Hello, this is Bob Strickland. Thank you for calling into the Wells Fargo fourth quarter 2008 earnings review pre-recorded call.
Before we discuss our fourth quarter results, we need to make the standard securities law disclosure. In this call we will make forward-looking statements about specific income statement and balance sheet items and other measures of future results of operations and financial conditions including generally statements about future credit quality and losses and the expected financial and other benefits and opportunities of the Wachovia merger including assumed cost savings, revenue synergies, internal rate of return and GAAP earnings accretion and specifically statements that the risk reduction or de-risking actions taken in the fourth quarter will reduce the likelihood of future losses, that the acquisition of Wachovia will add significantly to the Wells Fargo earnings run rate upon full integration and that we expect the additional revenue opportunities from adding long-term loans and securities during the current credit cycle to last longer than the higher charge offs because of the duration of the loans and securities that as we reduce the higher risk and lower return assets of Wachovia we expect the combined net interest margin to move somewhat towards the Wells Fargo historic stand-along margin, that we are on track for similar or higher mortgage application volume for the first quarter of 2009 compared with the fourth quarter 2008, that as customers refinance their mortgages at par we expect to recoup some of the mortgage warehouse write down, that we believe the combined Wells Fargo/Wachovia platform provides us with the ability to generate profitable growth, that until home prices stabilize we continue to expect higher losses in the home equity portfolio and that we feel good about our financial assumptions.
Forward-looking statements give our expectations about the future. They are not guarantees and results may differ from expectations. Forward-looking statements speak only as of the date they are made and we do not undertake any obligation to update them to reflect changes that occur after that date.
For a discussion of some of the factors that may cause actual results to differ from expectations, refer to our SEC filings including the 8K filed today which includes the press release announcing our fourth quarter results and the slides that accompany these pre-recorded comments. Also refer to our most recent annual report on form 10K and quarterly report on form 10Q filed with the SEC and to the information incorporated into those documents.
John Stumpf, our CEO, will make some concluding comments but first Howard Atkins, our CFO will review the company’s financial performance. A slide presentation to go along with Howard’s comments is available on our website.
Thanks, Bob. 2008 was a year in which the financial landscape was fundamentally reshaped. The environment in which Wells Fargo operates continued to be challenging in the fourth quarter and if anything became even more difficult with the unexpected, abrupt and sharp decline in economic activity late in the quarter. Our fourth quarter results were impacted by the economy and dysfunctional markets, in some cases like higher charge offs adversely impacted and in other cases like higher mortgage applications positively impacted.
In addition, we took numerous actions in the fourth quarter to reduce the risk, or as we like to say de-risk, the combined new balance sheet in preparation for the Wachovia acquisition. While some of these actions adversely impacted fourth quarter earnings, this de-risking will reduce the likelihood of losses in the future, improving the level and consistency of our performance going forward.
To put the fourth quarter in context I’d like to cover several topics.
First, the fourth quarter represented a continuation of the same profitable growth in lending and deposit gathering that Wells Fargo has always been successful at and which, if anything, accelerated since the start of the credit crisis in mid-2007.
Second, I will go over with you the balance sheet actions we took in the fourth quarter of 2008 to prepare for the next exciting stage of our growth; the acquisition of Wachovia which will create the premier coast to coast financial services organization and which we continue to believe will add significantly to the Wells Fargo earnings run rate upon full integration.
I will then go over fourth quarter results and how the actions taken in the fourth quarter to de-risk the balance sheet impacted fourth quarter earnings and the resultant capital position of the new company. I will conclude with color on credit quality and various key loan portfolios of the two banks that have now come together.
Wells Fargo is a diversified growth company that has always focused on providing a full range of financial services to all customers, consumers, small businesses, middle market commercial and large corporations. While many other banks and almost every other large bank retrenched from lending since the start of the credit crisis, Wells Fargo has remained open for business providing over half a trillion dollars in mortgage originations and new loan commitments to our consumer and commercial customers and on a net basis increasing on our balance sheet over $119 billion in loans and securities by year-end 2008.
The opposite was the case during the irrational exuberance of 2006 to 2007 when asset spreads were at all time lows and were not priced for risk. At that time our asset levels were relatively flat, in fact declining in 2006, while other financial institutions were leveraging their companies in some cases growing by double digit rates at low or no economic return.
We were building our capital in that period waiting for the dam to break and it sure did. We were also prepared to lose market share and in fact we lost, for example, mortgage market share because we maintained our disciplined lending standards throughout that period.
In the last one and one-half years as others needed to retrench, Wells Fargo accelerated its growth, taking market share in our chosen markets, increasing the number of households and businesses we serve and actively working to build relationships that will last forever. Wells Fargo’s growth in average earning assets, adjusted for acquisitions of 25% from the beginning of the credit crisis through year-end 2008 was the highest among our large bank peers and also the highest among the top 9 peers in the United States.
In terms of just loans, Wells Fargo’s acquisition adjusted 22% growth was the highest among our peers. Keep in mind that while Wells Fargo has been fully extending new credit we were simultaneously reducing high-risk loans including exiting indirect channels, tightening credit standards and pricing for risk.
For example, our home equity portfolio was essentially flat and our auto portfolios were reduced during this same period. Essentially, we have been reducing higher risk transactional lending as we have been expanding business with our customers.
In addition to increasing earning assets at a double digit rate since the start of the credit
crisis, we also increased deposits at a double digit rate over this same period, up 13% adjusted for acquisitions, well above the peer group averages while having the lowest average cost of deposits among our peers.
With the Wachovia acquisition, Wells Fargo has an 11.2% deposit market share, essentially tied for the highest in the nation with what is arguably the best distribution system across the country based on June 2008 deposits updated for subsequent acquisitions.
As we indicated previously, Wachovia has roughly half of Wells Fargo’s core deposits, even though they are roughly the same size as Wells Fargo. We look forward to working with the Wachovia salespeople to increase the base of core deposits in their region as well as increasing cross sell to existing Wachovia depositors.
As we have consistently provided credit to our customers throughout the credit crisis, we continued to grow and build the franchise in the fourth quarter of 2008. In the fourth quarter we extended $22 billion in new loan commitments, originated $50 billion in new residential mortgages and took $116 billion in new mortgage applications. We ended the year with a $71 billion unclosed pipeline, our largest pipeline since the second quarter of 2005.
Core deposits increased 31% annualized linked quarter. Net new consumer checking accounts once again exceeded 6% annual growth, as has been the case every quarter since third quarter 2005. Our net new consumer checking growth in California exceeded our overall growth rate.
For the fourth quarter, California grew at an 8.3% rate, up from a 6.5% average for the prior four quarters which we believe to be evidence of both our relationship driven strategy and a continuation of a flight to safety in the industry. We are also pleased to note that Wachovia’s core deposits resumed growth in the fourth quarter following the merger announcement with Wells Fargo, increasing 10% un-annualized from the trough early in the quarter and increasing across all customer segments. Both consumer and commercial depositors returned to Wachovia during the quarter.
As recently reported in the Wall Street Journal, most of our large bank peers shrank loans in the fourth quarter. Wells Fargo increased lending in the fourth quarter at a 10% annualized linked quarter growth rate, one of the few large banks in the country to actually increase loans.
The result of consistently extending credit and building our franchise shows up in our accelerated top line growth. A metric such as pre-tax, pre-provision profit, in other words growth in revenue net of expenses, is relevant because it demonstrates the underlying earnings power of the franchise each year and over the long term apart from the up and down impacts of the credit cycle.
Wells Fargo has typically grown pre-tax, pre-provision earnings at least 10% per year, except for 2006 when we were deliberately shrinking our balance sheet because we weren’t getting paid enough to hold assets. As spreads have widened significantly during the credit crisis we have been able to accelerate growth at wider margins and, consequently, pre-tax, pre-provision profit growth last year accelerated to 18%.
Relative to our peers, we have had the highest and most consistent growth in top line revenue net of expense growth over either 1 year or 5 year time periods. Adjusted for acquisitions, none of the large peers had positive pre-tax, pre-provision growth last year. Our relative performance is due to our faster loan and deposit growth as well as the fact that we have not had the revenue losses that all of our peers have had in connection with problems from covenant light leverage lending, structured investments, proprietary trading or market making in sub-prime or exotic securities because we have never had material exposure to those activities.
Our solid pre-tax, pre-provision profit growth is largely fueled by strong revenue growth. In addition, we have grown revenues at a faster rate than expenses, creating positive operating leverage. In 2008, Wells Fargo grew revenues by 6.1% organically while reducing our expenses by 2%. None of our large bank competitors had positive operating leverage last year, adjusted for significant acquisitions.
Our pre-tax, pre-provision performance has been driven in large part by strong growth in net interest income. For 2008, net interest income growth was 20% driven by both 17% earning asset growth and our industry leading net interest margin, 4.83% for the year. Net interest income grew to $6.7 billion in the fourth quarter, up 23% year-over-year with the margin widening further to 4.9%.
While the credit cycle is producing higher credit costs, the same external environment has produced numerous opportunities to add attractively-priced, long-term loans and securities for those banks that have had the capacity and origination systems to do so, like Wells Fargo. In the last year, our growth in net interest income from expanding our balance sheet $4.2 billion has essentially covered the additional charge offs we have incurred in this same period.
In effect, the opportunities from the credit cycle have offset pre-reserve build credit costs cumulatively in the last 18 months. While credit costs could remain high or elevated for a period of time, we would expect the additional revenue to last even longer given the duration of some of these assets.
One of the reasons we have been able to grow net interest income at above peer rates is because our net interest margin has consistently been one of the highest among our peers. In 2008, our net interest margin was 4.83%, rising to 4.9% in the fourth quarter, generally around 200 basis points above margins earned by other large competitors.
Note that Wachovia’s stand alone net interest margin has been closer to the other large peers shown in slide 15. As a result, the net interest margin of our consolidated organization will by definition be lower than Wells Fargo’s stand alone margin, although the combined margin of the two banks in the fourth quarter 2008 would still have been higher than any large peer.
As we integrate Wachovia and reduce its higher-risk, lower-return assets over time, we expect to move the combined margin somewhat toward Wells Fargo’s historically higher standalone margin. Keep in mind that while mathematically lower than Wells Fargo stand-alone, the new company’s margin will be associated with nearly twice as many assets as Wells Fargo’s stand-alone margin, benefiting net interest income.
The main reason for Wells Fargo’s high stand alone net interest margin is not only better long term asset yield, but more importantly our lower cost of deposits than the peers. At 0.91% in the fourth quarter of 2008, our average deposit cost on $368 billion of our average deposits remained lower than our peers, typically 25-50 basis points lower than our large peers on our entire base of deposits.
The primary reason for this is the proportionately higher percentage of non-interest bearing and low-interest demand and savings accounts in the mix of total deposits that we have accumulated and maintained over many years of successful cross selling and relationship building, as well as our ability to attract interest bearing deposits through our extensive store networks at lower cost than the competitors.
We have already begun to conform Wachovia’s deposit rates to Wells Fargo’s in their geographic markets and so far deposit retention rates at Wachovia have exceeded our expectations. Our overall growth pattern continued in the fourth quarter. Let me describe the drivers in each of our main business lines.
Regional banking had strong sales growth and cross sell, reflecting the continued focus on our vision of satisfying all our customers’ financial needs and helping them succeed financially in all economic environments. Regional banking had core product sales of $5.3 million in the fourth quarter, up 12% from the fourth quarter of 2007. These sales results benefited from better penetration of Wells Fargo Packages, which include a checking account and at least three other products such as a debit card, credit card and savings account.
Package sales were up 33% from the fourth quarter of 2007, purchased by 75% of all new checking account customers, up from 70% a year ago. Through acquisitions, not including Wachovia, and internal growth we added nearly 410,000 net new retail bank households in 2008, up 4%. Retail banking households have a record 5.73 products with Wells Fargo, up from 5.53 a year ago and up from around 3 at the time of the Norwest/Wells Fargo merger ten years ago.
24% of our retail bank households had 8 or more products, our long-term goal. Lower consumer spending in the fourth quarter impacted card fees and purchase volume. On Wells Fargo consumer credit cards, purchase volume was down 2% from the fourth quarter 2007 and down 4% on a linked quarter basis. Debit card purchase volume was up 3% from the fourth quarter 2007 but down slightly on a linked quarter basis.
We continued to have strong debit and credit card penetration of our retail bank households. 38% of Wells Fargo’s retail bank consumer households had a Wells Fargo credit card, up from 27% five years ago and 92% of our consumer checking account customers had a debit card, up from 86% five years ago.
Wachovia had much lower credit card penetration of 11% providing a natural growth opportunity for our card business in the future. Declining mortgage rates resulted in a surge in applications, $116 billion for the quarter, up 40% from third quarter. While 68% of applications during the quarter were for refis, almost $40 billion in new mortgage applications for purchased homes were taken in the quarter.
Application volume for the month of December was the fourth highest month on record in what is traditionally a seasonally slow period for the industry and application volume during the first 14 business days of January have already exceeded those of the full month in January 2008 and indicates we are on track for similar or better application volume than in the fourth quarter.
The mortgage pipeline ended the quarter at $71 billion including $5 billion from Wachovia, up from $41 billion at the end of the third quarter and the largest pipeline since the second quarter of 2005.
Our total residential servicing portfolio grew 21% from a year ago to $1.8 trillion, including $271 billion from Wachovia. Reflecting the continued stress in the housing market, the foreclosure rate for the servicing portfolio continued to increase to 1.41% at quarter end which we believe was still better than the industry average. We continue to work closely with customers who face financial difficulties.
Through repayment plans, modifications and other loss mitigation options we have delivered more than 143,000 solutions to customers in the fourth quarter alone. In 2008, we provided over 498,000 solutions to customers. We are working with government agencies, Hope Now and others and have led the industry in the development of programs for approximately 3 million at risk customers to avoid foreclosure.
Also, just this week we announced the expansion of our leading the way home program, which offers solutions to prevent foreclosure. By expanding our efforts to Wachovia, approximately 470,000 customers, including those with Pick a Pay loans, will have access to the program if they face payment challenges. Through our active communication programs, Wells Fargo home mortgage has reached 94% of its customers who are two or more payments past due.
For every 10 of these customers we have worked with seven on a solution, two declined help and one could not be reached. Of those who received a loan modification, one year later approximately 7 of every 10 were either current or less than 90 days past due.
Mortgage non-interest income in the fourth quarter included a $413 million write down due to additions to the repurchase reserve and a write down of aged mortgage warehouse loans due to spread widening on limited quotes in the secondary market. As customers refi at par old mortgages we are holding in the warehouse we expect to recoup some of that write down.
The impact of interest rates on origination and servicing non-interest income was a net positive of $7 million reflecting a net valuation loss of $346 million on MSR’s net of hedges, a $328 million loss due to the impact of interest rate changes on the pipeline/warehouse values net of hedge results which was reported in mortgage origination gains offset by $681 million in net gains on debt securities that were hedging the MSR’s reported in gains on debt securities available for sale.
We also had strong sales during the quarter in business banking with store based sales to our small business customers up 23% compared to fourth quarter 2007. Business banking households have a cross sell of 3.61 products per household. Sales of Wells Fargo Business Services packages, which include a business checking account and at least three other business products such as a business debit card, credit card or business loan or line of credit, were up 36% in the fourth quarter and were purchased by a record 51% of new business checking account customers.
Our Wealth Management Group, serving our high net worth customers, achieved 10% revenue growth and 20% growth in pre-tax, pre-provision profit from the fourth quarter 2007. Net income was negatively impacted by a charge off of $294 million pre-tax related to clients who were impacted by the Madoff fraud.
Average core deposits were up $7 billion or 40% from a year ago and increased 32% annualized from the third quarter of 2008. Wealth Management customers continued to place a premium on safety and quality when choosing where to place their financial assets.
Private Banking, serving our highest net worth customers, grew revenue by over 50% from the fourth quarter of 2007. In the fourth quarter, Private Banking grew average core deposits by 38% and average loans by 27% compared to the fourth quarter of 2007. Wells Trade, our online brokerage service, had double digit revenue and net income doubled and continued to attract and retain customers with account levels up 12% from last year.
Our wholesale and commercial banking business, which serves primarily middle market customers and the large corporate market from coast to coast, continued to have strong loan and deposit growth as Wells Fargo has remained open for business during a time when others have pulled back or exited from commercial lending.
Wholesale banking’s average loans increased 30% from fourth quarter of 2007 as we continued to have more opportunities to increase business with new and existing customers at improved credit spreads and with better structures. Loan growth was broad based across many of our commercial businesses including double digit growth in asset based lending, middle market lending, commercial real estate and specialized financial services which includes our capital markets activities and relationships with Fortune 500 companies.
Wholesale banking’s average core deposits grew 18% from fourth quarter last year and 26% from third quarter. This growth was strong in both interest bearing and non-interest bearing deposits reflecting the benefit from a flight to quality and the continued success of our relationship based model and national presence. By continuing to focus on our relationship model, wholesale banking increased cross sell to a record 6.4 products per customer relationship, up from 6.1 products a year ago.
Our middle market customers now have 7.8 products per relationship and U.S. corporate banking, serving Fortune 500 companies has an average cross sell of 7.6 products per relationship. This relationship focus will remain at the center of the integration of the wholesale businesses in the merger with Wachovia. The increased scale in many products will benefit customers across the country.
For example, in our mutual fund business Wells Fargo increased its rank from 18th a year ago to 14th in the fourth quarter and including the combination with Wachovia’s Evergreen funds we ranked 11th at year-end with a total of $254.5 billion in fund balances.
Our recently closed acquisition of Wachovia is the next important stage of Wells Fargo’s continued growth. On a combined basis, we now operate what we believe to be the nation’s premier coast-to-coast financial services franchise. This status is achieved by both the physical reach of our company as well as through the leading presence we have in key lending, deposit and brokerage activities across the country. We firmly believe that this platform provides us with the ability to generate profitable growth for our shareholders in much the same way our prior, pre-acquisition business did for decades.
We are now the number one in the U.S. in community banking presence, small business lending, middle market commercial banking, agricultural lending, commercial real estate lending, commercial real estate brokerage and bank owned insurance brokerage. We are number two in banking deposits in the United States, home mortgage originations and servicing, retail brokerage and debit card.
Although we just closed the acquisition on December 31, our integration efforts have been underway since the deal was announced and we are on or ahead of schedule in most key areas of our merger.
For example, our updated analysis throughout the fourth quarter of Wachovia’s loan portfolios reconfirmed our comfort with the prior credit assumptions; senior leadership structure is in place, our respective teams have been exceptionally active in combining best practices to provide the best possible service to our expanded customer base and all major operating system decisions have now been made.
All in all, we are very pleased with our progress and if anything are only more confident in the value of this merger. From an expense standpoint, approximately $74 million of merger and integration expenses have been taken through Wells Fargo’s earnings in fourth quarter and a preliminary $199 million of expenses were taken through purchase accounting adjustments at the time of the merger.
We are pleased with the progress Wachovia is making in returning to the business of lending to its retail and commercial customers and building deposits, which were up 10% un-annualized since the early fourth quarter trough.
The efforts made by Wachovia to reduce asset risk prior to the actual merger exceeded our initial expectations. Through a combination of asset write downs, sales of investment and trading securities and reductions in higher-risk lending, Wachovia made great progress toward reducing exposures on non-relationship portfolios that Wells Fargo has indicated will not be part of the long-term business mix of the new company. In the process reducing loans, securities, trading assets and loans held for sale by $115.2 billion, or 17% since June 30, 2008, almost entirely in the fourth quarter.
The asset run off underway at Wachovia was part of an overall effort to de-risk the two companies in preparation for the merger in order to reduce the potential losses that might have detracted from earnings growth going forward. The principal de-risking action was to identify and segregate what turned out to be $93.9 billion of higher risk loans on Wachovia’s balance sheet and impair those loans through purchase accounting adjustments at close for the $37.2 billion of estimated life of loan losses.
This is roughly consistent with our initial expectations and differs only in part because some of the originally estimated life of loan losses were already charged off in fourth quarter of 2008 or were essentially provided for in Wachovia’s reserve build instead of purchase accounting as the mix of loans between impaired and non-impaired was ultimately finalized.
Both Wachovia and Wells Fargo incurred costs in the fourth quarter related to credit de-risking. In addition to the $37.2 billion of credit marks on high risk Wachovia loans, which were taken as purchase accounting adjustments, Wachovia recorded through its earnings a $1.2 billion provision for fourth quarter charge offs in its Pick a Pay portfolio, largely for the pool of loans subsequently identified as high risk at close and a $4.2 billion credit reserve build.
Wells Fargo built reserves by $3.9 billion in the fourth quarter to conform both bank’s reserving practices to the more conservative of the two banks and also added $1.7 billion in reserves for projected credit deterioration. Apart from the $37.2 billion credit write down for impaired loans at Wachovia, the other items were charged to the respective earnings of the two banks.
Each bank had a number of other significant items including write downs of securities and loans as well as merger and integration expenses. As a result, Wells Fargo reported a $2.5 billion loss in the fourth quarter. While we were disappointed to have reported a loss, the quarter included numerous de-risking and merger related items amounting to $6.9 billion pre-tax, including the $3.9 billion provision to conform reserve practices to the most conservative of each company; the $1.7 billion additional credit reserve build; a $413 million write down of loans in the mortgage warehouse and additions to the mortgage repurchase reserve; $473 million of other than temporary impairment securities write downs; $294 million of net charge offs related to the Madoff fraud and $74 million of merger-related costs.
Had Wachovia remained a stand alone company it would have reported a loss of $11.2 billion in the fourth quarter which included a $2.8 billion deferred tax asset write down. Wachovia also had numerous significant items during the quarter including a reserve build of $4.2 billion and market disruption losses of $4.3 billion.
The company’s results were also dampened by the effect of declining market values on the market sensitive business model. Underlying business trends at Wachovia began to recover as we neared the second half of the quarter and we remain excited about the opportunities that still exist.
Wachovia did see positive business trends throughout its consumer and commercial businesses as the customer base stabilized and deposit and checking accounts began to grow again and new customer acquisition metrics remained positive. Each major business segment at Wachovia experienced positive deposit growth including retail/commercial, wealth clients, brokerage and cash management during the quarter.
Additionally, in the markets oriented businesses such as retail brokerage, sales of traditional banking products and were up and net inflows to Wachovia funds were up $1.4 billion in the fourth quarter versus a net outflow of $11.7 billion in the previous third quarter. Finally, net exposure in the investment bank to sub-prime, CMBS and leveraged loan assets ended the quarter down 85% from the prior year.
Tier-1 capital was $86.4 billion at December 31, 2008 after the impact of de-risking the balance sheet for credit impairments of loans and write downs of negative cumulative other comprehensive income at Wachovia, which in the aggregate reduced the tier-1 capital ratio of the combined organization by approximately 230 basis points to 7.9% at year-end, still well above regulatory minimums for a well capitalized bank even after the de-risking actions.
Another metric sometimes used to assess capital strength is the combination of tier-1 capital and the allowance for credit losses. For Wells, the combined amount of tier-1 capital and our $21.7 billion of allowance would approximate 9.4% of earning assets for the consolidated two banks and year-end 2008. That ratio is higher than Wells Fargo maintained on a stand alone basis at any point in the last six years other than 2006, a year in which Wells Fargo built excess capital by significantly reducing assets given the fact that asset spreads were not properly accounted for risk. We consider the capital position and allowance of the consolidated company to be a source of strength.
Since credit is such an important part of the current picture let me now conclude with an overview of the various loan portfolios including Wachovia’s major loan portfolios.
The new Wells Fargo has a combined total of $129.5 billion in home equity loans and lines of credit at the end of 2008 including loans and lines of credit that were originated through the National Home Equity Group, Wachovia, Wells Fargo Financial and the Wealth Management Group.
For reporting purposes, additions to the total reported portfolio at year-end are included within the core portfolio while the liquidating portfolio is reported on the same basis as prior quarters and is Wells Fargo only.
The fourth quarter home equity loss rate on a combined basis, excluding the impaired home equity portfolio, was 2.87%, down from the Wells Fargo home equity loss rate of 3.09% in the third quarter, which included home equity loans originated in the National Home Equity group only.
This improvement in loss rate reflects the higher quality of Wachovia’s home equity portfolio which was predominately retail originated, about 98.8%, with a higher percentage of balances in the first-lien position than Wells Fargo’s portfolio and with greater geographic diversity. About 20% of legacy Wachovia’s Home Equity portfolio balance was in a first-lien position compared with approximately 13% for stand alone Wells Fargo.
The addition of Wachovia’s Home Equity portfolio actually improved the geographic diversification of the overall Home Equity portfolio since 74% of Wachovia’s Home Equity portfolio is outside of California and Florida compared with 58% outside of California and Florida for the stand alone Wells Fargo Home Equity portfolio.
The liquidating portfolio reported a fourth quarter loss rate of 8.27% up from 7.59% in the third quarter, reflecting the continued decline in home prices, higher levels of unemployment and the proportionately higher percentage of the portfolio at a combined current loan-to-value of greater than 90%.
76% of this portfolio had a combined loan-to-value of greater than 90% at quarter-end based predominately on estimated home values from automated valuation models updated through December 2008. 40% of the core portfolio, excluding legacy Wells Fargo Financial and legacy Wells Fargo Wealth Management Group, had a combined loan-to-value of greater than 90%. The liquidating portfolio at December 31, 2008 was $10.3 billion, down from a peak of $11.9 billion a year ago. The higher risk home equity loans at Wachovia are reflected in the impaired portfolio with a beginning balance of $1.4 billion which were marked down 41% to $0.8 billion.
Until home prices stabilize we continue to expect higher losses in the home equity portfolio. It is important to remember, however, that most of our home equity borrowers were current with their loans at quarter-end.
Excluding the impaired home equity portfolio, about 2.48% of the portfolio balance were two or more payments past due compared to 2.29% at September 30, 2008 for the Wells Fargo stand alone portfolio.
We continue to work aggressively with our customers to avoid problems and mitigate loss. During the fourth quarter our loss mitigation activities within the National Home Equity Group benefited nearly 4,400 customers with over $429 million in balances. By working with these customers and finding solutions to their financial difficulties we believe we will end up keeping more customers in their homes and mitigating loss.
In addition to exiting most indirect home equity origination channels last year, we have been managing accounts to reduce risk while at the same time remaining open for business for credit worthy retail customers.
As you may remember, Wells Fargo has never originated option ARM's and we are not going to start now. In fact, Wachovia’s Pick a Pay portfolio is already in the process of being reduced as no new loans are made and existing loans mature, are modified or sold. However, we do believe that Wachovia’s option ARM portfolio, or Pick a Pay, is the highest quality option ARM portfolio in the industry.
After the effect of purchase accounting, the portfolio totaled $93.2 billion. $35.5 billion of the remaining portfolio are credit impaired loans which were marked down by 41% and represents the portion of the Pick a Pay portfolio we believe has the greatest probability of default.
Estimated future losses for the impaired portion of the portfolio have already been recognized as a reduction in these loan balances pursuant to purchase accounting and will not be charged against future earnings. We are already using the mortgage company’s expertise in mitigating losses with a test mailing to select Pick a Pay customers where we believe a loan modification may help keep them in their homes. This follows Wachovia’s modification efforts last fall with the mark that we have taken on the portfolio providing us with more flexibility particularly on balance and rate adjustments.
The portion of the Pick a Pay portfolio that we did not mark, $57.7 billion, has dramatically better credit performance and characteristics. For example, the 30 plus day delinquency ratio was only 10 basis points. Additionally, these borrowers have credit statistics that are more representative of Wachovia’s remaining consumer real estate portfolio with an average current FICO of 712 and an average current LTV of 80% at quarter end.
Within the first mortgage portfolio, Wells Fargo Financial had a total of $25 billion of debt consolidation loans originated through Financial’s U.S. retail stores at quarter end, flat from the third quarter due to tightening underwriting standards, declining real estate values and less investment in their distribution network.
The declining real estate values and increases in unemployment have resulted in higher delinquencies and charge offs in this portfolio with fourth quarter losses of $97 million, a 1.53% annualized loss rate. While losses and delinquencies increased they are still significantly better than published industry rates for non-prime mortgage portfolios.
The better credit performance in our portfolio was due to our consistently tighter underwriting standards compared to other non-prime mortgage originators. The Wells Fargo Financial team members who underwrite these loans originated through the store network underwrite to the customer first and the collateral second. This portfolio does not include any interest-only, stated income, option ARM or negative amortizing loans. $12 billion of the debt consolidation portfolio is in ARM products. Almost 25% of the ARM portfolio is in the adjustable period and an additional 20% is scheduled to have its initial adjustment in 2009.
Adjustable rates decreased for much of 2008 and if interest rates remain low loans scheduled to adjust in 2009 will, in fact, have lower monthly payments.
Wells Fargo Financial’s $24 billion auto portfolio declined 19% from last year reflecting tightened credit standards and car sales at a 26-year low. Net charge offs on the Wells Fargo Financial portfolio were up $55 million linked quarter, a 6.04% annualized loss rate reflecting seasonal trends, lower used car prices and the deterioration in the economy. Ninety days past due were up 11 basis points from the fourth quarter last year.
Wachovia’s $23.4 billion owned auto portfolio increased 4% year-over-year. While net losses in this portfolio are not included in Wells Fargo’s results for the quarter, the annualized net charge off ratio on the owned portfolio was 3.7% in the fourth quarter. Ninety days past due increased 7 basis points from both the third quarter of 2008 and the fourth quarter of last year.
Beginning January 1, indirect auto loans will be originated through Wachovia Dealer Services and Wells Fargo Financial will originate all direct auto loans. Approximately 90% of the combined auto portfolio was originated through indirect lending.
Wells Fargo’s Community Banking credit card portfolio had $13.7 billion in outstanding balances at quarter end, up 18% annualized from the third quarter and up 15% from a year ago. The growth of this portfolio has continued to slow, reflecting lower consumer spending and tighter underwriting standards. Losses in this portfolio continue to increase as a result of higher bankruptcy rates and higher unemployment.
We proactively manage our existing accounts, including restricting balance growth and transactions on riskier accounts, lowering and in some cases closing credit lines and for a small percentage of accounts re-pricing them consistent with the customer’s current risk profile. Since the vast majority of our bank card customers have other relationships with Wells Fargo, we monitor customer behavior using both internal and external measurements.
Wells Fargo Financial had $7.8 billion in credit card balances at quarter end, up 5% annualized from the third quarter. These cards are sold primarily to Wells Fargo Financial customers and through retailers and manufacturers with large dealer networks, not through mass mailing campaigns. Wells Fargo Financial’s card portfolio accounted for over half of the quarterly increase in consumer credit cards losses.
Similar to the bank’s credit card business, Wells Fargo Financial has continued to proactively manage new and existing accounts with tightened underwriting standards and by appropriately pricing for risk.
Wachovia had only $2.5 billion in credit cards outstanding at the end of the quarter. The Wachovia card business model mirrors Wells Fargo’s with cards sold only to banking customers. Wachovia’s fourth quarter loss rate was in line with the loss rate on Wells Fargo’s Community Banking card portfolio.
Within our commercial and commercial real estate loan portfolio, we have an $11.7 billion Business Direct portfolio consisting primarily of unsecured small loans and lines of credit to small business owners nationwide with an average balance of less than $20,000. Business Direct’s credit losses increased in the fourth quarter by $29.4 million from the third quarter. This increase is consistent with the higher losses experienced in our consumer portfolios.
Wells Fargo had a total of $68 billion of commercial real estate and construction loans outstanding at the end of the fourth quarter, up 6% from the third quarter, including $32 billion managed by the Wholesale Banking Group. Charge offs were $93 million in the fourth quarter, or a 0.55% loss rate. Although the portfolio has shown some signs of stress the loss rates have remained at an acceptable level.
Our real estate underwriting expertise has remained consistent through many prior cycles and continues to serve us well in this one. Within our commercial real estate portfolio, we had approximately $5.5 billion in residential, 1-4 family construction and land development loans. While losses in this portfolio increased due to the decline in the residential real estate market, losses remained within expectations because of the quality and experience of our people and our customers.
Wachovia’s commercial real estate portfolio totaled $70 billion including $45 billion managed by the real estate division after taking $7.7 billion of loan marks. We believe the loan marks taken in this portfolio were appropriate given the risk in the portfolio. Approximately $60 billion of the combined commercial real estate portfolio between the two banks is owner occupied commercial real estate.
Let me now briefly summarize the loan portfolio for the combined company. On a combined basis we had $865 billion in loans outstanding as of December 31, 2008. There is more geographic diversity in this portfolio than either bank had prior to the merger and we have maintained our balance of commercial and consumer loans. The allowance for credit losses of $21.7 billion at year-end covered more than 320% of non-performing assets, the highest coverage ratio among large bank peers. The allowance covers 12 months of estimated losses for all consumer loans and at least 24 months for commercial loans.
In summary, within the context of a challenging external environment, Wells Fargo remains an industry leader in providing credit to consumers and businesses extending over half a trillion dollars in new loan commitments and mortgage originations since the start of the credit crisis in mid-2007. Loan and deposit growth is driving significant and hopefully durable top line growth with pre-tax, pre-provision growth increasing 18% last year.
We successfully closed the Wachovia acquisition on schedule, on plan on December 31, 2008. In preparation for the next stage in our profitable growth, numerous actions were taken by both banks in the fourth quarter that will reduce the potential for loss going forward. While these actions and other significant items resulted in a reported loss at both banks in the fourth quarter, the balance sheet of the combined organization was strengthened and the resultant de-risked capital position of the new organization remains strong.
Let me now turn it over to John Stumpf, Wells Fargo’s President and Chief Executive Officer, for some concluding comments.
Thanks Howard. I just wanted to reiterate how enthusiastic we are about the future for Wells Fargo. With the completion of the Wachovia merger, we are one team, twice as strong. I feel better about this deal now than I did when it was first announced. I have met with thousands of Wachovia team members and customers all over the East Coast and the Southeast.
These are really great people in really great markets. This merger is coming together better than we ever could have expected. While the economy is worse, no question about that, than when we announced the merger, we feel very good about our financial assumptions including 20% IRR and at least 20% accretive to GAAP earnings in year three, 30% on a cash basis. I also believe that our cost save projections were low and our conversion cost projections were high.
The weakened economy is in many ways a benefit for bringing these companies together. Wachovia’s talented team members are choosing to stay with the company in greater numbers than we anticipated. These are really terrific team members who are among the very best at serving their customers and customers that left Wachovia prior to the merger are coming back and are excited about giving Wells Fargo their business.
Remember, we didn’t include any revenue synergies in our models. So, while economic conditions are still uncertain we couldn’t feel better about the future for Wells Fargo. I’m also happy to report that today the Board of Directors declared a common dividend of $0.34 per share consistent with our prior dividend.
Thank you for listening. If you have any questions, please call Bob Strickland, Director of Investor Relations, at (415) 396-0523, or Jim Rowe, Associate Director, at (415) 396-8216.
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