UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2003
OR
Commission file number 001-2979
WELLS FARGO & COMPANY (Exact name of registrant as specified in its charter)
420 Montgomery Street, San Francisco, California 94104 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 1-800-411-4932
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
FORM 10-Q TABLE OF CONTENTS
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PART I—FINANCIAL INFORMATION
WELLS FARGO & COMPANY AND SUBSIDIARIESCONSOLIDATED STATEMENT OF INCOME
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WELLS FARGO & COMPANY AND SUBSIDIARIESCONSOLIDATED BALANCE SHEET
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WELLS FARGO & COMPANY AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITYAND COMPREHENSIVE INCOME
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WELLS FARGO & COMPANY AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CASH FLOWS
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WELLS FARGO & COMPANY AND SUBSIDIARIESNOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Wells Fargo & Company and Subsidiaries (consolidated) (the Company) is a diversified financial services company providing banking, insurance, investments, mortgage banking and consumer finance through banking stores, the internet and other distribution channels to consumers, commercial businesses and financial institutions in all 50 states of the U.S. and in other countries. Wells Fargo & Company (the Parent) is a financial holding company and a bank holding company.
The accounting and reporting policies of the Company conform with generally accepted accounting principles (GAAP) and prevailing practices in the financial services industry. Preparing the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Certain amounts in the financial statements for prior years have been reclassified to conform with the current financial statement presentation.
The information furnished in these unaudited interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with the Company's 2002 Annual Report on Form 10-K (2002 Form 10-K).
Descriptions of the significant accounting policies of the Company are included in Note 1 (Summary of Significant Accounting Policies) to Financial Statements in the Company's 2002 Form 10-K. There have been no significant changes to these policies.
Stock-based Compensation
The Company has several stock-based employee compensation plans, which are described more fully in Note 14 (Common Stock and Stock Plans) to Financial Statements in the Company's 2002 Form 10-K. As permitted by Financial Accounting Standards Board (FASB) Statement No. 123 (FAS 123), Accounting for Stock-Based Compensation, the Company uses the intrinsic value method of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees, to account for its stock-based employee compensation plans. As required by FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment to FASB Statement 123, pro forma net income and earnings per common share information is provided, as if the Company accounted for its employee stock option plans under the fair value method of FAS 123. The fair value of options was estimated at the grant date using the Black-Scholes option pricing model, which was developed to estimate the fair value of traded options that have no vesting restrictions and are fully transferable. Because the Company's stock options have characteristics significantly more restrictive than those of traded or other freely
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transferable options, in management's opinion, existing valuation models, including the Black-Scholes model, do not necessarily provide a reliable single measure of the fair value of stock options.
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2. Business Combinations
The Company regularly explores opportunities to acquire financial institutions and related financial services businesses. Generally, the Company does not make a public announcement about an acquisition opportunity until a definitive agreement has been signed.
Transactions completed in the three months ended March 31, 2003 include:
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3. Intangible Assets
The gross carrying amount and accumulated amortization for intangible assets are presented in the following table.
The following table shows the current period and estimated future amortization expense for amortized intangible assets:
The projections of amortization expense shown above for mortgage servicing rights are based on existing asset balances and the existing interest rate environment as of March 31, 2003. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.
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The following table summarizes changes in the carrying amount of goodwill as allocated to the Company's operating segments for the purpose of goodwill impairment analysis.
Goodwill amounts allocated to the operating segments for goodwill impairment analysis differ from amounts allocated to the Company's operating segments for management reporting discussed in Note 7 (Operating Segments). At March 31, 2003, the balance of goodwill for management reporting for Community Banking, Wholesale Banking and Wells Fargo Financial was $2.89 billion, $634 million and $346 million, respectively, with $5.93 billion recorded at the enterprise level. At March 31, 2002, the balance of goodwill for management reporting for Community Banking, Wholesale Banking and Wells Fargo Financial was $2.87 billion, $589 million and $343 million, respectively, with $5.93 billion recorded at the enterprise level.
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The Company is authorized to issue 20 million shares of preferred stock and 4 million shares of preference stock, both without par value. All preferred shares outstanding rank senior to common shares both as to dividends and liquidation preference but have no general voting rights. No preference shares have been issued under this authorization.
The table below is a summary of the Company's preferred stock. A detailed description of the Company's preferred stock is provided in Note 13 (Preferred Stock) to Financial Statements in the Company's 2002 Form 10-K.
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The table below shows earnings per common share, diluted earnings per common share and a reconciliation of the numerator and denominator of both earnings per common share calculations.
At March 31, 2003 and 2002, options to purchase 73.2 million and 38.5 million shares, respectively, were outstanding but not included in the computation of earnings per share. The exercise price was higher than the market price, and the options were therefore antidilutive.
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The Company has three lines of business for management reporting: Community Banking, Wholesale Banking and Wells Fargo Financial. The results for those lines of business are based on the Company's management accounting process, which assigns balance sheet and income statement items to each responsible operating segment. This process is dynamic and, unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting equivalent to GAAP. The management accounting process measures the performance of the operating segments based on the Company's management structure and is not necessarily comparable with similar information for other financial services companies. The Company's operating segments are defined by product type and customer segments. Changes in management structure and/or the allocation process may result in changes in allocations, transfers and assignments. In that case, results for prior periods would be (and have been) restated to allow comparability.
The Community Banking Group offers a complete line of diversified financial products and services to individual consumers and small businesses with annual sales predominantly up to $10 million in which the owner generally is the financial decision maker. Community Banking also offers investment management and other services to retail customers and high net worth individuals, insurance and securities brokerage through affiliates and venture capital financing. These products and services include Wells Fargo Funds®, a family of mutual funds, as well as personal trust, employee benefit trust and agency assets. Loan products include lines of credit, equity lines and loans, equipment and transportation (auto, recreational vehicle and marine) loans, education loans, origination and purchase of residential mortgage loans for sale to investors and servicing of mortgage loans. Other credit products and financial services available to small businesses and their owners include receivables and inventory financing, equipment leases, real estate financing, Small Business Administration financing, venture capital financing, cash management, payroll services, retirement plans, medical savings accounts and credit and debit card processing. Consumer and business deposit products include checking accounts, savings deposits, market rate accounts, Individual Retirement Accounts (IRAs) and time deposits.
Community Banking provides access for customers through a wide range of channels, which encompass a network of traditional banking stores, banking centers, in-store banking centers, business centers and ATMs. Additionally, PhoneBankSM centers and the National Business Banking Center provide 24-hour telephone service. Online banking services include single sign-on to online banking, bill pay and brokerage, as well as online banking for small business.
The Wholesale Banking Group serves businesses across the United States with annual sales predominantly in excess of $10 million. Wholesale Banking provides a complete line of commercial, corporate and real estate banking products and services. These include traditional commercial loans and lines of credit, letters of credit, asset-based lending, equipment leasing, mezzanine financing, high yield debt, international trade facilities, foreign exchange services, treasury management, investment management, institutional fixed income and equity sales, online/electronic products, insurance and insurance brokerage services, and investment banking services. Wholesale Banking includes the majority ownership interest in the Wells Fargo HSBC
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Trade Bank, which provides trade financing, letters of credit and collection services and is sometimes supported by the Export-Import Bank of the United States (a public agency of the United States offering export finance support for American-made products). Wholesale Banking also supports the commercial real estate market with products and services such as construction loans for commercial and residential development, land acquisition and development loans, secured and unsecured lines of credit, interim financing arrangements for completed structures, rehabilitation loans, affordable housing loans and letters of credit, permanent loans for securitization, commercial real estate loan servicing and real estate and mortgage brokerage services.
Wells Fargo Financial includes consumer finance and auto finance operations. Consumer finance operations make direct loans to consumers and purchase sales finance contracts from retail merchants from offices throughout the United States and Canada and in the Caribbean. Automobile finance operations specialize in purchasing sales finance contracts directly from automobile dealers and making loans secured by automobiles in the United States and Puerto Rico. Wells Fargo Financial also provides credit cards, and lease and other commercial financing.
The Reconciliation Column consists of Treasury equity investment activities and balances and unallocated goodwill balances held at the enterprise level.
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The following table provides the results for the Company's three major operating segments.
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Mortgage banking activities, included in the Community Banking and Wholesale Banking operating segments, consist of residential and commercial mortgage originations and servicing.
The components of mortgage banking noninterest income are presented below:
The managed mortgage servicing portfolio totaled $635 billion at March 31, 2003, $613 billion at December 31, 2002 and $551 billion at March 31, 2002, and included loans subserviced for others of $29 billion, $36 billion and $56 billion, respectively.
Net of valuation allowance, mortgage servicing rights (MSRs) totaled $4.2 billion (.84% of the total mortgage servicing portfolio) at March 31, 2003, compared with $7.1 billion (1.63%) at March 31, 2002.
Each quarter, the Company evaluates mortgage servicing rights for possible impairment based on the difference between the carrying amount and current fair value of the mortgage servicing rights, in accordance with FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. If a temporary impairment exists, a valuation allowance is established for any excess of amortized cost, as adjusted for hedge accounting, over the current fair value through a charge to income. The Company has a policy of reviewing mortgage servicing rights for other-than-temporary impairment each quarter and recognizes a direct write-down when the recoverability of a recorded valuation allowance is determined to be remote. Unlike a valuation allowance, a direct write-down permanently reduces the carrying value of the mortgage servicing rights asset and the valuation allowance, precluding subsequent reversals. (See Note 1 (Summary of Significant Accounting Policies—Transfer and Servicing of Financial Assets) to Financial Statements in the Company's 2002 Form 10-K for additional discussion of the Company's policy for valuation of mortgage servicing rights.) In first quarter 2003, the Company determined that a portion of the asset was not recoverable and reduced both the asset and the previously designated valuation allowance by a $311 million write-down.
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The following table summarizes the changes in mortgage servicing rights:
The following table summarizes the changes in the valuation allowance for mortgage servicing rights:
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Wells Fargo Financial, Inc. and its Subsidiaries (WFFI)
On October 22, 2002, the Parent issued a full and unconditional guarantee of all outstanding term debt securities and commercial paper of its wholly owned subsidiary, WFFI. WFFI ceased filing periodic reports under the Securities Exchange Act of 1934 and is no longer a separately rated company. The Parent has also guaranteed all outstanding term debt and commercial paper of Wells Fargo Financial Canada Corporation (WFFC), WFFI's wholly owned Canadian subsidiary. Presented below are the Condensed Consolidating Financial Statements:
Condensed Consolidating Statement of Income
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Condensed Consolidating Balance Sheet
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Condensed Consolidating Statement of Cash Flows
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10. Guarantees
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 describes the disclosures to be made by a guarantor about obligations under certain guarantees the guarantor has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee.
Significant guarantees that the Company provides to third parties include standby letters of credit, various indemnification agreements, guarantees accounted for as derivatives, contingent consideration related to business combinations and contingent performance guarantees.
The Company issues standby letters of credit on behalf of customers in connection with contracts between the customers and third parties whereby the Company assures that the third parties will receive specified funds if customers fail to meet their contractual obligations. Standby letters of credit totaled $7.1 billion at March 31, 2003. Certain of these standby letters of credit back financial instruments and are considered financial guarantees. The Company had issued or purchased participations in these financial guarantees of approximately $3.6 billion at March 31, 2003. Substantially all fees received from the issuance of standby letters of credit are deferred and, at March 31, 2003, were immaterial to the Company's financial statements.
The Company enters into indemnification agreements in the ordinary course of business under which the Company agrees to indemnify third parties against any damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. These relationships or transactions include those arising from service as a director or officer of the Company, underwriting agreements relating to the Company's securities, securities lending, acquisition agreements, and various other business transactions or arrangements. Because the extent of the Company's obligations under these indemnification agreements depends entirely upon the occurrence of future events, the Company cannot estimate its potential future liability under these agreements.
The Company enters into written options with its customers and to hedge the Company's servicing assets and mortgage loan commitments. These options are exercisable by the option holder based on favorable market conditions. Additionally, the Company enters into written floors and caps with its customers. Periodic settlements can occur with customers based on market conditions. At March 31, 2003, the gross carrying amount of the written options liability was $202 million and the written floors and caps liability was $252 million. Because the Company's ultimate obligation under written options, floors and caps is based on future market conditions, the Company is unable to estimate the amount of maximum exposure it has related to written options, floors and caps. As part of its risk management strategy, the Company purchases offsetting positions to minimize its obligations associated with its written options, floors and caps.
The Company also enters into credit default swaps under which it buys protection from or sells protection to a counterparty in the event of default of a reference obligation. At March 31, 2003,
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the gross carrying amount of the contracts sold was a $51 million liability. The maximum amount the Company would be required to pay under those swaps in which it sold protection, assuming all reference obligations default at a total loss, without recoveries, was $2.4 billion. The Company has bought protection of $2.3 billion of notional exposure. Almost all of the protection purchases offset (i.e., use the same reference obligation and maturity) the contracts in which the Company is providing protection to a counterparty.
In connection with certain brokerage, asset management and insurance agency acquisitions made by the Company, the terms of the acquisition agreement provide for deferred payments or additional consideration based on certain performance targets. At March 31, 2003, the amount of contingent consideration expected to be paid was not material to the Company's financial statements.
The Company has entered into various contingent performance guarantees through credit risk participation arrangements with terms ranging from 1 to 30 years. The Company will be required to make payments under these guarantees if a customer defaults on its obligation to perform under certain credit agreements with third parties. Because the extent of the Company's obligations under these contingent performance guarantees depends entirely upon future events, the Company cannot estimate its potential future liability under these agreements.
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11. Derivative Instruments and Hedging Activities
Fair Value Hedges
The Company uses derivative contracts to manage the risk associated with changes in the fair value of mortgage servicing rights and other retained interests. Changes in options valuations caused by market conditions (volatility) and the spread between spot and forward rates priced into the derivative contracts (the passage of time) are excluded from the overall evaluation of hedge effectiveness, but are still reflected in earnings. The change in value of derivatives excluded from the assessment of hedge effectiveness was a net gain of $348 million in the first quarter of 2003 and $275 million in the same period of 2002. Also, the Company recognized a net gain from ineffectiveness in these hedging relationships of $202 million in the first quarter of 2003 and $297 million in the first quarter of 2002. The gains were more than offset by higher valuation provision for impairment and amortization expense on mortgage servicing rights and other retained interests of $1,482 million in the first quarter of 2003 and $1,107 million in the first quarter of 2002. The total gains on the mortgage-related derivative contracts, amortization expense and valuation provision for impairment are included in mortgage banking noninterest income. (See Note 8 (Mortgage Banking Activities).)
In the fourth quarter of 2002, the Company began using derivative contracts to hedge changes in fair value of its commercial real estate mortgages and franchise loans due to changes in LIBOR interest rates. The Company originates these loans with the intent to sell them. The ineffective portion of these fair value hedges was a net loss of $6 million for the first quarter of 2003, recorded in mortgage banking noninterest income. All components of gain or loss on these derivative contracts are included in the assessment of hedge effectiveness.
The Company also enters into interest rate swaps, designated as fair value hedges, to convert certain of its fixed-rate long-term debt to floating-rate debt. The ineffective portion of these fair value hedges was not material in the first quarter of 2003 and 2002.
As of March 31, 2003, all designated fair value hedges continued to qualify as fair value hedges.
Cash Flow Hedges
The Company uses derivative contracts to convert commercial floating-rate loans to fixed rates and to hedge forecasted sales of its mortgage loans. The Company recognized a net loss of $38 million in the first quarter of 2003, which represents the total ineffectiveness of cash flow hedges, compared with a net loss of $108 million in the first quarter of 2002. All components of gain or loss on these derivative contracts are included in the assessment of hedge effectiveness, except for volatility and the passage of time related to options hedging commercial loans indexed to LIBOR. As of March 31, 2003, all designated cash flow hedges continued to qualify as cash flow hedges.
At March 31, 2003, the Company expected that $43 million of deferred net losses on derivative instruments included in other comprehensive income will be reclassified to earnings during the next twelve months, compared with $191 million of deferred net gains at March 31, 2002. The change was primarily due to growth in mortgages held for sale and changes in interest rates, causing greater losses deferred to cumulative other comprehensive income at March 31, 2003.
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These deferred losses will be reclassified to earnings in the period the gains on the hedged item affect earnings. Gains and losses on derivative contracts that are reclassified from cumulative other comprehensive income to current period earnings are included in the same line item in which the hedged item's effect in earnings is recorded. The Company is hedging its exposure to the variability of future cash flows for all forecasted transactions for a maximum of two years for hedges converting floating-rate loans to fixed and one year for hedges of forecasted sales of mortgage loans.
Derivative Financial Instruments—Summary Information
The following table summarizes the credit risk amount and estimated net fair value for the Company's derivative financial instruments.
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FINANCIAL REVIEW
SUMMARY FINANCIAL DATA
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This report, including the Financial Statements and related Notes and the information in response to Items 2, 3 and 4 of Form 10-Q, contains forward-looking statements about the Company. Broadly speaking, forward-looking statements include forecasts of future financial results and condition, expectations for future operations and business, and any assumptions underlying those forecasts and expectations. Do not unduly rely on forward-looking statements. Actual outcomes and results might differ significantly from forecasts and expectations. Please refer to "Factors that May Affect Future Results" for a discussion of some of the factors that may cause results to differ.
OVERVIEW
Wells Fargo & Company is a $370 billion diversified financial services company providing banking, insurance, investments, mortgage banking and consumer finance through banking stores, the internet and other distribution channels to consumers, commercial businesses and financial institutions in all 50 states of the U.S. and in other countries. It ranked fourth in assets and third in market capitalization among U.S. bank holding companies at March 31, 2003. In this Form 10-Q, Wells Fargo & Company and Subsidiaries (consolidated) is referred to as the Company and Wells Fargo & Company alone is referred to as the Parent.
Certain amounts in the Financial Review for prior quarters have been reclassified to conform with the current financial statement presentation.
Net income for the first quarter of 2003 increased 8% to $1.49 billion, from $1.38 billion before the effect of an accounting change related to FAS 142, Goodwill and Other Intangible Assets, for the first quarter of 2002. On the same basis, diluted earnings per common share for the first quarter of 2003 were $.88, compared with $.80 for the first quarter of 2002, up 10%. On the same basis, return on average assets (ROA) and return on average common equity (ROE) for the first quarter of 2003 were 1.70% and 19.77%, respectively, compared with 1.78% and 20.01%, respectively, for the first quarter of 2002.
Net income for the first quarter of 2003 was $1.49 billion, compared with $1.10 billion for the first quarter of 2002. Diluted earnings per common share for the first quarter of 2003 were $.88, compared with $.64 for the first quarter of 2002. ROA was 1.70% and ROE was 19.77% for the first quarter of 2003, compared with 1.42% and 16.00%, respectively, for the first quarter of 2002.
Net interest income on a taxable-equivalent basis was $3.95 billion for the first quarter of 2003, compared with $3.68 billion for the first quarter of 2002, up 7%. The Company's net interest margin was 5.31% for the first quarter of 2003, compared with 5.67% for the first quarter of 2002.
Noninterest income was $2.58 billion for the first quarter of 2003, compared with $2.30 billion for the first quarter of 2002.
Revenue, the sum of net interest income and noninterest income, increased 9% to $6.51 billion in the first quarter of 2003 from $5.96 billion in the first quarter of 2002.
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Noninterest expense totaled $3.77 billion for the first quarter of 2003, compared with $3.33 billion for the first quarter of 2002, an increase of 13%.
During the first quarter of 2003, net charge-offs were $425 million, or .87% of average total loans (annualized), compared with $487 million, or 1.15%, during the first quarter of 2002. The provision for loan losses was $425 million in the first quarter of 2003, compared with $490 million in the first quarter of 2002. The allowance for loan losses was $3.89 billion, or 1.89% of total loans, at March 31, 2003, compared with $3.86 billion, or 1.96%, at December 31, 2002 and $3.84 billion, or 2.15%, at March 31, 2002.
At March 31, 2003, total nonaccrual loans were $1.56 billion, or .8% of total loans, compared with $1.49 billion, or .8%, at December 31, 2002 and $1.62 billion, or .9%, at March 31, 2002. Foreclosed assets were $200 million at March 31, 2003, compared with $201 million at December 31, 2002 and $187 million at March 31, 2002.
The ratio of common stockholders' equity to total assets was 8.31% at March 31, 2003, compared with 8.67% at December 31, 2002 and 9.08% at March 31, 2002. The Company's total risk-based capital (RBC) ratio at March 31, 2003 was 10.89% and its Tier 1 RBC ratio was 7.34%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively, for bank holding companies. The Company's RBC ratios at March 31, 2002 were 11.13% and 7.68%, respectively. The Company's Tier 1 leverage ratios were 6.43% and 6.50% at March 31, 2003 and March 31, 2002, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies.
Recent Accounting Standards
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The recognition and measurement provisions of this Interpretation are effective for newly created variable interest entities formed after January 31, 2003, and for existing variable interest entities, on the first interim or annual reporting period beginning after June 15, 2003. The Company adopted the disclosure provisions of FIN 46 effective December 31, 2002. The Company adopted the recognition and measurement provisions of FIN 46 for newly formed variable interest entities effective February 1, 2003, which did not have a material effect on the Company's financial statements. The Company will adopt the recognition and measurement provisions of FIN 46 for existing variable interest entities on July 1, 2003. The Company believes that it is reasonably possible that it could be a significant or majority variable interest holder in certain special-purpose entities formed to securitize high-yield corporate debt, commercial mortgage-backed and real estate investment trust securities. The Company does not expect that the adoption of FIN 46 will have a material effect on the Company's financial statements.
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In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149 (FAS 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, to provide clarification on the meaning of an underlying, the characteristics of a derivative that contains financing components and the meaning of an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. This statement will be applied prospectively and is effective for contracts entered into or modified after June 30, 2003. The statement will be applicable to existing contracts and new contracts entered into after June 30, 2003 if those contracts relate to forward purchases or sales of when-issued securities or other securities that do not yet exist. The Company does not expect that the adoption of FAS 149 will have a material effect on the Company's financial statements.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. The Company has identified three policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, the valuation of mortgage servicing rights and pension accounting. The Company, in consultation with the Audit and Examination Committee of the Board of Directors, has reviewed and approved these critical accounting policies, which are further described in "Financial Review—Critical Accounting Policies" and Note 1 (Summary of Significant Accounting Policies) to Financial Statements in the Company's 2002 Form 10-K.
EARNINGS PERFORMANCE
NET INTEREST INCOME
Net interest income is the difference between interest income (which includes yield-related loan fees) and interest expense. Net interest income on a taxable-equivalent basis increased to $3.95 billion in first quarter 2003 from $3.68 billion in first quarter 2002, an increase of 7%. The increase was primarily due to strong growth in mortgages held for sale and loans. In addition, lower funding costs were also a significant factor, due in large part to lower rates on interest-bearing deposits and short- and long-term borrowings. These factors were partially offset by a decline in investment portfolio income following the sale and prepayment of mortgage-backed securities.
Net interest income on a taxable-equivalent basis expressed as a percentage of average total earning assets is referred to as the net interest margin, which represents the average net effective yield on earning assets. The net interest margin decreased to 5.31% in first quarter 2003 from 5.67% in first quarter 2002. During the past several quarters, the Company has shortened the duration of its investment portfolio through sales and prepayments of long-term mortgage-backed securities. While this has had a modest adverse impact on net interest margin, it will provide flexibility to add securities in the event that interest rates rise and mortgages held for sale begin to decline.
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Individual components of net interest income and the net interest margin are presented in the rate/yield table on page 33.
Earning assets increased $38.9 billion due to increases in average loans and mortgages held for sale, offset by a decrease in debt securities available for sale. Loans averaged $199.2 billion in the first quarter of 2003, compared with $172.1 billion in the first quarter of 2002. Average mortgages held for sale increased to $58.4 billion from $37.1 billion due to increased originations, including refinancing activity. Debt securities available for sale averaged $26.1 billion during the first quarter of 2003 and $39.2 billion in the first quarter of 2002.
An important contributor to the growth in net interest income and net interest margin was an 11% increase in core deposits, the Company's low-cost source of funding. Average core deposits were $196.8 billion and $177.6 billion and funded 55.4% and 56.5% of the Company's average total assets in the first quarter of 2003 and 2002, respectively. While savings certificates of deposit declined on average to $22.0 billion in first quarter 2003 from $25.7 billion in first quarter 2002, noninterest-bearing checking accounts and other core deposit categories increased on average from $151.9 billion in first quarter 2002 to $174.8 billion in first quarter 2003 reflecting a combination of growth in mortgage escrow deposits, resulting from higher origination volume, and growth in primary account relationships. Total average interest-bearing deposits increased to $152.1 billion in first quarter 2003 from $129.6 billion in the first quarter of 2002. For the same periods, total average noninterest-bearing deposits increased to $71.6 billion from $59.5 billion.
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AVERAGE BALANCES, YIELDS AND RATES PAID (TAXABLE-EQUIVALENT BASIS) (1) (2)
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NONINTEREST INCOME
Service charges on deposit accounts increased 10% due to growth in primary accounts and increased activity.
Mutual funds and commission fees decreased 7% in first quarter 2003 predominantly due to a decrease in managed mutual fund balances. The Company managed mutual funds with $73 billion of assets at March 31, 2003, compared with $78 billion at March 31, 2002. The Company also administered corporate trust, personal trust, employee benefit trust and agency assets of approximately $416 billion and $434 billion at March 31, 2003 and 2002, respectively, and actively managed corporate trust, personal trust, employee benefit trust and agency assets of approximately $110 billion and $100 billion at March 31, 2003 and 2002, respectively.
Credit card fees increased 21% predominantly due to an increase in credit card accounts and credit and debit card transaction volume.
Mortgage banking noninterest income was $561 million in first quarter 2003, compared with $359 million in first quarter 2002. Origination and other closing fees increased to $276 million and net gains on mortgage loan origination/sales activities increased to $637 million in first quarter 2003 from first quarter 2002. A major portion of the increase was due to higher mortgage origination volume. Originations during the first quarter of 2003 grew to $103 billion from
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$70 billion during the same period of 2002. Mortgages held for sale increased to $62.6 billion at March 31, 2003 from $51.2 billion at December 31, 2002 and $26.3 billion at March 31, 2002.
Net servicing fees were a loss of $443 million and $73 million in first quarter 2003 and 2002, respectively, reflecting increased amortization and valuation provision for impairment of mortgage servicing rights (MSRs) offset by an increase in gross servicing fees due to portfolio growth and lower amortization relating to declining balances of other retained interests.
At March 31, 2003, the Federal National Mortgage Association (FNMA) Current Coupon rate (i.e., the secondary market par mortgage yield for 30 year fixed-rate mortgages) was 4.97%, compared with 6.59% at March 31, 2002. Consequently, assumed prepayment speeds, an important element in determining the fair value of MSRs, increased in the first quarter of 2003 resulting in higher amortization and valuation provision for impairment of $803 million and $592 million, respectively, compared with $370 million and $342 million, respectively, in the first quarter of 2002.
During first quarter 2003, the Company recognized a direct write-down of the mortgage servicing asset of $311 million. See "Financial Review—Critical Accounting Policies—Mortgage Servicing Rights Valuation" in the Company's 2002 Form 10-K for the method used to evaluate MSRs for impairment and to determine if such impairment is other-than-temporary. Key assumptions, including the sensitivity of those assumptions, used to determine the value of MSRs are disclosed in Notes 1 and 21 (Securitizations) to Financial Statements in the Company's 2002 Form 10-K.
Net losses from equity investments during the first quarter of 2003 were $98 million, reflecting other-than-temporary impairment in the valuation of publicly-traded and private equity securities, compared with $19 million for the same period of 2002.
The Company routinely reviews its investment portfolios for impairment. Such write-downs are based primarily on issuer-specific factors and results. General economic and market conditions, including those events occurring in the technology and telecommunications industries and adverse changes impacting the availability of venture capital financing are also taken into account. While the determination of impairment is based on all of the information available at the time of the assessment, new information or economic developments in the future could lead to additional impairment.
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NONINTEREST EXPENSE
The increase in salaries resulted from additional active, full-time equivalent team members. Incentive compensation increased predominantly due to commission expense resulting from higher mortgage origination volume. Employee benefits expense increased mostly due to higher pension and healthcare costs.
The increases in advertising and promotion, contract services and postage were mostly due to the increase in mortgage origination volume.
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OPERATING SEGMENT RESULTS
Community Banking's net income was $1,055 million in the first quarter, compared with $977 million for the same period in 2002, an increase of 8%. Net interest income increased by $205 million, or 8%, compared with first quarter 2002. The increase was primarily due to growth in consumer loans, mortgages held for sale and deposits. The provision for loan losses decreased by $45 million from 2002 due to the improved credit environment. Noninterest income was up $259 million in first quarter 2003 compared with 2002, primarily due to increased mortgage related business as well as service charges, credit card fees and other fees. Noninterest expense increased by $380 million over 2002 primarily due to increased mortgage originations.
Wholesale Banking's net income was $350 million in the first quarter of 2003, compared with $309 million before the effect of change in accounting principle in the first quarter of 2002. Net interest income decreased to $555 million from $570 million in the first quarter of 2002. Average outstanding loan balances were $49 billion in the first quarter of 2003, down 2% from $50 billion in the first quarter of 2002. Deposit balances grew to $21 billion in the first quarter of 2003 from $18 billion in the first quarter of 2002, an increase of 17%. Noninterest income increased to $716 million in 2003 from $657 million in 2002 due to higher income from asset-based lending, gains from commercial mortgage sales and securitizations, insurance and institutional brokerage. Noninterest expense was $684 million in the first quarter of 2003 and $660 million for the same period in 2002. The provision for loan losses decreased by $32 million to $53 million for the first quarter of 2003 compared with the first quarter of 2002.
Wells Fargo Financial's net income was $102 million in the first quarter of 2003, compared with $84 million before the effect of change in accounting principle in the first quarter of 2002, an increase of 21%. Net interest income increased $82 million, or 19%, due to lower funding costs combined with growth in average loans. The provision for loan losses increased $12 million, or 9%, due to the growth in average loans.
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BALANCE SHEET ANALYSIS
SECURITIES AVAILABLE FOR SALE
The following table provides the cost and fair value for the major components of securities available for sale carried at fair value. There were no securities classified as held to maturity at the end of the periods presented.
The decrease in federal agencies mortgage-backed securities was predominantly due to the prepayment of mortgage-backed securities held and sales of certain longer-maturity securities subject to prepayment risk.
The following table provides the components of the estimated unrealized net gains on securities available for sale. The estimated unrealized net gains on securities available for sale are reported on an after-tax basis as a component of cumulative other comprehensive income.
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The following table provides the components of the realized net gains on the sales of securities from the securities available for sale portfolio, including those related to marketable equity securities.
The weighted average expected remaining maturity of the debt securities portion of the securities available for sale portfolio was 5 years and 2 months at March 31, 2003. Remaining maturities will differ from contractual maturities because mortgage debt issuers may have the right to prepay obligations prior to contractual maturity.
The estimated effect of a 200 basis point increase or decrease in interest rates on the fair value and the expected remaining maturity of the mortgage-backed securities available for sale portfolio is indicated below.
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LOAN PORTFOLIO
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NONACCRUAL LOANS AND OTHER ASSETS
The table below presents comparative data for nonaccrual loans and other assets. A loan is placed on nonaccrual status (a) upon becoming 90 days past due as to interest or principal (unless both well-secured and in the process of collection), (b) when the full timely collection of interest or principal becomes uncertain or (c) when a portion of the principal balance has been charged off. Real estate 1-4 family loans (first and junior liens) are placed on nonaccrual status within 120 days of becoming past due as to interest or principal, regardless of security. Management's classification of a loan as nonaccrual does not necessarily indicate that the principal of the loan is uncollectible in whole or in part. The table below excludes certain loans that are 90 days or more past due and still accruing that are presented in the table on page 42.
The Company generally identifies loans to be evaluated for impairment when such loans are over $1 million and on nonaccrual. However, not all nonaccrual loans are impaired. Loans are considered impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. See Note 1 to Financial Statements in the Company's 2002 Form 10-K for further discussion of impaired loans.
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The table below shows the recorded investment in impaired loans and the method used to measure impairment for the periods presented:
The average recorded investment in impaired loans was $645 million and $791 million during the first quarter of 2003 and 2002, respectively. Total interest income recognized on impaired loans was $3 million for both the first quarter of 2003 and 2002, which was predominantly recorded using the cost recovery method. Under the cost recovery method, all payments received are applied to principal. This method is used when the ultimate collectibility of the total principal is in doubt.
Loans 90 Days or More Past Due and Still Accruing
The following table shows loans contractually past due 90 days or more as to interest or principal, but still accruing. All loans in this category are (a) both well-secured and in the process of collection or (b) real estate 1-4 family first mortgage loans or consumer loans that are exempt under regulatory rules from being classified as nonaccrual. Real estate 1-4 family loans (first and junior liens) are placed on nonaccrual within 120 days of becoming past due and are excluded from the following table.
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ALLOWANCE FOR LOAN LOSSES
The Company considers the allowance for loan losses of $3.89 billion adequate to cover losses inherent in loans, loan commitments and standby and other letters of credit at March 31, 2003. The Company's determination of the level of the allowance for loan losses rests upon various judgments and assumptions, including (1) general economic conditions, (2) loan portfolio composition, (3) prior loan loss experience, (4) the evaluation of credit risk related to both individual borrowers and pools of homogenous loans, (5) periodic use of sensitivity analysis and expected loss simulation modeling and (6) the Company's ongoing examination process and that of its regulators.
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OTHER ASSETS
Trading assets consist largely of securities, including corporate debt and U.S. government agency obligations, and fair value of derivative instruments held for customer accommodation purposes. Interest income from trading assets was $31 million and $45 million in the first quarter of 2003 and 2002, respectively. Noninterest income from trading assets of $141 million and $94 million in the first quarter of 2003 and 2002, respectively, is included in the "other" category of noninterest income.
Net losses from nonmarketable equity investments were $96 million and $20 million for the first quarter of 2003 and 2002, respectively, and included other-than-temporary impairment of $113 million and $43 million for the same periods, respectively.
GNMA pool buy-outs are advances made to GNMA mortgage pools that are insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA). These advances are made to buy out delinquent loans under the Company's servicing agreements. The Company undertakes the collection and foreclosure process for the FHA and VA. After the foreclosure process is complete, the Company is reimbursed for substantially all costs incurred, including the advances.
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DEPOSITS
The following table shows comparative detail of deposits.
The increase in other time deposits was primarily due to an increase in certificates of deposit greater than $100,000 sold to institutional customers.
REGULATORY AND AGENCY CAPITAL REQUIREMENTS
The Company and each of the subsidiary banks are subject to various regulatory capital adequacy requirements administered by the Federal Reserve Board and the Office of the Comptroller of the Currency. Risk-based capital (RBC) guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures.
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To remain a seller/servicer in good standing, the Company's mortgage banking affiliate must maintain specified levels of shareholders' equity as required by the United States Department of Housing and Urban Development, Government National Mortgage Association, Federal Home Loan Mortgage Corporation, and Federal National Mortgage Association. The equity requirements are generally based on the size of the loan portfolio being serviced for each investor. At March 31, 2003, the equity requirements for these agencies ranged from $1 million to $179 million. The mortgage banking affiliate had agency capital levels in excess of these requirements.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
As more fully described in Note 1 to Financial Statements in the Company's 2002 Form 10-K, the Company consolidates majority-owned subsidiaries. Affiliates in which there is at least 20 percent ownership are generally accounted for under the equity method of accounting and affiliates in which there is less than 20 percent ownership are generally carried at cost.
In the ordinary course of business, the Company engages in financial transactions, in accordance with generally accepted accounting principles (GAAP), that are not recorded on the Company's balance sheet or may be recorded on the Company's balance sheet in amounts that are different than the full contract or notional amount of the transaction. Such transactions are structured to meet the financial needs of customers, manage the Company's credit, market or liquidity risks, diversify funding sources or optimize capital.
Off-balance sheet arrangements include (1) securitization activities in the ordinary course of business, including mortgage loans and other financial assets (student loans, commercial mortgages and automobile receivables), (2) investment vehicles, typically in the form of collateralized debt obligations and (3) unconsolidated joint ventures, used to support origination activities of the Company's mortgage banking affiliate or formed with third parties for economies of scale.
In the ordinary course of operations, the Company enters into certain contractual obligations. Such obligations include (1) the acceptance of deposits, (2) the funding of operations through debt issuances, (3) leases for premises and equipment, (4) purchase obligations and (5) certain derivative instrument contracts.
For additional information on off-balance sheet arrangements and other contractual obligations see Note 10 (Guarantees) to Financial Statements and "Financial Review—Overview—Recent Accounting Standards" in this report and "Financial Review—Off-Balance Sheet Arrangements and Other Contractual Obligations" in the Company's 2002 Form 10-K.
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ASSET/LIABILITY AND MARKET RISK MANAGEMENT
Asset/liability management consists of the evaluation, monitoring, and management of the Company's interest rate risk, market risk and liquidity and funding. The Corporate Asset/Liability Management Committee (Corporate ALCO) maintains oversight of these risks. The Committee consists of senior financial and senior business executives. Each of the Company's principal business groups—Community Banking (including Mortgage Banking) and Wholesale Banking—have individual asset/liability management committees and processes that are linked to the Corporate ALCO process.
INTEREST RATE RISK
Interest rate risk, one of the more prominent risks in terms of potential earnings impact, is an inevitable part of being a financial intermediary. For more information, see "Financial Review—Asset/Liability and Market Risk Management—Interest Rate Risk" in the Company's 2002 Form 10-K. The principal tool used to evaluate Company interest rate risk is a simulation of net income under various economic and interest rate scenarios.
The Company assesses its interest rate risk by comparing its most likely earnings plan over a twelve-month period to various earnings simulations performed under multiple interest rate scenarios that differ in the direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. For example, earnings simulated assuming a gradual increase of 175 basis points in the federal funds rate, as well as earnings simulated assuming a gradual reduction of 75 basis points in the federal funds rate, were both within 1% of the Company's most likely earnings plan for 2003. Simulation estimates are highly dependent on and will change with the size and mix of the Company's actual and projected balance sheet at the time each simulation is done.
The Company uses exchange-traded and over-the-counter interest rate derivatives to hedge its interest rate exposures. The credit risk amount and estimated net fair values of these derivatives as of March 31, 2003 and December 31, 2002 are indicated in Note 11 to Financial Statements. Derivatives are used for asset/liability management in three ways: (a) most of the Company's long-term fixed-rate debt is converted to floating-rate payments by entering into received-fixed swaps at issuance; (b) the cash flows from selected asset and/or liability instruments/portfolios are converted from fixed to floating payments or vice versa; and (c) the Company's mortgage operation actively uses swaptions, futures, forwards and rate options to hedge the mortgage pipeline, funded mortgage loans and the mortgage servicing rights asset.
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MORTGAGE BANKING INTEREST RATE RISK
The Company originates, funds and services mortgage loans. These activities subject the Company to a number of risks, including credit, liquidity and interest rate risks. The Company manages credit and liquidity risk by selling or securitizing most of the loans it originates. Changes in interest rates, however, may have a potentially large impact on mortgage banking income in any calendar quarter and over time. The Company manages both the risk to net income over time from all sources as well as the risk to an immediate reduction in the fair value of its mortgage servicing rights. The Company relies on mortgage loans held on its balance sheet and derivative instruments to maintain these risks within Corporate ALCO parameters.
At March 31, 2003, the Company had capitalized mortgage servicing rights of $4.2 billion. The value of its servicing rights portfolio is influenced by prepayment speed assumptions affecting the duration of the mortgage loans to which the servicing rights relate. Changes in long-term interest rates affect these prepayment speed assumptions. For example, a decrease in long-term rates would accelerate prepayment speed assumptions as borrowers refinance their existing mortgage loans. The Company mitigates this risk in two ways. First, a significant portion of the mortgage servicing rights asset is hedged with derivative contracts. The principal source of risk in this hedging process is the risk that changes in the value of the hedging contracts may not match changes in the value of the hedged portion of the mortgage servicing rights for any given change in long-term interest rates. Second, a portion of the potential reduction in the value of the mortgage servicing rights asset for a given decline in interest rates is offset by estimated increases in origination and servicing fees over a twelve month period from new mortgage activity or refinancing associated with that decline in interest rates. In a scenario of much lower long-term interest rates, the decline in the value of the mortgage servicing rights and its impact on net income would be immediate whereas the additional fee income accrues over time. Under GAAP, impairment of the Company's servicing rights, due to a decrease in long-term rates or other reasons, is reflected as a charge to earnings. Net of impairment reserves, the capitalized mortgage servicing rights asset was valued at .84% of the total servicing portfolio at March 31, 2003, down from .92% of the servicing portfolio at December 31, 2002.
MARKET RISK—TRADING ACTIVITIES
The Company incurs interest rate risk, foreign exchange risk, equity price risk and commodity price risk in several trading businesses managed under limits set by Corporate ALCO. The primary purpose of these businesses is to accommodate customers in the management of their market price risks. Additionally, the Company takes positions based on market expectations or to benefit from price differentials between financial instruments and markets. All securities, loans, foreign exchange transactions, commodity transactions and derivatives transacted with customers or used to hedge capital market transactions done with customers are carried at fair value. Counterparty risk limits are established and monitored by the Institutional Risk Committee. Open, "at risk" positions for all trading business are monitored by Corporate ALCO.
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MARKET RISK—EQUITY MARKETS
Equity markets impact the Company in both direct and indirect ways. For more information, see "Financial Review—Asset/Liability and Market Risk Management—Market Risk—Equity Markets" in the Company's 2002 Form 10-K. The Company makes and manages direct equity investments in start up businesses, emerging growth companies, management buy-outs, acquisitions and corporate recapitalizations. The Company also invests in non-affiliated funds that make similar private equity investments. These private equity investments are made within capital allocations approved by the Company's management or its Board of Directors. Management reviews these investments at least quarterly and assesses them for possible other-than-temporary impairment. At March 31, 2003, private equity investments totaled $1,644 million, compared with $1,657 million at December 31, 2002.
The Company has marketable equity securities in its securities available for sale investment portfolio, including shares distributed from the Company's venture capital activities. These securities are managed within capital risk limits approved by management. Gains and losses on these securities are recognized in net income when realized and, in addition, other-than-temporary impairment may be periodically recorded. At March 31, 2003, the fair value of marketable equity securities was $525 million and cost was $569 million, compared with $556 million and $598 million, respectively, at December 31, 2002.
LIQUIDITY AND FUNDING
The objective of effective liquidity management is to ensure that the Company can efficiently meet customer loan requests, customer deposit maturities/withdrawals and other cash commitments under both normal operating conditions and under unforeseen and unpredictable circumstances of industry or market stress. To achieve this objective, Corporate ALCO establishes and monitors liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. To ensure that the Parent is a source of strength for its regulated, deposit-taking subsidiary banks, the Company sets liquidity management guidelines for both the consolidated and Parent balance sheets.
In addition to the immediately liquid resources of cash and due from banks and federal funds sold and securities purchased under resale agreements, asset liquidity is provided by the debt securities in the securities available for sale portfolio. Asset liquidity is further enhanced by the Company's ability to sell or securitize loans in secondary markets.
Customer core deposits have historically provided the Company with a sizeable source of relatively stable and low-cost funds.
The remaining funding of assets is mostly provided by long-term debt, deposits in foreign offices, short-term borrowings (federal funds purchased and securities sold under repurchase agreements, commercial paper and other short-term borrowings) and trust preferred securities. Liquidity for the Company is also available through the Company's ability to raise funds in a variety of domestic and international money and capital markets.
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Parent. The Parent has registered with the Securities and Exchange Commission (SEC) to issue a variety of securities, including senior and subordinated notes and preferred and common securities to be issued by one or more trusts that are directly or indirectly owned by the Company and consolidated in the financial statements. In March 2003, the Parent registered for issuance an additional $15.3 billion in senior and subordinated notes and preferred and common securities. During the first quarter of 2003, the Parent issued a total of $4.4 billion of senior notes, leaving unused issuance capacity of $18.0 billion at March 31, 2003. The Company used the proceeds from securities issued in the first quarter of 2003 for general corporate purposes and expects that it will use the proceeds from the future issuance of any securities for general corporate purposes as well. The Parent also issues commercial paper and has two back-up credit facilities amounting to $2 billion.
On April 15, 2003, the Company issued $3 billion of convertible senior debentures as a private placement. If the price per share of the Company's common stock exceeds $120.00 per share, or approximately 150% above the closing stock price of $47.45 on April 8, 2003, the holders will have the right to convert the convertible debt securities to common stock at an initial conversion price of $100.00 per share. While the Company has the ability to settle the entire amount of the conversion rights granted in this convertible debt offering in cash, common stock or a combination, the Company intends to settle the principal amount in cash and to settle the conversion spread (the excess conversion value over the principal) in either cash or stock. The Company can also redeem all or some of the convertible debt securities for cash at any time on or after May 5, 2008, at their principal amount plus accrued interest, if any.
Bank Note Program. In March 2003, Wells Fargo Bank, N.A. established a $50 billion bank note program under which it may issue up to $20 billion in short-term senior notes outstanding at any time and up to a total of $30 billion in long-term senior and subordinated notes. This program updates and supercedes the bank note program established in February 2001. Securities are issued under this program as private placements in accordance with OCC regulations. During the first quarter of 2003, Wells Fargo Bank, N.A. issued $4.4 billion in senior long-term notes. At March 31, 2003, the remaining issuance authority under the long-term portion was $19.9 billion.
Wells Fargo Financial. During the first quarter of 2003, Wells Fargo Financial Canada Corporation, a wholly owned Canadian subsidiary of Wells Fargo Financial, Inc., issued $200 million (Canadian) in senior notes, leaving at March 31, 2003 a total of $750 million (Canadian) available for issuance.
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CAPITAL MANAGEMENT
The Company has an active program for managing stockholder capital. The objective of effective capital management is to produce above market long-term returns by opportunistically using capital when returns are perceived to be high and issuing/accumulating capital when costs are perceived to be low.
The Company uses capital to fund organic growth, acquire banks and other financial services companies, pay dividends and repurchase its shares. During the first quarter of 2003, the Company's consolidated assets increased by $20 billion, or 6%. During 2002, the Board of Directors authorized the repurchase of up to 50 million additional shares of the Company's outstanding common stock. During the first quarter of 2003, the Company repurchased approximately 16 million shares of its common stock for a total of $744 million. At March 31, 2003 the total remaining common stock repurchase authority was approximately 41 million shares. In January 2003, the Board of Directors approved an increase in the Company's quarterly common stock dividend to 30 cents per share from 28 cents per share, representing a 7% increase in the quarterly dividend rate.
The Company's potential sources of capital include retained earnings, common and preferred stock issuance and issuance of subordinated debt and trust preferred securities. In the first quarter of 2003, net income was $1.5 billion and retained earnings increased by $955 million, after payment of $506 million in common stock dividends. In the first quarter of 2003, the Company issued a total of $227 million in common stock for various employee stock plans, which included $81 million related to the conversion of preferred stock to common stock under the Employee Stock Ownership Plan.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We make forward-looking statements in this report and in other reports and proxy statements we file with the SEC. In addition, our senior management might make forward-looking statements orally to analysts, investors, the media and others. Broadly speaking, forward-looking statements include:
In this report, for example, we make forward-looking statements discussing our expectations about:
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Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements often include words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "project," "target," "can," "could," "may," "should," "will," "would" or similar expressions. Do not unduly rely on forward-looking statements. They give our expectations about the future and are not guarantees. Forward-looking statements speak only as of the date they are made, and we might not update them to reflect changes that occur after the date they are made.
There are several factors—many beyond our control—that could cause results to differ significantly from our expectations. Some of these factors are described below. Other factors, such as credit, market, operational, liquidity, interest rate and other risks, are described elsewhere in this report (see, for example, "Balance Sheet Analysis"). Factors relating to the regulation and supervision of the Company are described in our 2002 Form 10-K. Any factor described in this report or in our 2002 Form 10-K could by itself, or together with one or more other factors, adversely affect our business, results of operations and/or financial condition. There are factors not described in this report or in our 2002 Form 10-K that could cause results to differ from our expectations.
Industry Factors
As a financial services company, our earnings are significantly affected by general business and economic conditions.
Our business and earnings are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the U.S. economy and the local economies in which we operate. For example, an economic downturn, increase in unemployment, or other events that negatively impact household and/or corporate incomes could decrease the demand for the Company's loan and non-loan products and services and increase the number of customers who fail to pay interest or principal on their loans.
Geopolitical conditions can also impact our earnings. Acts or threats of terrorism, actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts including the aftermath of the war with Iraq, could impact business and economic conditions in the U.S. and abroad. The terrorist attacks in 2001, for example, caused an immediate decrease in demand for air travel, which adversely affected not only the airline industry but also other travel-related and leisure industries, such as lodging, gaming and tourism.
We discuss other business and economic conditions in more detail elsewhere in this report.
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Our earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.
The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part our cost of funds for lending and investing and the return we earn on those loans and investments, both of which impact our net interest margin, and can materially affect the value of financial instruments we hold, such as debt securities and mortgage servicing rights. Its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and hard to predict or anticipate.
The financial services industry is highly competitive.
We operate in a highly competitive industry which could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can now merge by creating a new type of financial services company called a "financial holding company," which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Recently, a number of foreign banks have acquired financial services companies in the United States, further increasing competition in the U.S. market. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and some have lower cost structures.
We are heavily regulated by federal and state agencies.
The holding company, its subsidiary banks and many of its nonbank subsidiaries are heavily regulated at the federal and state levels. This regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole, not security holders. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer and/or increasing the ability of nonbanks to offer competing financial services and products. Also, our failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies and damage to our reputation. For more information, refer to the "Regulation and Supervision" section and to Notes 3 (Cash, Loan and Dividend Restrictions) and 25 (Regulatory and Agency Capital Requirements) to Financial Statements in the Company's 2002 Form 10-K.
Future legislation could change our competitive position.
Various legislation, including proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced in the Congress. This legislation may change banking
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statutes and the operating environment of the Company and its subsidiaries in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company or any of its subsidiaries.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit, we may assume that a customer's audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on the audit report covering those financial statements. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or that are materially misleading.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks. For example, consumers can now pay bills and transfer funds directly without banks. The process of eliminating banks as intermediaries, known as "disintermediation," could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.
Company Factors
Maintaining or increasing our market share depends on market acceptance and regulatory approval of new products and services.
Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increasing pressure on financial services companies to provide products and services at lower prices. This can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet-based services, could require us to make substantial expenditures to modify or adapt our existing products and services. We might not successfully introduce new products and services, achieve market acceptance of our products and services, and/or develop and maintain loyal customers.
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The holding company relies on dividends from its subsidiaries for most of its revenue.
The holding company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the holding company's common and preferred stock and interest and principal on its debt. Various federal and/or state laws and regulations limit the amount of dividends that our bank and certain of our nonbank subsidiaries may pay to the holding company. Also, the holding company's right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors. For more information, refer to "Regulation and Supervision—Dividend Restrictions" and "—Holding Company Structure" in the Company's 2002 Form 10-K.
Our accounting policies and methods are key to how we report our financial condition and results of operations, and they may require management to make estimates about matters that are inherently uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so that not only do they comply with generally accepted accounting principles but also that they reflect management's judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative. Note 1 to Financial Statements in the Company's 2002 Form 10-K describes our significant accounting policies.
We have businesses other than banking.
We are a diversified financial services company. In addition to banking, we provide insurance, investments, mortgages and consumer finance. Although we believe our diversity helps mitigate the impact to the Company when downturns affect any one segment of our industry, it also means that our earnings could be subject to different risks and uncertainties. We discuss some examples below.
Merchant Banking. Our merchant banking activities include venture capital investments, which have a much greater risk of capital losses than our traditional banking activities. Also, it is difficult to predict the timing of any gains from these activities. Realization of gains from our venture capital investments depends on a number of factors—many beyond our control—including general economic conditions, the prospects of the companies in which we invest, when these companies go public, the size of our position relative to the public float, and whether we are subject to any resale restrictions. Factors such as a slowdown in consumer demand or a deterioration in capital spending on technology and telecommunications equipment, could result in declines in the values of our publicly-traded and private equity securities. If we determine that the declines are other-than-temporary, additional impairment charges would be recognized. Also,
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we will realize losses to the extent we sell securities at less than book value. For more information, see in this report "Balance Sheet Analysis—Securities Available for Sale."
Mortgage Banking. The impact of interest rates on our mortgage banking business can be large and complex. Changes in interest rates can impact loan origination fees and loan servicing fees, which account for a significant portion of mortgage-related revenues. A decline in mortgage rates generally increases the demand for mortgage loans as borrowers refinance, but also generally leads to accelerated payoffs in our mortgage servicing portfolio. Conversely, in a constant or increasing rate environment, we would expect fewer loans to be refinanced and a decline in payoffs in our servicing portfolio. Although the Company uses dynamic and sophisticated models to assess the impact of interest rates on mortgage fees, amortization of mortgage servicing rights, and the value of mortgage servicing assets, the estimates of net income and fair value produced by these models are dependent on estimates and assumptions of future loan demand, prepayment speeds and other factors which may overstate or understate actual subsequent experience. In addition, although the Company uses derivative instruments to hedge the value of its servicing portfolio, the hedges do not cover the full value of the portfolio and the Company can provide no assurances that the hedges will be effective to offset significant decreases in the value of the portfolio. For more information, see "Financial Review—Critical Accounting Policies—Mortgage Servicing Rights Valuation and Risk Management—Asset /Liability and Market Risk Management" in the Company's 2002 Form 10-K.
We rely on other companies to provide key components of our business infrastructure.
Third parties provide key components of our business infrastructure such as internet connections and network access. Any disruption in internet, network access or other voice or data communication services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party.
We have an active acquisition program.
We regularly explore opportunities to acquire financial institutions and other financial services providers. We cannot predict the number, size or timing of future acquisitions. We typically do not comment publicly on a possible acquisition or business combination until we have signed a definitive agreement for the transaction.
Our ability to successfully complete an acquisition generally is subject to regulatory approval, and we cannot be certain when or if, or on what terms and conditions, any required regulatory approvals will be granted. We might be required to divest banks or branches as a condition to receiving regulatory approval.
Difficulty in integrating an acquired company may cause us not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected
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benefits from the acquisition. Specifically, the integration process could result in higher than expected deposit attrition (run-off), loss of key employees, the disruption of our business or the business of the acquired company, or otherwise adversely affect our ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative impact of any divestitures required by regulatory authorities in connection with acquisitions or business combinations may be greater than expected.
Legislative Risk
Our business model is dependent on sharing information between the family of companies owned by Wells Fargo to better satisfy our customers' needs. Laws that restrict the ability of our companies to share information about customers could negatively impact our revenue and profit.
Our business could suffer if we fail to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense. We may not be able to hire people or to keep them.
Our stock price can be volatile.
Our stock price can fluctuate widely in response to a variety of factors including:
General market fluctuations, industry factors and general economic and political conditions and events, such as the recent terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, also could cause our stock price to decrease regardless of our operating results.
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CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As required by SEC rules, within the 90-day period prior to the filing date of this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures. The Company's management, including the Company's chief executive officer and chief financial officer, supervised and participated in the evaluation. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the Company's disclosure controls and procedures were effective as of the evaluation date.
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
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PART II—OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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CERTIFICATIONS
I, Richard M. Kovacevich, certify that:
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I, Howard I. Atkins, certify that:
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