an extremely challenging economic environment. Keep in mind that the significant amount of customer accommodations we provided for our consumer and commercial customers since the start of the pandemic will delay the recognition of net charge off delinquencies and non-accrual status for those customers who would have otherwise moved into past due or non-accrual status. However, I will point out that this dynamic was considered an allowance for credit losses. Commercial criticized assets increased $13.3 billion or 53% from the first quarter, with C&I up $7.2 billion and CRE up $6.1 billion. Non-accrual loans increased $1.4 billion from the first quarter, driven by growth in commercial non-accruals. I would note that 75% of our commercial non-accrual loans were current on interest principle as of the end of the second quarter. We provide more detail on C&I non-accrual loans on page 17. While C&I loans outstanding and total commitments declined from the first quarter, non-accrual loans increased 59% driven by oil and gas and real estate and construction C&I loans, which includes credit facilities to REITs and other non-depository financial institutions. Last quarter, we provided more details on industries with escalated monitoring, and those industries largely drove the increase in criticized assets in the second quarter, including retail, entertainment, and recreation. Turning to our commercial real estate portfolio on slide 18, we are the nation's largest commercial real estate lender, and our portfolio is well diversified both by property type and geography. Our commercial real estate loans are subjected to rigorous underwriting standards and are well structured. Before COVID-19, this portfolio was performing at historically strong credit levels with a good mix of assets and geography, a well-capitalized customer base, and overall low levels of leverage. We had proactively reduced our exposure to retail and have minimal exposure to land or condos, where losses were highest in the last cycle. Since the pandemic began, we've worked to assist customers on a -by-case basis. We've continued our strict routine monitoring process with the goal of identifying problems early. Our CRE team is an experienced bench with workout backgrounds and perspective in times of distress, which has enabled us to ramp up quickly. However, these are unprecedented times, and non-accruals were up $286 million or 30% from the first quarter.
spk17: Given what's
spk02: been going on in the economy, it's not surprising that shopping centers, retail, and hotels motels accounted for 59% of non-accrual loans in the second quarter and accounted for 90% of the increase from the first quarter. Criticized assets were up $6.1 billion or 140% from the first quarter, driven by the same sectors that drove the increase in non-accruals with the addition of office buildings. Turning to our oil and gas portfolio, on page 19, oil and gas loans accounted for 1% of our total of non-accrual loans outstanding with $12.6 billion outstanding at the end of the quarter, down 12% from the first quarter. Total commitments were down $1.7 billion from the first quarter, reflecting the impact of spring redetermination changes on borrowing basis, proactive portfolio management, as well as the weaker credit environment. Net charge-offs increased $111 million from the first quarter, with 87% of second quarter net charge-offs from the E&P sector. Non-accrual loans increased $865 million from the first quarter, with approximately 93% of non-accruals still current on payments. Criticized loans increased 26% from the first quarter, reflecting downward credit migration resulting from commodity price volatility and included numerous credit downgrades of publicly rated companies. On page 20, we provide detail on our allowance for credit losses. The $8.4 billion increase included $6.4 billion for commercial loans and $2 billion for consumer loans. Our allowance coverage for total loans was .19% of 100 basis points from the end of the first quarter, with the largest increases across commercial loans, junior lien mortgage loans, and credit card loans. We highlight the key drivers of the increase in our allowance for credit losses on page 21. We considered current economic conditions, which worsened significantly compared to prior expectations as unemployment levels reached .7% in the second quarter. In addition, over $2.4 trillion in fiscal stimulus programs, as well as customer accommodations provided near-term support for borrowers. On this page, we provide details on economic forecasts in our base case scenario for the second quarter allowance, which assumes near-term economic stress recovering in the late 2021, including unemployment levels declining to approximately 6% by the fourth quarter of 2021. While housing prices are forecasted to remain relatively stable, commercial real estate prices are forecasted to decline by low to mid-teens, with hotel, restaurant, and retail sectors expected to decline much further. In addition, collateral prices remain highly uncertain given limited property sales. While the large majority of weight is placed on the base case scenario, we apply some weighting to a downside scenario to reflect the uncertainty in the economic forecast. And as I previously mentioned, customer forbearance and other deferral activities provided in response to COVID-19 were considered in our loan portfolio performance expectations and loss forecast. However, please keep in mind that our allowance for credit losses is influenced by a variety of factors, including changes in loan volumes, portfolio credit quality, as well as general economic conditions. While the timing of the end of the pandemic and the eventual path to economic recovery remain unclear, we believe that our allowance captures the expected loss content in our portfolio as of the end of the second quarter. Turning to capital on page 22, as I highlighted earlier, our CET1 ratio increased to 10.9 percent in the second quarter. We elected to apply the modified Cecil transition provision to our regulatory capital. The impact of this selection was an increase in capital of $1.9 billion and a 14 basis point increase in our CET1 ratio. Additionally, as a result of senior debt issuance during the second quarter and a decline in our RWA, our TLAC ratio increased to 25.3 percent, which provides a significant buffer to our required minimum of 22 percent. In summary, our results in the second quarter were disappointing and economic conditions remain uncertain, but we're focused on doing the work necessary to improve the earnings capacity of the company, including reducing our expenses while meeting our regulatory commitments. And Charlie and I will now take your questions.
spk12: At this time, if you'd like to ask a question, please press star followed by the number one on your telephone keypad. Our first question will come from the line of Erica Najarian with Bank of America. Please go ahead.
spk13: Yes, good morning. You know, my first question is a clarification question for Charlie. Charlie, during your prepared remarks, you noted that your expenses were about $10 billion greater than your peers or where you need to be to be equivalent to peers on efficiency. Are you saying that lopping off $10 billion in expenses is an eventual long-term goal for this company to be in line with their larger peers?
spk04: Well, I mean, what I said was that the math, if you do the math, what it says is that when you look at their efficiency ratios versus ours, our expenses are at least $10 billion higher than they should be, and there's no reason why that should occur. And so we are doing the work to create a roadmap for a company which is significantly more efficient. Exactly what the time frame is and where we ultimately get to, I think, you know, we'll provide more information on that in the future and play itself out, but, you know, we can do the same math that you can do, and there's no reason why, as a management team, we don't have the ability to be as efficient as the rest.
spk13: Got it. That's clear. And my follow-up question has to do with the potential for the Fed to extend the income test beyond a third quarter dividend. And I'm wondering, so, you know, as we think about you mentioned that expenses should start coming down in 2021, you know, as I think about how consensus is formulating future earnings power, I think, you know, consensus is expecting that, you know, the majority of your reserve build should be behind you, but I don't think that restructuring costs, for example, that would relate to future efficiency initiatives are in consensus. And I guess the question that I'm really asking here is that, you know, if the Fed extends the income test beyond the third quarter, do you feel confident that according to how they're looking at dividend capacity, that Tencent is supportable going forward?
spk02: Sure. This is John. They certainly have the ability to extend the current framework, and it frankly even seems likely just given the way the calendar lines up and the resubmission process is going to work for the next CCAR. I think Charlie's point is we're going to do what's necessary to get as efficient as we can be. And to the extent that that kicks off one-time charges, which you might expect, and if that has an influence on our dividend capacity as a result of the Fed keeping the current regime in place, then we'll have to tolerate that. I don't think we're not going to do what's right economically because of accounting consequences. We're going to do, we're going to follow a gap. We're going to get as efficient as we can. The outcome is going to be the outcome. In part, we set the current dividend or propose to set the current dividend where it is so that it would buy us plenty of room to operate while we get through the next few quarters and chart the eventual path to greater profitability. But, you know, accounting consequences will be what they are. It wasn't a primary consideration in setting the number where we did.
spk04: The only thing that I would add is I think is that when we think of the work that we did, you know, we didn't, our board didn't approach this conversation around the dividend with an idea of looking at it each quarter and making a determination. And so, you know, our hope is that, this does become a level which is sustainable as we go through this period of uncertainty and as the Fed decides how they want to treat capital return over the next series of quarters. We do have some items that impact our capital, our ability to return capital with this rule that doesn't reflect our earnings power going forward, right? We had a three billion dollar settlement with the Department of Justice which is in our historical numbers that three billion dollars when you look at it is something like round numbers, 18 cents a share of a negative that ultimately will roll out and is already actually in our capital number. So, you know, we have these dynamics that the board thought about when we set the dividend level for the quarter that don't relate to the future earnings capacity of the company even as we look out into 2021.
spk13: Got it. Thank you for the clear answer.
spk12: Your next question comes from the line of John McDonald with Autonomous Research.
spk15: Yeah, hi. Good morning. Good morning. John, could you remind us just where you are on the asset cap, flexibility, what needs to be done each quarter now, you know, with deposits coming in and some loan demand and what kind of flexibility you have to operate under that and where you are today on the, you know, the way it gets measured. Thanks.
spk02: Sure, sure. So, we were in compliance with it at the end of the second quarter and the items that we did during the late first and early second quarter to maintain compliance were really focused on our wholesale funding footprint by shrinking the amount of external repo and other financing that we do and taking trading assets down. And we had to focus on certain categories of non-operational deposits, the ones that have very low liquidity value. And it's really, this is from this point forward, this is more of a liability management exercise to make sure that we don't retain too much in the way of low liquidity value deposits that we're thoughtful about other liabilities. On the asset side, there's so much cash on the balance sheet right now
spk00: that
spk02: it gives plenty of flexibility, I think, to do what we need to do with loans. We saw that our LCR print is 129% for the quarter and deposits have grown nicely. So, we're very thoughtful and cautious about how we price deposits, about those that have low liquidity value. We're thoughtful about maturities as they come up in non-deposit funding because with the inflow of deposits, we can rely more on that and less on notes and institutional CDs and other things. That's the work that we've been doing and that's the path that we have for the next quarter or two.
spk15: Okay, and you reiterated the Net Interest Income Outlook for the year. How should we think about kind of the jumping off point for the Net Interest Margin and Net Interest Income as we go into next quarter? What are some of the puts and takes that we should factor into the model?
spk02: I think it's going to be relatively flat from where it is today. We're sort of in that zone and as I said, $41 to $42 billion for the year still feels like the right number. So, I think it'll be, you know, we're not really carefully managing the NIM. It's we're looking for the dollars in Net Interest Income, but it shouldn't deviate too much from where we are right now.
spk15: Okay, got it. Is there anything in terms of asset cap progress? Charlie can comment. I know you can't say too much, but in terms of the work being done and in progress and doing what you need to do to satisfy the Fed?
spk04: You know, John, I appreciate everyone being interested, given the limitations of it and asking the question. It's going to be the same response every single quarter, which is we're focused on it. It is, along with the other enforcement actions, the biggest priority that we have. We're doing our work and the Fed will determine when the work is done to their satisfaction.
spk15: Understood. Thanks.
spk04: Thanks, Joe.
spk12: Your next question comes from the line of Scott Seethers with Piper Sandler.
spk19: Hi, Scott. Morning, guys. Okay, thanks for taking it. John, just was hoping you might be able to sort of update or refresh your thoughts on how and sort of when losses might evolve. I guess embedded in that is sort of how are you treating re-upped deferral requests, things like that. I guess additionally, the updated reserves build kind of implies sort of what you're thinking about cumulative losses through the period, but just any updated thoughts you can share,
spk02: please. Yeah, well, as it relates to deferrals, which generally speaking is the consumer side of the house, the fact that we are deferring definitely pushes out roles through delinquency buckets into charge-off. And so the actual charge-offs themselves will probably come later than they otherwise would. We believe that we've fully provided or captured that in the allowance, and so we've taken the credit charge today that we think is the right one at the end of the quarter, even if the charge-offs come somewhat later. We're also seeing we saw a tick-up in charge-offs in commercial, but there also, you know, things do take a little bit before they roll. I think, I guess I would expect the charge-off rates, and it'll be different by asset category, to sort of move up slowly through the end of the year, even into the first couple of quarters of next year, and then start to flatten out after that. Just based on the way things progress through loss recognition.
spk19: Okay, perfect. And then maybe just to switch gears a little, the additional customer remediation accruals. Tarla or John, could you go through sort of the, I know you alluded to sort of taking a fresh look at things under new management, but I guess just curious, given the charges we've already seen over the past couple of years, sort of what drove those additional accruals and the new management? Okay.
spk02: Yep, it's, as Charlie said, it was new leadership at the top of the organization in consumer lending and in the center capability that we have running customer remediation. I think they've gone item by item and thought about how to be a little bit more expansive, a little bit more consumer-friendly. You know, many of these things aren't crystal clear, and you're always making a judgment as to who it applies to, how much should apply, and over what time frame, and really in an effort, as Charlie said, to speed it up and move it through. They were a little bit more expansive in order to accomplish that. But it's by and large, it's the same items that we've been talking about for the last couple of years. There are always new things that come in out of that bucket, but the bigger dollars relate to the same topics that we've been covering for a while.
spk04: And the only thing I'd emphasize, as John said, is most of the dollars do relate to those items, and there's a lot of value in getting these things behind us. It's the work, it's the overhang, it's what our customers and communities think about us. And so we're obviously going to do what's right for the financial position of the company, but we want to treat people properly, and we want to move on and move to the future. And so we made decisions around what we were willing to do, certainly with that balanced lens.
spk19: Okay, perfect. Thank you very much.
spk12: Your next question comes from the line of Betsy Grasick with Morgan Stanley. Hi Betsy.
spk16: Hi, good morning. Hey, a couple of questions. So first off, Charlie, just want to get a sense as to where we should be thinking about where the expense improvements come from. And the reason I'm asking is, I know you're in the middle of business unit reviews, you've got new business unit heads in several places. You know, typically folks like that are going to want to invest in, you're not going to touch the regulatory side. So, you know, where should we anticipate you have room to start bringing down expenses ahead of regulatory framework changes?
spk04: Yep. And I think your point is actually a very important one, which is part of the reason why we've been, we're trying to be very careful about making it clear that we are going forward and actively going to start to take actions to reduce expenses. But we don't want to back ourselves into a corner until all of our work is done because of those two things that you mentioned, which are very important. Having said that, and the reality is that the work that we have to do, the foundational work to build the risk and strong infrastructure and ultimately satisfy the work that the regulators would like us to satisfy, it's clear, it's distinct. It is fairly broad across the company, but we know exactly what it is and what resources are decked against that. When we look elsewhere in the company, and I think I use the words in the prepared remarks, it is we just, we have spans and layers at the company which are well beyond what I've seen at other places and makes us a very, very inefficient company. When we just look at the work that's being generated, the things that are being done, we as a management team believe that we can change the priorities so that we're being really clear on what has to get done and stop a bunch of work that has to get done. We have duplicative platforms, duplicative processes across the company. As we think about a series of these things, they are extremely significant because these things exist just about in every part of the company. In addition, I just also want to point out that we have stopped any reductions that we're going to take place just given the environment. There is a series of actions that we are ready to take. In fact, we have a series of employees who've been told that their jobs will ultimately go away, but we were going to let some time pass as we got through the initial stages of the COVID crisis. We do see a clear path to start making an impact on the expense base. It's like an onion. The more we do, the more clearer the next round will become.
spk16: Is that something that you could start in second half? I know you mentioned that we'd see the benefits here in 2021 with expenses below 20, but should we anticipate that some of this will start in second half 20?
spk04: We are clearly going to take the actions in the second half of this year. Obviously, depending on what the economics of all that is and the accounting of it, not quite sure whether you'll see it here or in next year.
spk16: Got it. Okay, that's understandable. Then could I just switch gears to a question on mortgage? I just want to
spk04: add one thing, which I just think is important, which is because I didn't say this in the prepared remarks, but I've certainly talked about this inside the company, which is we don't look at a quarter like this and just say, okay, that is what it is. Losses are higher. Our margins are narrow. We know we've got some work going on, so we'll eventually get around to it. While we knew these things had to get done and the work was getting done, it's not lost on us our underperformance relative to where we should be earning. And so while I think there was a sense of urgency towards both getting the regulatory work done and improving our performance, whatever sense of urgency existed before is going to be small relative to what it is going forward.
spk16: Yeah,
spk04: I get that.
spk16: No, I get that. And I also am hearing in your commentary that the costs around the regulatory and the risk and those costs, is it fair to say, are more known today than they were maybe a year ago?
spk04: Yeah, I think absolutely. As time goes on and we become, you know, we get clear on what has to be done, it's clearly easier for us to put, you know, our broad understanding of what that takes. And again, just to be clear, when we go, and part of the reason why it takes us a period of time to do this properly is we're going to have very formal processes in place to ensure whatever reductions in our expense base we take that they do not impact any of that work. And so that'll be informal and it will be very, very formal because that would be just a terrible, terrible mistake for everyone if we were not to do that properly. So beyond heightened consciousness on that issue.
spk16: Okay. All right. Just switching to mortgage, you know, refi speeds have been incredibly high through second quarter. And, John, I just wanted to get your sense as to what's in your base case assumptions for 3Q, 4Q? I mean, part of the reason for asking is it impacts, you know, the servicing, prepayment speeds, it impacts your NII outlook with, you know, refinancing on the agency. And then I also just wanted to have a quick follow-up question here on the GINI buyouts that you did that, you know, the American Banker highlighted this morning. Just understand, is that the first of many or not? Thanks.
spk02: Yep. Good question. So on mortgage speeds, and it shows up in the MSR, it shows up in our investment portfolio, and it shows up in the runoff of book loans that are in our held for investment portfolio and loan form. The speed assumptions vary depending on the vintage, the coupon, the debt to income, the, you know, LTV, et cetera, and the refinanceability of borrower by borrower. But I think we're as aware as anyone of how fast things have gotten, and we're seeing 30-handle CPR on various pools of loans. And so while we think we've captured that in our updated estimates on the MSR in particular, it does feed into this level of, you know, call it $500 to $700 million per quarter of premium amortization for mortgage securities, which we, as I said, is likely to remain for the rest of the year. On GINI buyouts, you know, what's happening there is that there are loans that have gone delinquent, in part because of COVID. And as the servicer, we essentially have accounting consequence of owning them whether we buy them out or not. They're deemed, because the option to purchase them is so deeply in the money, we're deemed to have bought them. And so our calculus was either to have a giant pile of cash and that consolidated asset or to go ahead and buy them out and not have that asset, essentially that asset twice, but use the cash to buy the asset. And these are guaranteed loans. You know, from our perspective, not a huge credit consequence. It's just carrying the asset for a period of time before it either gets redelivered or sold or worked out in some way. So that's why we were a big buyer in the, actually that was after the end of the quarter. And then with respect to whether it continues on, it's facts and circumstances. The same tension will apply if we're deemed to have them on our books because we have the option to buy them. Then we may, and if cash levels remain where they are, then we may go ahead and do it just so that we don't really double up the size of our balance sheet. And that is an asset cap consideration.
spk16: Yeah, I know that makes a ton of sense. But so it's a function of in more forbearance from here. Is that the driver?
spk02: Yeah, more slash ongoing. That's right. And whether we're the servicer or not. But that's,
spk16: that's right. Yeah, of course. All right. Okay, thank you.
spk17: Yep.
spk12: Your next question comes from the line of Ken Houston with Jeffries.
spk17: Good morning, good afternoon. Now at East Coast. Just a follow up question on the NII outlook. Seems like in the second half, some pluses or minuses to get to the mid zone of your 41-42. But just can you help us understand just how much more roll through there needs to be from here on both asset yields and securities yields to your early points of how you're what from here can also happen on the deposit cost side as a partial offset?
spk02: Yep. So I think on the deposit cost side, the our anticipation is that between the reduction in pricing for interest bearing deposits and the growth or continuity of non-interest bearing deposits, that our average deposit cost is back in the single digit basis points by the third or fourth quarter. That's the trajectory that we're on. That's where we were 2015-2016. On the asset side, depending on what happens to LIBOR probably in particular, spreads are holding firm where we're lending and there will be some lower spread loan product that is replaced with higher. You've heard about that in autos. It's true in some categories of C&I. But that's a piece of it. On the securities front, we've been trying to stay invested, but the level of prepayments that Betsy just referred to, I think, had our securities portfolio down by almost $30 billion in the quarter. And so how much more duration we want to add at these low yields is a separate issue. We haven't been adding much in credit related securities product. As I mentioned to John, the outlook for NIMM is relatively range bound for the rest of the year. We're sort of bumping along what we think the bottom could be. Obviously, things could change. But at zero in the front end and 60, 70 basis points in the long end, this feels about where we're likely to be with the things that I mentioned.
spk17: Right. And then so I guess then it really just NII growth next year or just you're starting from a high point this year. So we'll probably be in the hole still next year. But really, does it depend on the asset cap then or does it depend on the mix of earning assets in order to get that kind of off this $10 billion-ish type of NII number?
spk02: Yeah, it's a good question. It's both. So it's what choices we make on the asset side and what the market is offering, where loan demand comes from, I think will matter a lot. The slope of the curve, if things get a little steeper, that obviously could be helpful because we're so exposed at the long end. And then if there's an opportunity to have a bigger balance sheet, we're certainly not budgeting that way or counting on it. But that would be a difference maker.
spk17: Okay. One just quick follow up, John, on the servicing side of mortgage, you know, great production and then the tougher servicing results. There's both the core fees that are contracting because of the prepays and then there's all the hedging. What's the best way you can help us understand how that mortgage banking line item just projects from here, given especially the uncertainty and how you model out the servicing side?
spk02: Yeah, it's tricky. But so I think what we've said is we expect volumes on the production side to be a little bit higher and margins to be relatively constant. So if those two things hold true, the third quarter should be a relatively great production environment for mortgage. And on the servicing side, we think we've captured the higher servicing costs for default servicing, modification servicing, et cetera. We now have faster speed expectations in the model, although we said that a quarter ago too. We were surprised on the downside. But if both of those things are captured, then we will produce lower servicing fees because the book itself is getting smaller. But, you know, I'll take smaller servicing revenue as long as we're not taking big write downs on the asset that are offsetting the benefit that we're generating on the origination side. And hopefully the third quarter reflects that.
spk17: Okay, got it. Thanks, John. Yeah.
spk12: Your next question comes from the line of Saul Martinez with UBS.
spk18: Thanks, Saul. Hey, Guy. Hello. Thanks for taking my questions. You know, first of all, a really, really specific question related to the fourth quarter dividend cap. Can you just, you know, verify, John, that that's based on net income before preferred stock dividends? And because I think that the guidance from the Fed is public, that it's based on your Y9C net income figure. And for you guys, obviously, that does matter given the size of the preferred stock dividends. So I just wanted to make sure that that point was clarified.
spk02: Yeah. The way we're calculating it's NIAT after tax, but before preferred stock dividends, which gets you to NIAC, available to comment.
spk18: Okay. Got it. Okay. So you're calculating it before preferred stock dividends, just to be correct. Okay. Got it. A much, much, much broader question. And, you know, kudos on the donation to CDFI. I think, you know, a lot of them do, you know, a lot of very good work. And I guess on that point, I do think that it's pretty clear that Wells does have to, maybe more than others, really focus on multiple stakeholders and different goals. And, you know, the idea of, you know, strictly shareholder driven capital is obviously already under attack. And you have to make your regulators meet their demands, employees, I think you guys genuinely are concerned about the communities you work in. And then you have guys like me who, you know, talk about, you know, your Rossi's and, you know, super high efficiency ratios and how you're going to right size your cost structures. And I guess how do you think about that, the balancing act and those competing demands? I think in the past, most management teams have argued that they can, you know, do all of those things simultaneously. And I think to a certain degree, maybe that is true, but there are some trade offs and, you know, and, you know, some element of a zero sum dynamic going on. So I guess, Charlie, I'm curious, maybe just more philosophically, how you think about that. And I guess, you know, ultimately, how do you think about shareholder, you know, shareholder value in that in that totem pole of goals?
spk04: Yeah, I guess I don't think about it as a trade off. And I don't think about it as something which is different for us versus other significant companies, whether you're a financial institution or not. I think, you know, it is very, very clear that our ability to be successful as a company for our shareholders includes the fact that we are broadly considering a much broader set of stakeholders. If we don't do that, customers, whether they're consumers or companies, ultimately, won't want to be supportive of us, will have issues in our local communities. It'll filter through to the legislative and likely the regulatory agenda. So I think we very much think that they are very much related and that there's no reason why the things that we should be doing to be more thoughtful of a broader set of stakeholders. They aren't a set of financial negatives. Ultimately, it should be something beyond that. You know, the PPP fees were certainly something that was very unique. We are in the middle of this, you know, really horrific time for small businesses and especially minority-owned small businesses. The right thing for us as a significant company in this country is to be as helpful as we can with that community. It's also ultimately helpful for us if we can make a difference in the communities that we operate. And then we also looked at that relative to just the, you know, what we thought was fair for us in order to participate in the PPP program. And so I think, you know, you put all those things together and there is alignment. And those that don't think about it that way will likely suffer over the long term.
spk18: All right. That's it. Thanks for the thoughtful answer. Appreciate it.
spk12: Your next question comes from the line of Stephen Shuback with Wolf Research.
spk09: Hi. Good afternoon. So I wanted to start off, Charlie, with, you know, just a theoretical question on the asset cap. You talked about the proactive steps that were taken to manage the balance sheet to stay below and how that's negatively impacted NII. Now, since most investors are focusing at this juncture on normalized NII and through the cycle revenue growth expectations, if the Fed were to lift the asset cap tomorrow, I was hoping you can give us some idea or context around the amount of pent-up growth potential in the balance sheet today. I think it would be helpful if you could frame the impact of the asset cap on NII or at least volume growth based on where things stand today.
spk02: So, this is John. If, just as a data point, using rough math, if our balance sheet was expanded by, call it $200 billion or about 10% during this COVID timeframe, and there is a question about whether there was ample opportunity to do that around several asset classes, but in certain areas there certainly was, with something like our average NIM, the impact that that would have had on us would have been, and these are approximations, but to reduce the drawdown on NII by 50%. So, half of how things have worsened would have been covered by that expansion of the balance sheet. That's one way to think about it. There were more immediate opportunities to put loans on, in particular, I would say in March as capital markets were closed. I think everybody knows that. We saw customers drawing on available facilities and there were other requests for new facilities. The bigger, probably more constant piece of an increased balance sheet, at least in the businesses that we serve today, would probably be to have a bigger securities and securities financing portfolio in support of our corporate and investment bank where we have drawn down as part of managing under the asset cap. And there's a handful of benefits to that, including being able to do more business with the companies and the institutions that we're financing in that realm. But you also end up with a big LIBOR-funded book that is a little bit less asymmetric in a down rate scenario, and we certainly suffered from that. There's a real benefit to being substantially deposit funded in that it's very low cost to begin with, but in a down rate environment it's a little bit more violent in the outcome that it generates. And to have a bigger component piece of LIBOR-funded assets with LIBOR-funded liabilities, it's a little bit less high producing in the best of times, but it maintains its margin in a down rate environment. So that would have been a benefit also. Charlie, you may have other thoughts.
spk09: I think that's okay. Charlie Pagelopoulos Okay. No, that's helpful, Coller John. So thanks for that. Just had one more question. This one, I guess, after the last couple of quarters, but wanted to get some context around the core fee income level or the jumping off point we should think about for the back half. You cited some of the tailwinds for mortgage production. Trust fees should benefit from the higher markets, but you also have some normalization of trading activity. And just given all the different moving pieces, I was hoping you can give us some sense as to what the right jumping off point might be for 3Q.
spk02: Coller John Yeah. We don't put a number on it and call it core, but rather talk about the component pieces of it. And so service charges on deposits, which is a big one for us, my assumption is that it's going to feel, at least for a while, like it does today. People are spending differently. They're maintaining cash balances at a higher level. And so there are, whether it's waivers because of high balances or the absence of overdraft, that puts pressure on that line item as our customers do what's right for them in this environment. You mentioned brokerage advisory, et cetera. That should be stronger going into the second half of the year. Investment banking, you know, we had a record high grade market in the first quarter. So while other activity may pick up a little bit, my sense is that that probably normalizes somewhat. Card fees have reflected what I mentioned in my prepared remarks, which is at least in the debit card space, we've got balances or flows in dollar terms about equal to last year, but the number of transactions lower, which has a negative impact in card fees. And credit card fees have been improving but haven't caught up. So that I don't think is going to pop back up anytime really quickly. Mortgage, I mentioned on the production side should be very strong, or should be strong. And hopefully we've accounted for faster speeds and higher costs in servicing. Trading, as you said, probably gets a little bit softer. And other items are less material and nothing really noteworthy. So that's how I would think about the categories.
spk09: Well, you covered the gamut. Thanks so much for that, John.
spk02: Beth.
spk12: Your next question comes from the line of Matt O'Connor with Deutsche Bank.
spk10: Hi, Matt. Hi. I want to sort of go back on kind of the longer term view of getting your efficiency closer to peers. And I guess the first question is, you know, why do you necessarily think it's an expense issue versus a revenue issue? Or is it a combination of both?
spk02: It's definitely a combination of both. You know, revenue, particularly interest income, which doesn't carry a lot of expense load, would be very helpful. I think what we're trying to do is assess where the company is today and what we can do about it. And we can do more about expense than we can about revenue in a balance sheet constrained environment, in a recession and in a low rate environment. So it's actionable by the management team. But without a doubt, some amount of normalization of certain categories of revenue would contribute to it. But having said that, I think we've sort of vectored in a variety of different ways on the idea that all things being equal, and I'm sure they won't be, but at least as we think about it that $10 billion is a reasonable amount to go after, to put Wells Fargo on a level playing field with the large cap peers.
spk04: And the only thing I would add to what John said is, this isn't, you know, the calculation of the $10 billion, you know, that is a mathematical exercise. When the management team, the operating committee gets in a room, there is absolutely no disagreement in the room, not about the math, but about the inefficiencies that exist inside the company away from all of these risk-related activities. And the work that we've been doing is to build the plans from the bottom up to identify where that is. And so, you know, whether that's the full $10 billion or not, you know, we'll see what we get to. But there is, you know, we certainly have a clear belief that we can make a significant dent based upon what we know.
spk10: And just to be clear, what you think kind of the longer-term cost base can be, you know, when you use the $10 billion as kind of a reference point, should we just annualize this quarter's costs? That gets you about $58, you take out $10, gets you around $48. I mean, is that the thought process?
spk02: I think of $54-ish is more of the normalized starting point without the excess expenses that are loaded into this quarter for the items that we mentioned.
spk10: So take $10 off to $54?
spk02: Yeah.
spk10: Okay. And I guess just relate to that, like, whenever I think about kind of cost saves, like, there are areas that you'll want to invest in. There is just natural inflation creep. So, I mean, you guys kind of opened up a little bit of the can of worms on the $10 billion. So I know these are things that are tough to predict, like, looking at a few years, but...
spk04: You know, but we didn't
spk10: open a can
spk04: of worms because I don't look at it like we open a can of worms. I think we look at it like we're acknowledging what the facts are, which is the facts are is we compete with other companies that are investing tremendously and with that, those set of investments, the math says the following. And so what we, you know, we've again purposely haven't said we're going to reduce our expenses by a certain point in time because we are doing the work to figure out what the timing looks like with our reductions versus our investments. But I think what's important is not just that we acknowledge that that gap exists, but we are proactively working to get to a place which makes sense, both from an efficiency standpoint, knowing that we should be investing in the business.
spk10: Okay. All right. It sounds like we'll get some more details in the third quarter. So I think we all look forward to that. Thanks. Your
spk12: next question comes from the line of John Pencarey with Evercore ISI.
spk05: Good morning, John. On the credit side, just want to see if I can get your updated thoughts around your through cycle loss estimates that you would expect. I know your 2020 company run DFAST is about $27.7 billion. Is that a fair way to think about it? And then also want to get your thoughts around the reserve. You took a pretty good addition this quarter and now your reserve is about 74% of that 2020 DFAST. Do you think there's likelihood for additional substantial reserve additions from here?
spk02: Thanks. Thanks for the question. So we do the math to compare our own estimations to the DFAST outcomes, but we don't think of them as necessarily better informed about our loans and our portfolios and our risk profile and our collection activity, etc. So it's a useful data point. It's an external one that people can judge against. But we think more about our own experience and the scenarios that we believe are the likely ones in the world that we're living in. And so that's how we focused it. With the build that we made in the allowance, I think we're at almost .2% coverage of the outstanding loan portfolio. And of course, it's very different by loan category like it is for every other bank. I think we believe that if the world unfolds in the way that we've got it modeled and assumed in our both modeled loss estimations and in our bottoms-up portfolio by portfolio work that we will have captured the loss content in the portfolio as of the end of the quarter. And as a result, unless things really bled in a worse direction, that this would have accounted for those losses.
spk05: Thanks, John. And then related to that, on the commercial real estate side, just want to see if you could discuss the credit trends that you're seeing in commercial real estate. I know that delinquencies in CNBS structures really spiked for the industry beyond even financial crisis levels. But clearly that is being saved off somewhat at the banks by forbearance efforts. Could you just give us a little bit of that granularity around what you're seeing and the level of forbearance in commercial real estate? And is it seeing a greater pressure in the portfolio to forbear, given the pressure that your borrowers are seeing? Thanks.
spk02: The first distinguishing point I would make is that, and I know you know this, but for everybody's CNBS structures are non-recourse loans. So there's no alternative other than realizing on the collateral. There's no mechanism for extra cash flow to enter into a structure unless somebody does something that they're not contractually obligated to do to try and shore things up. And I think as I've seen most recently, the June numbers in CNBS are about 13% of loans are not current. Conversely, on a bank's balance sheet, most of the loans that we have have real sponsorship and recourse and generally speaking are lower LTV than CNBS to begin with. So our actual performance is quite different. And then I think we talked about this last quarter too, but the variation in how deep we'll go from an LTV perspective is, as you'd hope, you know, with the more stable property types, we might have higher leverage. And with the least stable property types, we'd have lower leverage, which helps a lot in a downdraft. So we have, you know, in round numbers, roughly $150 billion worth of commercial real estate loans outstanding at the end of the quarter. The biggest piece is a quarter of that is office, 20% of that is apartments, 12% is industrial, 10% is retail excluding shopping centers, and then 9% is shopping centers, and everything else is below 9%. Actually, hotels is about 8%, which is a volatile property type. And then among non-accrual loans, the shopping centers are 32%, hotels 14%, and retail excluding shopping centers is another 14%, and everything else is below 14%. There's about a billion three of non-accruals overall. So that's what it feels like. You know, we're working through these things borrower by borrower. Sometimes the concessions that we're making are just covenant related. Sometimes they are, you know, real forbearance, and we allow people to take a little bit more time to pay. Our borrowers have been generally calm and constructive. It's not a lot of panic at this point in the cycle. The problem loans have skewed towards retail projects, many of which were already struggling, and then also the hotel owners with lower capitalization. So I hope that's helpful.
spk05: Got it. Now that is helpful. So really, you're reserving within commercial real estate, you would say that that represents the similar stance for your overall portfolio? In other words, you're pretty much finished building reserves there as well?
spk02: For how we understand the world at the end of the second quarter, yes. And we think that's relatively, we think it's very realistic. I should also add that in commercial real estate and elsewhere, you know, our teams have gone loan by loan, borrower by borrower, and made an assessment of, you know, where we think we are and where we think things are going. So it's not just modeled set of expectations, but real, a real careful review of every borrower, every property, and their circumstances.
spk07: Got it.
spk02: All right. Thanks, John.
spk12: Your next question comes from the line of Ryan Klein-Hensel with KBW.
spk11: Hi, Brian. Thanks, guys. Hey. One quick question, that's more of a clarification. You did mention that slide 16, that said every set of non-accruals were current on interest in principle. Was that referring to the 1.4 billion increase, or was that referring to the total, and I guess why non-accrual or fair current on interest in principle?
spk02: Total. Total amount.
spk11: Okay. And then, separately, when you think about the D-FAST results, and you're saying that you may perform better than those results, I guess, where do you take exception with kind of how the modeling your stress losses versus how you see them coming through this cycle?
spk02: Yeah. Forgive me if I don't start a response by saying we take exception with the Fed's results in the following way, because that's not really, that won't be helpful. But they draw from different models and have different approaches, and we draw from our own, as I said, bottoms up, our own modeled outcomes, our own historical outcomes, changing the composition of the portfolio, changing underwriting standards, since whatever we're comparing it to, and we end up with the numbers that we end up with. I'm happy to note that I think, in general, the Fed applies, in general, a lower loss rate for a variety of loan categories to Wells Fargo than they have for some other lenders. It's not universally true based on the composition of portfolios, but we're, we like our numbers, we're a lot of work with a lot of very close inside knowledge of borrowers, properties, etc., goes into it, and it's being compared with something that's more statistically driven from a model that we don't have access to.
spk11: Okay, thanks.
spk12: Your next question comes from the line of Chris Kotowski with Oppenheimer & Company.
spk07: Yeah, good morning, Chris. One, just to follow up on Matt's question, I mean, just, you know, from 2017 to today, I mean, your revenue runway went from $88 billion to, you know, roughly $70 ish billion, and your core operating expenses have kind of stayed flatish at $54 ish, let's say. So, I mean, sitting here on the outside, it would look like it's primarily a revenue problem, not an expense problem. And, I mean, when you put out a number like $10 billion, are you worried that that is going to, like, forgo the optionality on capturing back that $18 billion in lost revenues, or should we assume that that's kind of gone?
spk04: Yeah, you know, I think you should go back and listen to the words that we use to describe what the $10 billion is and how we're thinking about this. Listen, there's no question in our minds that we should have the ability to generate higher revenues in the future. No question that will help when it comes to an efficiency ratio. What we're talking about is, if you go back and look at where we were as a company versus the others, the others, the big companies that we compete with have been working on this for five to ten years. And there is, and again, I'm just being very factual about this, which you should go back and check yourself, which is there is this meaningful difference between what our expense base looks like and theirs. And then I recognize you're on the outside, but what we're telling you is from what we're seeing on the inside that we as a management team continue to believe that the opportunities are substantial to improve the efficiency of the organization because we see it day in and day out. And we're going through a process to identify exactly what it is, where it is. It's not just people. It's the third party spend here is extraordinary. The things that we rely on outside people to do is beyond anything that I've ever seen. Our ability to reduce facilities is substantial. And so there's this long list of things that we will actively be working on. Whether that gets to ten billion, whether it gets to more, whether it gets to less, we'll see. We're going to share more as we develop the plans. But I think it's just important for us as a management team to be very objective at what things looked like for this company before we wound up in today's environment. And those efficiencies clearly exist in the company.
spk07: Okay. And then just a small thing. I thought I heard John say that you're no longer accepting home equity and personal line of credit applications. And I mean, I realized that those have been declining categories and that they are not the kind of product lines that today that they were before the great financial crisis and all that. But still, aren't those kind of sort of key products in a big consumer bank's arsenal? And doesn't it send the wrong message to not even take the applications?
spk04: Well, I guess let me, I'll talk about it, I guess the way to think about it is, first of all, we do offer personal lines in the company because we have a credit card business. And so, you know, for us, it's a question of making sure that we've got the right product in front of the customer. And so we think we have the ability to do that. The home equity product, as you rightfully mentioned, has certainly declined in terms of the amount of production that was taking place. But we do have to make a determination in the uncertain environment as to what is a smart thing for us to participate in along with consumers as they add risk to their balance sheet. As time goes on, if we feel differently about the environment and about real estate values, those decisions could change as well.
spk07: Okay, fair enough. Thank you.
spk12: Your next question comes from the line of Vivek Genasia with JT Morgan.
spk14: Hi, Charlie. Hi, John. Couple of questions, thanks for taking them. Firstly, Charlie, are you still on track to be giving us some kind of strategic review, a strategic plan towards the end of the year? And should we expect that with the cost details that you're going to give us in the third quarter? How are you thinking in terms of timing of the two things?
spk04: I think in as we between the third and fourth quarter, we're looking at getting both done to share the complete set of thoughts with you.
spk14: Okay, so you'll do them, so you'll give it to simultaneously so that we can see how the two fit together?
spk04: Again, I think that's what we're targeting, but we'll have to see how it plays out and our work progresses.
spk14: Okay, in that same vein, Charlie, as you're thinking about all of this, you talk about not having too much of an expense dollar relative to your peers. How much of this is going to be in the way you find businesses where it's because you just don't have enough scale on the revenue side? Are you thinking you're going to exit some of those businesses? What are you thinking there? Are you thinking about more business exits? Any thoughts on that?
spk04: Yeah, that's a good question, Vivek. I think we've talked about this a little bit over the last of quarters. There absolutely are some things that we do which either we don't have scale in or it just might not be big enough to have an impact on the company going forward, and it's not clear that it's integral to us being able to fulfill the primary banking relationships that we have from the consumer to the small business and middle market up to the corporate. So I think as we think about what the company should look like, we absolutely are looking at those things, and so we certainly expect that we would continue to, I think John has used the word prune, some of these things that exist inside the company as we've been doing. I don't think about them in terms of, you know, say differently, the five lines of business that we've determined we do believe are key to the future of the company, but when you go below that, there's certainly some activities which might not meet our criteria for continuing to be here.
spk14: And then when you give us these combined reviews, will you give us some sense of, you know, we've been, we've heard about, you know, need to spend more in technology areas that you're behind in. Will you give us some sense also where that stands business by business and what you need to do and how that sort of dovetails with the numbers too?
spk04: I, you know, listen, we'll see when we get closer the level of details that we go through with you, but certainly the work that we're doing contemplates the fact that we don't want to stand still in our businesses.
spk14: Thank you.
spk12: Your next question comes from the line of Charles Peabody with Portales.
spk03: Good afternoon. Thank you. Two questions. One, and I apologize if you've already covered this, but I transitioned over late from the Citigroup call. What were the variables that went into your thinking on the level of the dividend? I mean, was it, this was a level that you didn't have to worry about it again? Was it a function of what you think your core earnings power is going forward or is it a desire to build capital more quickly? What were the variables that got you to that level?
spk02: A handful of things, of course, and with the expectation that it's likely that the constraints on the calculation of allowable dividend hang around for a while, even though they may not, but they certainly may, you know, we've found a level that we believe is is something that gives us more of an upside ability as the COVID environment clears up, as the medium term earnings power of the company becomes more known, both in terms of sources of revenue and what's happening with expense, et cetera, so that we don't, we wouldn't end up or have a low likelihood of ending up in an environment where we're making, you know, repeated changes to the dividend. So not so much about, our capital levels are fine. We have 23-ish billion dollars of excess on top of our regulatory capital requirements and we feel it's gone up, as you may have observed, and that's even after building a 20 billion dollar allowance, so not so much capital sufficiency, although in the future could turn out differently than we and others are planning right now, but really more about thinking about the core earnings power and resulting upward trajectory when the time is right.
spk04: And Charles, I would just add, I know we certainly appreciate the multiple calls that are going on today and it's a busy day for you all. I would encourage you to go back and look at the prepared remarks because we did walk through the thinking.
spk03: Thank you. And as a follow-up question, there's a 40 or 50, 60 congressmen on both sides of the aisle, so bipartisan, and it's addressed to Mnuchin and Powell, and in this letter they, you know, warn of a looming crisis in the CRE and particularly the CMBS market, and they asked for help from the Treasury and the Fed. I was curious what actions you think they might be thinking about taking to support the CMBS market, or what actions would you like to see them take?
spk02: I don't know if we have an opinion on what actions we'd like to see them take. I do think that as between the risk owners and CMBS transactions and servicers and borrowers, you know, people should be looking to maximize recovery value, but, you know, I think that's a little bit thoughtful. This isn't the first downturn that those market participants have been through, and my expectation is that a lot of decision-making power is going to end up in the hands of special servicers, and I don't know how to, I don't know why it would be a good idea to impose some other regime on top of that, that changes those contracts, but I don't have a careful, thoughtful review of what's being proposed.
spk12: Thank you. Our final question will come from the line of Gerard Cassidy with RBC.
spk06: Hello Gerard. Thank you. Hi, John. I apologize if you touched on this already, but when you guys gave us in slide two, I'm sorry, slide three, the number of customers you have helped with deferring payments and waiving fees, can you give us some color on the trend in terms of the applications for these deferrals? I assume they were very heavy early on and they've faded downwards, and then second, how many of the customers that have come up for renewal have actually asked for a second extension of the, you know, for the deferrals?
spk02: Well, it's different by loan category, and yes, it's true that the people initially asking, it was sort of a high point, we peaked, our peak was the second week in April. I think on average we had about 60 or 70,000 accounts per day who were asking. We've dropped almost entirely, I think we're at 4,000 a day for the week of late June, so if that's helpful. And then of course the extension question is related to how long was the initial deferral to begin with, and you know, in general I would say that more people are getting comfortable with coming out the other side, but yet we still have a good base of folks who are in deferral.
spk06: And then second, John, have you guys gotten any color from the Fed on how long they're going to be supportive of the industry, yourselves included, in granting these deferrals without having to reclassify the loans and, you know, put more capital against them?
spk02: I don't think we've got a specific conclusion on that, although we do assume that there's going to be some point in time after which, whether it's the regulators, not only the Fed, and or our accounting convention is going to cause us to have to consider these as something other than a performing loan. It might be different by category, it might be different by regulator, but the longer we go on, the greater the risk of that.
spk06: Great, and lastly, thank you again for the great detail that you guys give in your commercial and industrial loan portfolio, and I noticed, as you mentioned, the increase in non-accruals on page 17, the different categories. Can you give us some color on the real estate and construction non-accruals from the $290 million up from, I guess it was $49 million in the prior quarter? How much was construction versus loans to the non-depository financials?
spk02: You know, I don't think I have the breakout in front of me, but I can have the IR team follow up with you.
spk06: Okay, great. Now, I appreciate it, John. Thank you. You bet.
spk04: All righty, guys. Wilson, thank you very much for the time. We appreciate it, and we will talk to you soon. Take care.
spk12: Ladies and gentlemen, this does conclude today's call. Thank you all for joining, and you may now disconnect.
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