wells fargo bank analysis, robert petts
TRANSCRIPT
Examining Risk Management Policies and Practices of Wells Fargo
Robert Petts
Professor Cebenoyan
December 4th, 2014
Introduction
Over 160 years ago in 1852, Henry Wells and William Fargo founded Wells Fargo & Company.
Today one of the “Big Four Banks” of the U.S. (alongside JP Morgan Chase, Citigroup, and
Bank of America), Wells Fargo is one of the largest multinational banking and financial services
holdings company in the world. Indeed, Wells Fargo is the fourth largest U.S. commercial bank
by assets ($1.6T) and the largest bank by market capitalization ($281.02B). Wells Fargo is also
the second largest bank in terms of deposits, home mortgaging servicing, and debit cards. It is
the 8th largest publicly traded company in the world, and the 29th biggest company in the U.S. by
revenue. Headquartered in San Francisco, Wells Fargo provides banking, insurance, investments,
mortgages, and consumer and commercial finance through more than 8,700 locations, over
12,500 ATMs, online, and through mobile devices. Although Wells Fargo used to boast being
the only American bank to be rated AAA, after the financial crisis, Wells Fargo’s ratings had
been dropped to AA-.
This paper will analyze Wells Fargo based on the most recently completed 5-year period (2013-
2009) ending December 31st, 2013. The analysis will be done using financial information
obtained from the FDIC website as well as from Wells Fargo through the website of the
Securities and Exchange Commission. The analysis will span Wells Fargo’s profitability, capital
adequacy, exposure to credit risk, liquidity risk, sovereign risk, off-balance sheet risk, market
risk, interest rate risk, and methods of risk management. Wells Fargo will be compared to the
other members of the “Big Four” when applicable in order to give a relative idea of how Wells
Fargo is doing in these areas. All values are in thousands of dollars ($) unless otherwise stated.
Profitability
Wells Fargo’s profitability will be measured using two ratios: Return on Assets (ROA), and
Return on Equity (ROE). Return on Assets is computed as net income/assets, and measures how
efficiently a company is creating profit with the assets that it owns. Wells Fargo has consistently
held a higher ROA than any of the other Big Four banks in the United States.
Return on Assets
Return on
Equity
Similarly to
Return on
Assets,
Return on
Equity shows
how efficient
a company is
in earning
profit, but
0.00%
0.50%
1.00%
1.50%
2.00%
2009 2010 2011 2012 2013
Wells Fargo's Return on Assets
-0.50%
0.00%
0.50%
1.00%
1.50%
2009 2010 2011 2012 2013
Big Four Return on Assets
Wells Fargo JP Morgan Chase
Bank of America Citibank
Return on Equity measures this against the amount of investors’ funds that it has at its disposal.
ROE for both Wells Fargo and the rest of the Big Four banks shows the same trends as ROA.
Again, Wells Fargo is above the rest of the Big Four in terms of ROA for all 5 years, with the
only exception being JP Morgan Chase in 2010.
Return on Equity
Despite a slight dip from 2009-2010, Wells Fargo’s (as well as the rest of the Big Four’s)
profitability has been steadily increasing. In regards to both of these measures listed above,
Wells Fargo is not at risk of becoming unprofitable.
Capital Adequacy
Capital adequacy is a means of determining whether or not a bank has enough capital to cover
any potential risks or losses they might encounter. After the financial crisis of 2008, capital
adequacy became a very important measure for banks, as it reflects their financial stability. The
Basel Accords require banks to hold a Tier I (Core) Capital Ratio (calculated as Tier I Capital/
Risk Weighted Assets) of at least 4%, and a Capital Adequacy Ratio (calculated as (Tier I + Tier
II Capital)/ Risk Weighted Assets) of at least 8%. Tier 1 Capital is the capital that a bank can use
without having to stop its operations. Tier 1 Capital consists of common stock and disclosed
reserves. Tier 2 capital, on the other hand, is also capital that a bank can use to absorb losses, but
requires a bank to cease operations. Tier 2 is made up of general provisions, undisclosed
reserves, and revaluation reserves. A bank would use Tier II capital in the liquidation of its
assets.
In both measures, Wells Fargo holds a lower level of capital to risk-weighted assets. However,
this isn’t necessarily bad, as Wells Fargo is still well above the Basel requirements. Because of
this, Wells Fargo is more likely to remain solvent in the face of unanticipated loss.
0.00%
5.00%
10.00%
15.00%
20.00%
2009 2010 2011 2012 2013
Wells Fargo's Return on Equity
-5.00%
5.00%
15.00%
2009 2010 2011 2012 2013
Big Four Return on Equity
Wells Fargo JP Morgan Chase
Bank of America Citibank
Credit Risk
Analyzing a bank’s Credit risk is important because it determines the amount of future cash
flows that it will actually receive from its borrowers.
Long Term Assets
In determining Credit risk, it is important to look at the ratio of a bank’s long term assets to its
total assets, as long term assets have a higher potential of defaulting. Wells Fargo has been
steadily increasing its long term assets in the past few years after an initial jump in 2009 from
about $135B to $273B in 2010. In comparison with the rest of the Big Four banks, Wells Fargo
has the 3rd highest LTA/A proportion, second only to Bank of America. While this may insinuate
that Wells Fargo is exposed to more Credit risk because of its high amount of Long Term Assets,
this isn’t necessarily true; not all long term assets have the same amount of default risk, and
some may be quite safe compared to others.
5.000%
7.000%
9.000%
11.000%
13.000%
15.000%
17.000%
2009 2010 2011 2012 2013
Big Four Tier I Capital Ratio
Wells Fargo JP Morgan Chase
Bank of America Citibank0.000%
2.000%
4.000%
6.000%
8.000%
10.000%
12.000%
2009 2010 2011 2012 2013
Wells Fargo's Tier I Capital Ratio
10.500%
11.000%
11.500%
12.000%
12.500%
13.000%
13.500%
14.000%
2009 2010 2011 2012 2013
Wells Fargo's Capital Adaquecy
10.000%
12.000%
14.000%
16.000%
18.000%
2009 2010 2011 2012 2013
Big Four Capital Adaquecy
Wells Fargo JP Morgan Chase
Bank of America Citibank
Noncurrent
Loans & Net
Charge-Offs
While LTA/A
may give a
rough idea as to
how much
credit risk an
institution
holds, looking
at a bank’s
Noncurrent Loans/ Loans (NCL/L) and Net Charge-Offs/ Loans (NCO/L) can give a more
specific idea as to how risky an institution’s loans really are. Noncurrent loans are loans that are
at least 90 days past due, or are not earning interest income because the borrower isn’t paying;
noncurrent loans are much more likely to default than other loans, and are a good indicator of a
bank’s credit risk exposure. Net charge-offs are the amount of loans that are written off as bad
debt, accounting for any money that was recouped by the written off loan.
Wells Fargo’s NCL’s and NCO’s are fairly typical as far as the Big Four average goes. Both
measures are also slowly diminishing in time, meaning that Wells Fargo is taking measures to
ensure that the loans that it gives our are being repaid in a timely manner.
Loans
Looking at a bank’s loan portfolio can also give insight as to how much credit risk a bank is
exposed to. Loans, regardless of how risky or safe they might seem, always have a certain
probability of default. Because of this, holding a large proportion of loans as a bank’s assets is
risky. Wells Fargo holds a higher percentage of loans in its assets compared to the rest of the Big
0
50000000
100000000
150000000
200000000
250000000
300000000
350000000
400000000
2009 2010 2011 2012 2013
Wells Fargo Long Term Assets
0.00%
10.00%
20.00%
30.00%
40.00%
2009 2010 2011 2012 2013
Big Four Long Term Assets/Total Assets
Wells Fargo Bank of America
JP Morgan Chase Citibank
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
2009 2010 2011 2012 2013
Big Four Net Charge-Offs/Loans
Wells Fargo JP Morgan Chase
Bank of America Citi
0.00%
5.00%
10.00%
2009 2010 2011 2012 2013
Big Four Noncurrent Loans/ Loans
Wells Fargo JP Morgan Chase
Bank of America Citibank
Four banks. This is because Wells Fargo derives much more of its income from lending than the
other three.
This information alone would imply that Wells
Fargo holds more credit risk than the rest of the
banks within its peer group. However, once
again, it is important to take a look at the
breakdown of the loan portfolio in order to get
an accurate idea as to the riskiness of a bank’s
loans. Wells Fargo’s loan portfolio seems to be
weighted in similar proportions as JP Morgan
Chase’s loan portfolio. Wells Fargo does have a
bit more of its loan portfolio in real estate than
does JP Morgan (over 50% in 2013 as opposed
to just over 40%), which is worrisome, as real
estate has been proven to be quite risky in the
past. If a real estate turmoil such the last
financial crisis were to unfold, Wells Fargo
would be heavily exposed. However, Wells Fargo appears to be cognizant of this, as it has been
steadily decreasing the amount of real estate loans that it holds. Wells Fargo also holds slightly
less than 20% of its loan portfolio in commercial and industrial loans. These loans generally have
a floating rate, so it is important to hold a certain amount of them in a bank’s portfolio as a buffer
and for diversification. Around 10% of Wells Fargo’s loans are individual loans, such as credit
card balances, student loans, and automobile loans. While these loans may be risky, Wells Fargo
manages those risks by determining who qualifies for certain loans and charging risk premiums
in certain cases. Despite their riskiness, individual loans add a much needed level of
diversification to a bank’s portfolio.
0.000%
20.000%
40.000%
60.000%
80.000%
100.000%
JPM Chase Loan Portfolio
2009 2010 2011 2012 2013
0.000%
20.000%
40.000%
60.000%
80.000%
100.000%
Wells Fargo Loan Portfolio
2009 2010 2011 2012 2013
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
2009 2010 2011 2012 2013
Big Four Loans & Leases/ Assets
Wells Fargo JP Morgan Chase
Bank of America Citibank
If these two loan portfolios are an accurate representation of the Big Four as a whole, than it
would imply that Wells Fargo holds a greater amount of risk than the other banks, as it holds the
same (or, as seen previously, possibly more risky) assets in a higher proportion.
Credit Risk Overview
Overall, Wells Fargo holds a reasonable amount of credit risk given the fact that it’s a large
commercial bank and lending in various forms is one of its main sources of income. It is
impossible to be without any amount of credit risk whatsoever, as the risk/return trade-off is the
basis of the financial industry. By holding a quality, well-diversified portfolio of loans (as well
as using some derivatives to hedge), Wells Fargo manages the amount of credit risk that it must
hold well.
Market Risk
Any bank that buys and sells securities in order to earn additional income also exposes itself to
the risk of being involved in the securities market. Market risk is difficult for a bank to manage,
as markets are fairly unpredictable.
Trading Account Assets
The most
accurate way
to measure
Market risk
would be to
look at the
different
durations of
the securities
in a bank’s
security
portfolio, but
this can’t be
done given the information in Wells Fargo’s financial statements. The next best way is to see
what proportion of the bank’s assets are at risk by looking at the amount of trading assets they
hold in comparison to total assets, and how much of their income is derived from these trading
assets. Wells Fargo, being a more traditional commercial bank than the rest of the Big Four, do
not hold many trading assets in their asset portfolio, instead choosing to loan more of their
available funds and derive income in this way. However, from 2012 to 2013, Wells Fargo did
have a slightly sharp increase in the proportion of trading assets to total assets from 1.85% to
8.5%, but this still leaves them below the average of the Big Four banks.
Security Portfolio Breakdown
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
2009 2010 2011 2012 2013
Big Four Trading Account Profits/Net Income
Wells Fargo JP Morgan Chase
Bank of America Citibank
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2009 2010 2011 2012 2013
Big Four Trading Account Assets/ Total Assets
Wells Fargo JP Morgan Chase
Bank of America Citibank
Although this is still a small
percentage, nominally, 8.5% of Wells
Fargo’s total assets is an enormous
amount of money, so it is important to
analyze the breakdown of Wells
Fargo’s security portfolio to see
whether or not it is seriously exposed
to market risk. Wells Fargo holds
approximately 50% of its securities
portfolio in U.S. government
treasuries, and quite a large
percentage in mortgage-backed and
asset-backed securities. Wells Fargo
also holds a very small percentage of its securities portfolio in equities. This breakdown reveals
that Wells Fargo’s securities portfolio is not only well diversified, but also lacking in any real
major market risk, as the large majority of its securities are either backed by collateral or from
the U.S. government.
Liquidity Risk
At any time, a bank could be exposed to liquidity risk if it doesn’t either have enough cash or the
ability to turn its assets into cash when a depositor wants to reclaim their deposit.
Liquid Assets/ Total Deposits
To analyze Wells Fargo’s liquidity risk, the first metric to look at is the ratio of its cash and
available for sale securities to total deposits. This is a direct measure of a bank’s liquidity, as it
compares a bank’s most liquid assets to the amount of deposits that could be demanded. Until
2013, Wells Fargo held the lowest ratio of cash and
AFS securities to total deposits of all the banks in
the Big Four. However, in 2011 it began acquiring
more cash, and in 2013 it held a ratio of 38.15%.
Holding such a small fraction of deposits in liquid
assets is implicit of liquidity risk on Wells Fargo’s
behalf.
Total Loans/ Total Deposits
The next metric used in analyzing a bank’s exposure
to liquidity risk is the amount of total loans/ total
deposits. Wells Fargo has quite a large amount of
loans compared to the amount of deposits that it
holds. This also insinuates that Wells Fargo is
exposed to quite a bit of liquidity risk; if all of a
sudden a large amount of its deposits were
demanded back, it wouldn’t be able to return them because the funds would be tied up in loans. It
0.000%
10.000%
20.000%
30.000%
40.000%
50.000%
60.000%
2009 2010 2011 2012 2013
Big Four Cash & AFS Securities/Total Deposits
Wells Fargo JP Morgan Chase
Bank of America Citibank
0.0000%10.0000%20.0000%30.0000%40.0000%50.0000%60.0000%
Wells Fargo Security Portfolio
2009 2010 2011 2012 2013
also means that Wells Fargo has to rely heavily on borrowed funds to reach the level of liquidity
that it needs to maintain.
Based upon these two metrics, it is clear that Wells
Fargo holds quite a large amount of liquidity risk. If
something like a bank run were to happen and Wells
Fargo needed to provide its depositors with their funds,
it would be in trouble, and would need to borrow funds
to cover itself.
Sovereign Risk
Banks operating internationally also must ensure that they are not exposed to sovereign risk.
Wells Fargo, although an international bank, does not have many dealings in foreign countries
except for deposits. It’s foreign loans have always been less than 4%, and the amount of interest
income that it receives from abroad is minimal, maxing out at around 1.2% in 2013. However,
both of these measures seem to be increasing, and if they reach a point at which they are
substantial, they will need to be cognizant of the risks involved in being financially involved in
other nations.
0.000%
10.000%
20.000%
30.000%
40.000%
50.000%
60.000%
70.000%
80.000%
90.000%
2009 2010 2011 2012 2013
Big Four Loans/Deposits
Wells Fargo JP Morgan Chase
Bank of America Citibank
0.000%
1.000%
2.000%
3.000%
4.000%
2009 2010 2011 2012 2013
Foreign Loans/Total Loans
0.000%
5.000%
10.000%
15.000%
2009 2010 2011 2012 2013
Foreign Deposits/Total
Deposits
0.000%
0.500%
1.000%
1.500%
2009 2010 2011 2012 2013
Foreign Interest Income/ Interest
Income
Off Balance Sheet Exposures
Wells Fargo engages in many types of
off balance sheet activities, particularly
in purchasing many different types of
derivatives. While Wells Fargo may use
these derivatives to hedge some of the
risk from its other investments, by
holding them they also expose
themselves to the risk that these off
balance sheet items will unexpectedly
cause damage to the balance sheet in the
future. To analyze off balance sheet risk
exposure, it is useful to look at a bank’s
derivatives/ total assets ratio. Although
Wells Fargo holds an enormous amount
of derivatives in comparison with its total assets (353% in 2013), the amount that it holds is
miniscule compared to the rest of the banks in the Big Four. This is to be expected given the fact
that Wells Fargo invests quite a bit less than the other Big Four banks. Although they may be
using these derivatives to hedge the risk of their investments, the fact that these banks are
holding such massive amounts exposes them to a large amount of off balance sheet risk. Wells
Fargo, on the other hand, would be much better off than these banks in an unexpected off
balance sheet event that might negatively affect their balance sheet.
Interest Rate Risk
One of the most dangerous risks facing a bank is interest rate risk; specifically, the risk that a
change in interest rates will diminish a bank’s assets (which are usually longer term) more than
they might diminish a bank’s liabilities (which are usually shorter term), and cause the bank to
drain the difference from its equity.
Interest rate risk is analyzed using the repricing
gap/ assets, which is the difference between the
amount of rate sensitive assets and rate sensitive
liabilities in a certain maturity bucket divided by
the bank’s total assets. Wells Fargo has a positive
repricing gap (meaning that it has more rate
sensitive assets than rate sensitive liabilities) in
every maturity bucket except for the 3-12 month
bucket. The repricing gap for the < 3 month
maturity bracket is extremely high for Wells
Fargo, due to the fact that they hold a large
0.00%
1000.00%
2000.00%
3000.00%
4000.00%
5000.00%
6000.00%
2009 2010 2011 2012 2013
Big Four Derivatives/ Assets
Wells Fargo JP Morgan Chase
Bank of America Citibank
-10.0000%
0.0000%
10.0000%
20.0000%
30.0000%
40.0000%
50.0000%
2009 2010 2011 2012 2013
Wells Fargo Repricing Gap
<3 Months 3-12 Months
1-3 Years >3 Years
amount of current loans (around $400B) compared to current deposits.
This means that Wells Fargo would benefit from an increase in interest rates, as the value added
to the assets would be more than the value added to the liabilities. The fact that Wells Fargo has
a negative repricing gap for the 3-12 Month maturity bucket would offset this gain by a bit, but
the amount of assets and liabilities in that particular bucket is small enough that it wouldn’t have
a large enough impact to completely negate the gain. This can be seen in the table below, where
the change in Wells Fargo’s net income for a 1% increase in interest rates is show. Due to the
fact that the yield curve is predicted to be upward sloping, Wells Fargo would appear to be in a
favorable position in terms of interest rate risk exposure.
Change in Net Income for a 1% Increase in Interest Rates
Maturity
Bucket
2013 2012 2011 2010 2009
<3 Months 0.2746%
0.3114%
0.3396%
0.3682%
0.3889%
3-12 Months
-0.0088%
-0.0020%
0.0035%
-0.0018%
-0.0037%
1-3 Years
0.0335%
0.0325%
0.0269%
0.0259%
0.0498%
3< Years 0.2021%
0.2018% 0.1855%
0.1683%
0.1367%
Risk Management
As a large international institution, Wells Fargo has many different methods of managing the risk
that comes with operating a bank.
The main way that Wells Fargo manages its credit risk is by looking at the customer’s credit
history. This isn’t to say that they won’t offer a loan to someone who possibly has a worse credit
history, but they may not offer them as much, and may charge them a bit of a higher risk
premium than someone with a better credit history. Wells Fargo also tries to work with
customers who are struggling to make payments on their loans through loan restructuring.
Through the monitoring of both current and potential loans, Wells Fargo has been successful in
the past few years in decreasing the amount of loan write-offs, meaning that their risk
management techniques have been working.
Wells Fargo manages market risk in much the same way as most other banks; through hedging
their investments with derivatives. The use of derivatives limits the downside potential of Wells
Fargo’s investments, ensuring that even if a detrimental, unforeseen event were to occur that
diminished the value of their investments, they would be covered. Due to the low amount of
market investments that Wells Fargo takes place in relative to the rest of the Big Four banks, the
low amount of derivatives that it holds also helps manage Wells Fargo’s off balance sheet risk
exposure.
In terms of liquidity risk, Wells Fargo offers liquidity to its customers through the holding of
cash and highly liquid securities, although as seen before in this analysis, they don’t hold enough
cash or highly liquid securities to deposits. Because of this, they must rely heavily on borrowed
funds if a severe event were to occur where they must provide liquidity to many depositors.
However, as seen in the graphs above, Wells Fargo is starting to add to the amount of liquid
assets that it holds, meaning that they are cognizant of the risk and taking steps to decrease their
exposure.
Although sovereign risk does not appear to be much of a concern to Wells Fargo due to its low
amounts of involvement in foreign countries, Wells Fargo still rates each country based on its
default risk and uses that information to ensure that they are only taking on quality foreign
endeavors.
Wells Fargo manages interest rate risk much the same as was done in this analysis. They
breakdown their rate sensitive assets and liabilities and run through a variety of scenarios
involving different changes in interest rates. They look at the overview of these scenarios and
decide which is most likely to occur, and then use this information to try and cover themselves
from future changes in interest rates.
Future Outlook
The biggest problem facing Wells Fargo today is their lack of liquidity. Although an event such
as a bank run of a magnitude that would drain all of Wells Fargo’s liquid assets is highly
unlikely, nothing in the future is certain. Arguably, however, the fact that they choose to use
more borrowed funds if such an event were to occur is a sort of contingency plan to deal with
this, so Wells Fargo isn’t in too bad of a position.
Although this analysis looks at the period after the worst point in the latest financial recession,
from the data shown, Wells Fargo has done a good job bouncing back from the recession. They
remain very profitable, and it seems that they are steadily growing in all the right ways. Wells
Fargo is also diminishing the amount of bad debt that it incurs, as can be seen in the trends
shown in the graphs above.
Overall, Wells Fargo has a bright future ahead of them. They are quite profitable, and very
proficient in their risk management techniques. They are more secure in terms of their income by
offering more loans as opposed to involving themselves in riskier, open market activities, such as
the rest of the Big Four banks seem to be doing. As long as they maintain the level they are at
now and continue to improve in the various areas of risk management, they should also continue
to display success and retain their position as one of the leading banks in the U.S. and the world.
Works Cited
FDIC Website: https://www2.fdic.gov/idasp/main.asp
SEC Website (for 10-K’s and 10-Q’s):
http://www.sec.gov/Archives/edgar/data/72971/000007297114000597/wfc10q_20140930.htm
Wells Fargo’s website (for historical information, investor relations, and annual report):
https://www.wellsfargo.com/about/history
https://www.wellsfargo.com/invest_relations/filings
https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/2013-annual-report.pdf