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Executives

Jim Rowe - Director, Investor Relations

Timothy J. Sloan - Senior EVP, CFO

John G. Stumpf - Chairman, President and CEO

Analysts

John McDonald - Sanford Bernstein

Erika Penala - Bank of America Merrill Lynch

Matt O'Connor - Deutsche Bank

R. Scott Siefers - Sandler O'Neill

Ken Usdin - Jefferies & Company

Paul Miller - FBR Capital Markets

Joe Morford - RBC Capital Markets

Michael Mayo - CLSA

Nancy Bush - NAB Research

Andrew Marquardt - Evercore Partners

Betsy Graseck - Morgan Stanley

Chris Mutascio - Keefe, Bruyette & Woods

Chris Kotowski - Oppenheimer

Wells Fargo & Co. (WFC) Q2 2013 Earnings Conference Call July 12, 2013 10:00 AM ET

Operator

Good morning. My name is Regina, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the Wells Fargo Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

I’d now like to turn the call over to Jim Rowe, Director of Investor Relations. Mr. Rowe, you may begin your conference.

Jim Rowe

Thank you, Regina. Good morning, everyone. Thank you for joining our call today during which our Chairman and CEO, John Stumpf; and CFO, Tim Sloan will discuss second quarter results and answer your questions.

Before we get started, I’d like to remind you that our second quarter earnings release and quarterly supplement are available on our website at wellsfargo.com. I’d also like to caution you that we may make forward-looking statements during today’s call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings including the Form 8-K filed today containing our earnings release and quarterly supplement.

Information about any non-GAAP financial measures referenced, including the reconciliation of those measures to GAAP measures, can also be found in our SEC filings, in the earnings release, and in the quarterly supplement available on our website.

I’ll now turn the call over to our Chairman and CEO, John Stumpf.

John G. Stumpf

Thank you, Jim. Thanks to everyone for joining us today. Wells Fargo had a terrific quarter and has now generated 14 consecutive quarters of earnings per share growth, with record earnings in the second quarter. This consistent strong performance during our dynamic economic and interest rate environment again demonstrates the benefit of our diversified business model.

We are not dependent on any one business to generate growth. We have over 90 businesses that are all focused on just one thing, meeting our customer’s financial needs. Our results this quarter demonstrate the momentum we have throughout for all of our businesses.

Our strong performance is broad based compared to a year-ago we earned a record $5.5 billion, up 19% and grew earnings per share of 20%. We grew pre-tax pre-provision profit by 3%. We reduced our expenses and improved our efficiency ratio by 90 basis points to 57.3%. Our core loan portfolio grew by $42.3 billion, up 6%. Our credit performance was outstanding, benefiting from our conservative underwriting in improving economic conditions, especially of housing with net charge-offs down to 58 basis points and our total net charge-off down 48% from just a year-ago.

Our strong deposit franchise, which becomes even more valuable in a rising great environment continue to grow, with total deposits up 10% from a year-ago, while we reduced total deposit cost by 5 basis points to 14 basis points.

We achieved record retail cross-sell of 6.14 products per household. Wholesale Banking grew their cross-sell to 6.9 products and Wealth Brokerage Retirement cross-sell increased to over 10 products – 10.35 to be exact. We grew return on assets by 14 basis points to 1.55% and return on equity increased by 116 basis points to 14.02%.

Our capital levels continue to grow with our estimated Tier 1 common equity ratio under Basel III increasing to 8.54% and based on our initial review of the leverage ratio proposed – proposal issued this week; we believe our current leverage levels would exceed the well capitalized requirements at both the bank and the holding company.

Our strong earnings growth has enabled us to grow our capital levels, while returning more capital to our shareholders. In the second quarter, we increased our dividends to $0.30 a share, up 36% from a year-ago and we continue to buyback stock.

Before turning the call over to Tim, let me conclude with some comments about my views on how the current economic and rate environment impacts Wells Fargo. We continue to be optimistic about the improvements we’re seeing throughout the economy. While commercial loan demand is still modest, jobs are been created, consumer confidence is increasing and the housing market continue to demonstrate strong momentum.

In fact, in the second quarter, the housing market improvement was stronger and more broad-based than it has been since before 2008. Sales were up and residential property prices increased in by 13% across the country. Yet, affordability still remains attractive, even with the increased prices and higher interest rates. The strength in the housing market was a positive catalyst to our results in the second quarter in a number of ways including higher originations performed purchases, lower environmental costs, reduced repurchase reserves and improved credit quality.

Assuming the housing market state remains strong, and we currently believe it will, our overall results will continue to reflect these benefits. While the economy continues it’s slow, but steady improvement, the current rate environment is obviously very different than it was just 90 days ago when we last announced our earnings.

We knew rates would eventually rise as we’ve been planning for a rising rate environment for sometime. The benefit of our diversified business models is that it provides opportunities to generate earnings growth over a variety of rate environment. Some of our businesses can actually do better in a lower rate environment and others benefit from the rising rates.

Tim will highlight the growth we’ve achieved across a number of our businesses on our call today. We do not manage Wells Fargo based on a specific rate environment. We manage Wells Fargo as we have for decades to satisfy our customer’s financial needs. Rates rising for the right reason and improving economy is beneficial for our customers, which then in turn benefits Wells Fargo.

Tim will now provide more details on our second quarter results. Tim?

Timothy J. Sloan

Thanks, John, and good morning, everyone. My comments would follow the presentation included in the first half of our quarterly supplement starting on Page 2. John and I will then take your questions.

As John mentioned, Wells Fargo had another outstanding quarter with record earnings of $5.5 billion, up 19% from a year-ago and up 7% from the first quarter. Earnings per share grew to $0.98, up 20% from last year and up 7% from the first quarter. We’ve now achieved 14 consecutive quarters of EPS and nine consecutive quarters of record earnings per share.

As John just mentioned, the rate environment this quarter was very different from last quarter. In fact, the economic housing rate environment has differed significantly over the past 14 quarters of our earnings growth. While the drivers of our growth have varied, our consistent risk discipline and diversified business model have remained the same.

Our results this quarter compared to the first quarter, clearly show the advantage of our diversity with our bottom line results benefiting from strong broad based trends including net interest income growth as we drew loans and invested in securities, fee growth across a variety of our businesses, reduced expenses generating positive operating leverage and improved credit and capital levels.

As you can see on page 3, our year-over-year results were also strong with growth in pre-tax, pre-provision profit, net income, EPS, both total and core loans, core deposits, ROA and ROE.

Our revenue diversification is highlighted on slide 4. A 50-50 split between spread revenue and fee revenue from our diversified businesses and cross-sell activities. Trust and investment fees were once again our largest fee category and it has been for the past five quarters. We achieved positive momentum across many of our businesses which I'll highlight throughout the call.

Let me start by highlighting some of the key drivers of our second quarter results from the balance sheet and income statement perspective. On page 5, you can see we had good balance sheet growth this quarter growing loans, deposits and securities. I'll provide more detail on the securities we purchased later on the call. The decline in our provision expense this quarter reflected improvement in home prices and our overall credit performance.

Turning to the income statement on page 6, mortgage revenue was stable in the quarter and revenue growth was driven by stronger trust and investment fees and higher net interest income. Our expenses declined as we expected primarily reflecting seasonally lower employee benefit costs.

Let me now cover our business drivers in more detail. As shown on page 7, we continued to have solid loan growth with period end loans up $26.8 billion or 3% from the year ago and up $2 billion from the first quarter. Loans grew even after the continued run off of our liquidating portfolio. This portfolio has declined by over 50% since 2008 and the headwind to overall loan growth caused by this run-off has continued to slow.

In the second quarter, the liquidating portfolio declined $15.5 billion from a year ago and $3.2 billion from the first quarter. Excluding these liquidating loans, our core loan portfolio grew by $42.3 billion or 6% from a year ago and was up $5.2 billion from the first quarter.

Commercial loans grew $1.8 billion in the quarter with board-based growth in C&I and foreign loans. Consumer loans grew $250 million with growth in nonconforming first mortgage loans, auto and credit card, partially offset by the expected run-off from liquidating and core home equity portfolios.

Deposit growth remained strong with period end deposits up $10.9 billion from the first quarter. Average deposits were up $23.6 billion from the first quarter and up $85.8 billion or 9% from the year ago. Average core checking and savings deposits were up 8% from a year ago. We grew our primary consumer checking customers by a net 3.5% from a year ago, up 2.1% from last quarter. These are active checking account customers who transact with Wells Fargo regularly.

The growth we've achieved with these relationship-based customers demonstrate the strength of our deposit franchise and should generate future growth as we focus on remaining their primary bank and meeting more of their financial needs. We continued to lower our deposit costs with average deposit costs of 14 basis points in the second quarter, down 1 basis point from the first quarter and down 5 basis points from the year ago. We've successfully grown deposits while reducing our deposit costs for 10 consecutive quarters.

As shown on page 9, we grew tax-equivalent net interest income by 3% from the first quarter. The growth in NII was driven by securities purchases, lower funding costs, loan growth, higher variable income as well as the benefit from an extra day in the quarter. Average earning assets grew $31.1 billion from the first quarter, reflecting increases in short-term investments, loans and AFS securities. We purchased $21 billion of AFS securities during the second quarter, primarily agency MBS, and we purchased an additional $6 billion of securities in the first two weeks of the third quarter.

We remained disciplined during periods of lower rates and we were prepared to deploy liquidity as rates rose. We benefitted from this disciplined approach in the second quarter by investing in higher yield and securities. While higher rates driven by an improving economy will be positive to our results over the long term, including higher yielding earning asset growth and improving credit quality, there are also some short-term effects such as lower mortgage refi volume and reduced OCI that I'll highlight throughout the call.

Higher rates impact our businesses in different ways and in different times, which reinforces the benefit of our diversified model. Our net interest margin declined by 2 basis points from the first quarter to 3.46%. This decline was driven by three primary factors. First, our continued deposit growth caused cash and short-term investments to increase reducing the margin by 6 basis points.

As I've highlighted in the past our deposit growth has little impact on net interest income but it is dilutive to the net interest margin. Offsetting this decline by 2 basis points was higher variable income including higher PCI loan resolutions and periodic dividends. This variable income is obviously lumpy and can increase or decrease in any quarter.

Finally, the net impact of re-pricing and balance sheet growth improved the margin by 2 basis points largely due to the benefit of the growth in the AFS portfolio and reduced funding costs. While margin was relatively stable this quarter, it is still reasonable to expect continued net interest margin pressure.

Despite a decline in total fee income in the quarter, many of our businesses demonstrated strong momentum including deposit service charges up $34 million from the first quarter benefitting from seasonality and account growth. Trust and investment fees up $292 million on strong investment banking fees and higher retail brokerage asset based fees. Card fees grew 75 million on credit and debit card account growth and higher purchase volume. Commercial real estate brokerage commissions grew $28 million with strong activity for both private and public deals.

Overall, noninterest income was down slightly from the first quarter on lower gains from deferred compensation plan investment income which is P&L neutral, weaker customer accommodation trading and lower fees including the lower gain on the sale of the PCI loans.

Our mortgage business continued to generate strong results in the second quarter with revenue up modestly from the first quarter as highlighted on page 11. Mortgage originations were $112 billion, our seventh consecutive quarter of more than a $100 billion in originations reflecting the benefit of the housing market improvement and low interest rates. As rates rose late in the quarter, applications for home purchases remained strong but refi application volumes declined as expected.

We still had a relatively large unclosed pipeline at the end of the quarter but refi volume is obviously very sensitive to rates. Refis were 56% of originations in the second quarter, down from 69% in the first quarter. We managed through many refi cycles in the past and we will adjust the size of our business based on production volumes through this cycle. Gain on sales margins declined to 2.21% and with the increase in mortgage rates, we would expect further declines in our margins and originations.

Expenses declined from seasonally high first quarter levels as shown on page 12. This decline was driven by a 4% reduction in personnel expenses reflecting lower employee benefit expenses due to the first quarter seasonally high payroll taxes and 401(k) matching. These declines were partially offset by higher salaries reflecting annual merit increases and higher revenue-based incentive compensation expense from strong results in capital markets, WBR and mortgage.

We also had increases in other expense categories primarily driven by our continued investment in our business to drive future growth, including project spending for product improvement and system enhancements, higher advertising and promotion expense driven by seasonality and a new campaign launched in the second quarter.

Operating losses increased $131 million in the second quarter, primarily from litigation accruals related to various legal matters and we also experienced increased costs associated with regulatory and compliance requirements. Our focus on reducing expenses while investing in our businesses to generate revenue growth is reflected in our efficiency ratio declining to 57.3% in the second quarter. We expect our efficiency ratio to remain within our target range of 55% to 59%.

As John mentioned at the start of the call, the recovery in the housing market is driving significant improvement in a number of areas, including some of our environmentally elevated costs. As highlighted on page 13, in the second quarter, most of these costs were significantly below what they had been over the past few years.

We got a nominal amount of cost associated with the independent foreclosure review this quarter of customer call volumes following the distribution of remediation checks. The improvement in real estate values helped to reduce foreclosed asset expenses by $49 million compared to the first quarter and by $143 million from a year ago. Mortgage revenue this quarter was reduced by $25 million for additions to our repurchase reserve not related to card originations which is the lowest build we’ve had since prior to 2008.

Outstanding and purchase demands were relatively stable compared with the first quarter and new demands emerged consistent with our expectations. However not all elevated costs are behind us. Mortgage revenue is reduced by $82 million to reflect higher servicing and foreclosure costs as foreclosure timelines continue to extend especially in judicial foreclosure states.

Turning to our segment results starting at page 14, community banking earned $3.2 billion in the second quarter up 28% from a year ago and up 11% from the first quarter. Retail banking achieved a record cross-sell of 6.14 products per household up from 6 products a year ago. To support sales and household growth we grew platform bank or FTE by approximately 1,900 from a year ago.

Our credit card business continued to have strong account growth with the record 594,000 new accounts in the second quarter, up 16% from a year ago. Our household penetration increased to 35%, up from 31% a year ago. Credit card balances were up 3% from the first quarter and up 9% from a year ago due to strong transaction volumes and account growth.

We also had momentum in our auto business with record originations in the second quarter of $7.1 billion up 4% from the first quarter and up 9% from a year ago. Our continued focus on serving our small business customers generated a 2.7% growth in business checking accounts from a year ago and we extended $9.3 billion of new loan commitments to small business customers during the first half of the year up 25% from a year ago.

Wholesale banking earned $2 billion in the second quarter up 7% from a year ago and down $41 million from the first quarter. Wholesale banking generated record revenue of $6.1 billion. Investment banking fee growth was strong driven by higher equity underwriting, credit originations and loan syndication fees. Investment banking results included a 34% increase in the year-to-date revenue from commercial and corporate customers. This relationship focus also benefited treasury management as revenue grew 12% from a year ago benefiting from better penetration of our existing customers.

Wholesale banking’s cross-sell reached 6.9 products per relationship up from 6.8 a year ago. Wholesale banking results continue to benefit from steady loan growth with loans having grown for a 11 consecutive quarters. The average loans increased 6% from a year ago with growth nearly all portfolios including asset back finance, capital finance, commercial banking, commercial real estate, corporate banking and government and institutional banking. Credit quality remained strong with net recoveries in the second quarter reflecting the improvement in our economy and our risk in underwriting discipline.

Wealth, Brokerage and Retirement earned a record $434 million, up 27% from a year ago and up 29% from the first quarter reflecting the success of our core business strategy of growing asset based relationships and the benefit from the improvement in the markets. Revenue grew 10% from a year ago reflecting strong growth in asset based fees and higher brokerage transaction revenue.

Retail, brokerage, managed account assets reached the record $331 billion, up 19% from a year ago driven by strong net flows and market performance. WBR had strong loan growth with average loans up 4% from the first quarter driven by non-conforming mortgages. WBR continued to effectively partner with retail banking to meet the financial needs of our customers, increasing cross-sell to 10.3 products per household. Assets referred from community banking to WBR grew over 25% from a year ago based on first quarter results. This partnership is a great example of how our businesses work together to meet the financial needs of our customers.

Turning to credit quality on Page 17, we had continued improvement across our commercial and consumer portfolios. Second quarter net charge-offs declined to 58 basis points of average loans. Losses in our commercial portfolio were only $44 million or 5 basis points of average loans. Consumer losses declined to 101 basis points. We had especially strong improvement in our commercial and residential real estate portfolios. These portfolios are now providing a tailwind for our credit performance compared to the headwind they provided when the real estate market was weaker.

Reflecting these improvements our provision expense declined $567 million from the first quarter and included $500 million in reserve releases, compared with the release of $200 million in the first quarter and $400 million from a year ago. We continue to expect further reserve releases absent a significant deterioration in the economic environment and while we don’t know what our release will be in the third quarter the favorable condition to grow this release for this quarter have not dissipated.

The recovery in the housing market also benefited our expected losses in the PCI portfolio. This quarter the accretable yield balance increased by a net $2.1 billion which included $1.6 billion increase in expected cash flows and $876 million reclassification primarily from our pick-pay portfolio. This re-class did not impact second quarter results but will be accreted into income over the remaining life of these loans.

In addition to lower charge-offs and provision expense non-performing asset also improved with MPAs down $1.8 million from the first quarter and down $3.8 billion or 15% from a year ago. Loans 90 days or more passed due decreased $206 million from the first quarter and were down 15% from a year ago with improvement in both commercial and consumer loans. Early stage consumer loan delinquency balances and rates also declined from the first quarter and from a year ago.

Earnings are the primary driver of capital growth for Wells Fargo. As shown on Page 19, our Tier 1 common equity ratio included 10.73%, up 34 basis points from last quarter. Our estimated Tier 1 common equity ratio under Basel 3 which reflects our interpretation over Basel 3 capital rules adopted July 2, increased to 8.54% in the second quarter. OCI negatively impacted the ratio by 24 basis points in the quarter due to the increase in interest rates. Because of our strong earnings growth we grew capital even with the impact on the increasing rates. We expect reductions to unrealized securities gains when rates rise and this is one reason why as we discussed over a year-ago we're targeting a capital buffer of approximately 100 basis points.

And just this week, as John mentioned the U.S. regulatory agencies issued a supplemental leverage ratio of proposal. Based on our initial review we believe our current levels -- leverage levels would exceed the well capitalized requirements at both the bank and holding company. We increased our second quarter dividend to $0.30 per share a 20% increase over the first quarter dividend and purchased 26.7 million shares in the second quarter and executed a $500 million forward contract that is expected to settle in the third quarter for approximately 13 million shares.

Including the shares under the forward contract, our share count would have been relatively flat for the quarter offsetting 40 million shares issued during the quarter primarily related to profit sharing and match contributions to 401(K) plans and team members exercising option. With many opportunities to generate growth at Wells Fargo on Slide 20 we summarized the demonstrative momentum we have throughout our businesses that I’ve highlighted on the call. In each of our businesses we have opportunities for growth reflecting the expanding needs of our customers. This customer account and balance growth along with increased cross-sell with help drive our future results and reflects the benefits of our diversified model.

In summary we had a very good quarter with strong broad based improvement and demonstrative momentum across many of our businesses. This included growth in loans, deposits, net interest income and fee growth across many of our businesses. We reduced expenses and benefited from a continued improvement in credit quality that reflected our conservative underwriting and the strengthening economy especially the rebound in housing. Our ROA and ROE continue to grow and we grew capital levels while returning more capital to shareholders.

We will now open up the call for your questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question will come from the line of John McDonald with Sanford Bernstein.

John McDonald - Sanford Bernstein

Hi, good morning.

John G. Stumpf

Good morning, John.

Timothy J. Sloan

Morning.

John McDonald - Sanford Bernstein

Tim, just a question on liquidity. Could you tell us where you are on the liquidity coverage ratio relative to your understanding of what will be required of you in the new regulatory rules?

Timothy J. Sloan

Yeah. John, it's a good question. One of the challenges is that the rules haven't been finalized and similar to the Basel III capital rules from the point that which they were originally proposed to where they were finalized, there was a fair amount of discussion in change. I would tell you that we have adequate capital to operate Wells Fargo. Having said that, we are going to continue to work with the regulators in terms of those interpretations. There may be some incremental amount of liquidities that we need to raise, but we certainly – it's certainly that we are focused on because liquidity risk is a key risk for the company. But given over $1 trillion of deposits we have and given the experience we have in terms of operating in different environments, again we think we've got adequate liquidity. We may need to raise a little bit more but it shouldn't be material for the company.

John McDonald - Sanford Bernstein

Okay. So it's a factor in – as you think about the pace at which you look for your cash, you mentioned buying some securities here today. Is that a factor in how you think about deploying your liquidity?

Timothy J. Sloan

No, it's not a big factor at all, John. Again, to me it's much more important to think about the liquidity needs for operating the business as it relates to how much we want to invest in securities because the first call for any of our liquidity has always got to be to our customers in terms of loan demand. But it's not a primary driver in terms of the pace of activity. The primary driver in terms of the pace of our investment activity has been there over the last year. We've been in this very low rate environment and turned the clock back a year ago, we had a lot of excess liquidity, there was a lot of concern that we were going to be in low rates for a while and there was a view that we weren't investing fast enough. We wanted to stay disciplined then. That was the primary driver. Just like today, one of the primary drivers for why we're investing more in our securities portfolio is because we think given the rate back up, the returns are much more attractive.

John McDonald - Sanford Bernstein

Yeah. And we did see a benefit there in the degree of net interest margin compression, but you still have an expectation for some continued margin compression. What are the drivers there, Tim? And then in terms of NII dollars, do you still expect to grow the NII dollars from the current level?

Timothy J. Sloan

Okay. So on the net interest margin, I don't think the drivers have really changed that much. As you recall, if you look at our net interest margin decline, which we've had one over the last year 14 quarters, the primary driver for the decline has been the fact that we've been growing deposits which long-term – for the company, financing that. Within a quarter, we can have some variability based upon the variable income which was positive this quarter but last quarter was negative. The balance sheet continues to re-price a bit. So the factors really haven't changed because we haven't gotten to a point that the balance sheet has completely re-priced. So we could continue to see some continued compression in the net interest margin. The underlying factors really haven't changed. In terms of net interest income and our goal is to grow net interest income over time. What happens in a quarter-by-quarter basis I just don't know for sure because there's a lot of factors. We had a lot of positive factors that drove our net interest income this quarter which I think was absolutely terrific. Again, I don't know if that means we're going to grow net interest income in the third quarter, but over time I believe that we can grow net interest income and this quarter I think we've demonstrated our ability to do that.

John McDonald - Sanford Bernstein

Okay. And switching gears over to the mortgage revenues, the gain on sale margin of the 221 you mentioned hold up better than expected. What were the factors there? And is there any framing you can do for us on how much pressure that market could experience as you move to the next several quarters?

Timothy J. Sloan

Yeah, John, I think that's a very fair observation and candidly I think the mortgage sale margin has held up better not just for the last quarter but for the last year than I think anybody in the business or in industry would have expected. That said, it has come down and it came down over 30 basis points in the quarter. And our best guess is that we are seeing pressure in the gain on sale margin and the gain on sale margin has significantly declined. Recall that last quarter we framed the gain on sale margin variability over last few years if you annualize it, the low end was 160 and the high end again on an annualized basis was 220. We've been at the high end. We think we're going to start to move down from there. So I think there is going to be pressure. I do not believe you're going to see a 2.21% gain on sale margin, I think it's more likely to be lower. But again, it's really a function of the competitive environment which we think has been very rational as we've gone through this cycle as well as the rate environment. Recall that our best guess in the second quarter was that originations were going to be a little bit lower than the first quarter but in fact originations were up in the second quarter because rates stayed low for a longer period of time. Rates are now up and that's going to affect originations for sure. So there's a lot of variability but to put it very bluntly we think that the gain on sale margin is going to decline and it will decline somewhere in the range of what we've seen over the last few years, but it is going to decline.

John G. Stumpf

But John as you know and Tim's absolutely right, it will decline and margins will be under some pressure but we have this wonderfully balanced business within the business. In other words when rates increase, refis drop, margins come in because there's more competition but then you have a servicing portfolio and that does better. So there's balance within this business and there's also a flush down in the broad distribution and diversity within the company. So some businesses do better, some do not as well when rates rise.

John McDonald - Sanford Bernstein

Okay. Thanks, John. Tim, one follow-up on that. Could you remind us of the mechanics by which the higher servicing income can work its way through the income statement and why didn't – it didn't seem like we saw any of that start this quarter with the big move into 10-year. What will trigger kind of offsetting balance on the servicing side where the income then will see that start to rise?

Timothy J. Sloan

Yeah, John points out over time I think that there is some balance in the business on the revenue side because of the fact that servicing income tends to be a little bit less volatile. We should see some benefit in terms of servicing income increasing as the housing industry continues to improve. As we pointed out, we did reduce the value of this servicing for some elongation of some foreclosure timelines. Over time that will dissipate. And then we'll continue to get the carry in the underlying servicing income. Our hedge ratio is pretty high, so it's not like we're vetting the farm on or the stagecoach on an increase in rates in the servicing portfolio. We'll see some benefit there, but I think it's also really important to remember that there will also be some expense trade-offs in the mortgage business itself. If it turns out that originations are down, then it's immediately in the quarter if you get a benefit from the revenue-based compensation, the commissions coming down and then to the extent that that volume continues, then you also make adjustments that tend to be on a lag basis, on a quarterly basis in terms of some of your other expenses.

John McDonald - Sanford Bernstein

Are you starting to make those adjustments based on what you're seeing in the pipeline and the outlook given rates?

Timothy J. Sloan

John, we're making adjustments all the time. The fact of the matter is we entered the quarter with actually a pretty strong pipeline of $63 billion which was only down 10%, 15% from the end of the quarter. But there's no question that to the extent that we continue to see a decline in the pipeline that we will make adjustments. And so you can assume that we will begin to make some of those adjustments this quarter.

John McDonald - Sanford Bernstein

Got it, okay. Thanks.

Timothy J. Sloan

Thank you.

Operator

Our next question comes from the line of Erika Penala with Bank of America.

Erika Penala - Bank of America Merrill Lynch

Good morning.

John G. Stumpf

Good morning, Erika.

Erika Penala - Bank of America Merrill Lynch

My first question is a follow-up to John's last. We heard another mega bank today say that if loan rates stay where they are that the mortgage market could shrink to 30% or 40% in the second half of the year. Do you agree with that statement for your company, given what you’re seeing in purchase trends? And additionally, could you quantify if that number is correct? How much of the expenses can come up proportionate to that 30% to 40% decline?

Timothy J. Sloan

Yeah, it’s a fair question. I don’t think anybody really knows what the volumes in the mortgage business are going to be. I think one of the challenges for anybody in making that estimate today is that the complexion of the originations is really changing. When you look at the percentage of refi volume versus purchase money volume that we had in the first quarter of this year for example, it was about 1/3 purchase money and about 2/3s refi volume.

As the housing industry continues to improve and as we’ve got it – went into the spring selling season, you saw that mix shift in sales was more like 55, 44, 45 or whatever and what that means is that a larger portion of your originations are coming from the purchase portion of the business. So, I think it is a fact that refinance volume is certainly very much impacted by rates, but also we’re seeing now rates at the long end start to come down 10 basis points just in the last few days and so we don’t think – we don’t know for sure where volume is going to be. We believe it's going to be lower in this quarter and one of the things that we’ve learned in the mortgage business is, it's probably not a good thing to think, six months out or nine months out because there can be so much variability.

We think volumes going to be down, but whether it’s going to be 30% to 40%, I just don’t know. As it relates to expenses, again, the timeline generally is that the revenue based compensation declined immediately and then to the extent we have a continued origination reduction, then you bring – you start to reduce some of your expenses that tends to occur on a lag quarter basis. But at the end of the day we still believe that we can continue to have good margins in the business and to keep the efficiency ratio above where it is, because also remember that one of the other important things that’s going out into business, if you got an improvement in the underlying housing industry so that your environmental related costs hopefully will coming down including foreclosures at the same time.

John G. Stumpf

One of the thing that – I know that we should not forget now we went through this a lot – many times, but we have 6,200 stores, 30,000 or 40,000 personal bankers that refer business in, so when rates rise and its more of a purchase money business we have all folks on deck helping serve customers. And we still have tons of our customers who are interested in buying homes and moving and so forth who are our customers, but do their mortgage business in other places. So we have still lot of opportunity to capture purchase money business, which is still not at the levels it was, pre-prices. So, there is lots of activity going on there. Surely, the refinance volume is going to come down significantly, if rates continue to stay at high. But as Tim mentioned, I don’t know what rates will be. 90 days ago we wouldn’t have talked about what we’re talking about today. Things change very quickly in this business.

Timothy J. Sloan

Yes, Erika, let me reinforce again. As you think about the third quarter, and you think about the volume that we’ve seen over the last couple of years, we’ve been very fortunate to see quarters in which volume is been above the $100 billion. We just don’t think that we’re going to see $100 billion in mortgage volume, given the current rates today in the third quarter.

Erika Penala - Bank of America Merrill Lynch

Got it. Speaking of how Wells benefit as housing recovers, I know that you’re frustrated by the obsession on your margin. But as I think about slide 26 in your deck, it seems like you have $876 million of reclassification to accretable yield and $1.6 billion of additional expected cash flows that could be helpful to your margin over time. Should we think of the pick-a-pay portfolio similar to how we think about reserve relief for the entire company in that as housing gets better, you could release some of the markets into net interest income which would benefit or alleviate some of the concerns on margin.

Timothy J. Sloan

There is no question that, that the key drivers for the improvement in the – or the reclassification or housing prices as well as the underlying credit performance within that portfolio and those are very similar to the drivers for the improvement that we’ve seen in our first mortgage portfolio and our home equity portfolios.

In terms of the impact, I’d love to tell you that when – if you re-class the 876, we get an immediate impact, that’s not the way it works. It occurs over the life of the loan. There will be some positive impact and you’ve seen that and I’m hopeful if the current trends continue, and this isn’t the last time that we seen a reclassification, I can’t promise you that it's going to be the case. But it will provide some positive benefit over time. But again, we’ve got to make sure that we put it in the right context because our best estimate is the weighted life of that portfolio is still about 14 years.

Erika Penala - Bank of America Merrill Lynch

Okay. Got it. And just, if I could sneak one more in, just a clarification follow-up to John’s question on the LCR. Your cash balances keep growing, but in other calls you’ve mentioned that you have – something like $50 billion of excess cash. Is that true still, relative to how we should think about Basel III LCR compliance? And I guess, if the main message is potentially the cash back until continue to build from here?

Timothy J. Sloan

Yeah, I think that the challenge we all have including where we’re in terms of the liquidity coverage ratio is the rules haven’t been finalized. If you would tell me what the final rules are, then I could tell you whether or not we’re too much or not enough for the write or whatever. What I do know is that we believe that we have additional ability based on how we’re running Wells Fargo based on our interpretations of the LCR to invest some of our liquidity in securities, but more importantly we have it ready for our customers when they want to borrow money. That doesn’t mean that we made – now that raise liquidity, when some of the rules are finalized. But we don’t believe and we believe that, that’s possible to do without a significant impact or material impact in terms of running the company. But again, I think it will be premature to conclude what the final rules like – look like because they haven’t been finalized.

Erika Penala - Bank of America Merrill Lynch

Okay. Thanks for taking my questions.

Timothy J. Sloan

You’re welcome.

Operator

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

Matt O'Connor - Deutsche Bank

Good morning.

John G. Stumpf

Good morning, Matt.

Matt O'Connor - Deutsche Bank

Hopefully just a couple of quick ones here. You mentioned the trust investment fees, good strength in both the brokerage and investment banking, which of course you now split out. On the broker side, is that just the higher market levels or are you seeing some inflows there as well? I did notice that the deposits in that segment were down a couple of billion, so I’m just wondering if there is some flows coming into the brokerage area?

Timothy J. Sloan

Well I think it’s all the above, Matt. There is no question that we’ve been benefited as everybody in the industry has been benefited by the improving market, the improving equity markets and the fact that retail investors want to be part of that business. We did see some movement from deposits to investing in the market. We think that’s a good thing. We’ve been waiting for that for a while, but we also grew our customer levels too.

John G. Stumpf

And Matt the other thing, this is a big emphasis for the Company. David Carroll and his great team are working with Carrie Tolstedt and her team and Dave Hoyt and within the company this is a one Wells Fargo working together. So not only the markets help us, we’re also putting a big emphasis on this. We think it’s a big growth opportunity for this Company.

Matt O'Connor - Deutsche Bank

And then, just separately on the mortgage servicing rights, I know you’ve talked about potentially testing the waters to sell and sorry if I missed it, but did you sell any this quarter and thoughts going forward in terms of potentially selling them. I would think they’re worth a little bit more now than two months ago?

Timothy J. Sloan

We hope that’s the case Matt. I think that as you know we entered into a transaction to sell our – a portion of our reversed mortgage portfolio in the first quarter. We didn’t have any sales of MSRs this quarter. But we will continue to look at selling MSRs, we think that’s prudent risk management that the primary driver for doing that is not because we feel like there is pressure as it relates to capital. But I wouldn’t be surprised if we moved forward and executed a sale of MSRs this quarter and next.

Matt O'Connor - Deutsche Bank

Okay. That's it for me. Thank you.

John G. Stumpf

Thanks, Matt.

Operator

Your next question comes from the line of R. Scott Siefers with Sandler O'Neill.

John G. Stumpf

Hi, Scott.

Timothy J. Sloan

Hi, Scott.

R. Scott Siefers - Sandler O'Neill

Good morning. John, I guess I was just hoping you could expand kind of generally on the comments you made in your prep remarks early on about the housing market. I guess what I'm thinking about is high rates impact affordability but you certainly seem pretty optimistic about the prospects for the housing market and continued improvement. So what trends are you seeing generally, particularly I guess most recently just since you guys see so much of the mortgage and customarily the housing market that makes you keep this sustained optimism?

John G. Stumpf

Sure. So first of all, I think I had mentioned before that we look at 400 or so MSAs, Metropolitan Statistical Areas, and we have a unique and pretty grounded way of seeing real estate across the country. And the deal, it's better everywhere or going on – in some cases two years surely in the past year and it's been stronger in some places than even probably we had expected. Some of the states that were hardest hit, Nevada, Florida, Arizona, California, are showing huge or very large price appreciation kinds of numbers. Also if you look at – and yes, rates have gone up but if you were in the mortgage market before 2000, you know that these are unbelievably good rates. My first mortgage was at 8.5%, my second one was 11.5% and I thought those were great rates at the time. So affordability still is there, household formation continued to happen in the last four or five years where people weren't buying, so there's a lot of pent-up demand. The three important issues to a home purchase what you make, what the house costs and what's the financing costs? One of those is still close to 40, 50-year record lows compared to rental. Owning a home makes economic sense. It surely depends on where you want to live and how long you want to live there and so forth. So there is just strength there. And it improves customer confidence. The thing I hear most about when I'm out in the marketplace is the lack of inventory. So we are expecting that prices will continue to improve, probably not at the level they have in the past but housing sure has strength to it. So I don't know what's going to happen to rates all the time but when housing improves, it's good for Americans, it's good for competence and which in turn is good for the financial services industry and Wells Fargo.

R. Scott Siefers - Sandler O'Neill

All right, I appreciate the color. And then I guess, Tim, sort of along the same lines. You're consumer credit improvement, I guess we kind of knew would improve. I think the magnitude was probably a little better than I would have anticipated. If we were to say stay at this sort of level of housing, I mean is there a point where you need continued improvement to impact the sustainability of such strong consumer trends or are we there yet or how are you thinking about that dynamic?

Timothy J. Sloan

Yeah, I think it's a fair question, Scott. The underlying trends that in fact John referred to are still improved. And so it's hard to imagine improvement not continuing. Whether it continues to improve at the same rate, I don't know. I think we've continued to be surprised by how housing has positively impacted our results. I think also it's important to remember that particularly when you think about the reserve release that there were some overwriting factors that impacted the reserve release over the last few quarters including the fact that we had the OCC guidance that impacted the third and fourth quarters of last year and also the potential for the impact from the damage of Hurricane Sandy that's been working its way through the system. But again, I think the fundamentals for housing are strong. We have a large first mortgage and second mortgage portfolio that tends to be the portfolio where we have the disproportionate share of our losses even though they improved, the consumer losses improved just a touch over 1% this quarter. So we're feeling pretty good about the improvement.

John G. Stumpf

Scott, I'll just add one more thing. Housing is uniquely different than any other consumer asset class. When housing improves, people feel better. I mean two-thirds of Americans or so own a home. When housing improves, it improves the confidence. People spend more. The multiplier effect on buying washers and dryers and other consumer goods is just – it's just very special around housing. So when housing gets better, it really lifts all [bolts] on the consumer side.

R. Scott Siefers - Sandler O'Neill

Okay. Well, guys, I definitely appreciate the help. Thank you.

Timothy J. Sloan

Thank you, Scott.

Operator

Your next question comes from the line of Ken Usdin with Jefferies.

Ken Usdin - Jefferies & Company

Thanks. Good morning, guys.

John G. Stumpf

Hi. Good morning.

Ken Usdin - Jefferies & Company

First question, Tim, that other income line that you talk about the equity method and less PCI loan sale gains, that lines up into 450 million to 500 million for the last several years. Is there anything particular that happened this quarter and is there anything that would prevent it from kind of going back to that more normal run rate?

Timothy J. Sloan

Yeah, good question. It's really not what happened, it's what didn't happen this quarter. The comparison in the first quarter and the primary drivers for the decline were – we had an equity investment that we accounted for under the equity method and as you know, when those appreciate in value as opposed to the cost method you have to go ahead and write up the value, which we did in the first quarter. Just so you know, we actually sold that equity investment so we got the cash in the second quarter. Then secondarily we had $151 million gain which we had called out in the first quarter from the sale of some PCI loans that again were in the first quarter that we just didn't have in the second quarter. So I think it's more of what was missing in the second quarter than what occurred. So I don't know what's going to happen in the third quarter but I think if you look over a long period of time, the income from that line item being as low as it has been is not typical.

Ken Usdin - Jefferies & Company

Right, okay. And then secondly, the share count again was up and you guys had talked about that we might be getting towards the point where we finally start to see it reduce and I'm just wondering, are we at that point and what needs to happen just with the [mix] to finally start getting the share count down?

Timothy J. Sloan

We were almost at that point this quarter. That's one of the reasons why I called out the fact that the timing of the settlement from a structured sale had that occurred in the second quarter and it's going to occur relatively early in the third quarter, we would have been about flat. Notwithstanding the second quarter tends to be a quarter in which there's more share issuance as we called out. I don't know exactly what's going to happen but my guess is that we're very close to the point at which we will start to see share reductions.

Ken Usdin - Jefferies & Company

Okay. And then on the mortgage business, the pipeline was down but you guys had mentioned last quarter that your closing times had gone down from 90 to 60. I'm just wondering how much of a market share opportunity is this, because it doesn't sound like you've really cut capacity yet. So could you just walk us through originations versus pipeline and how much more you're actually just pumping through the channel regardless of what's happening with the overall origination volumes in the marketplace?

Timothy J. Sloan

Yeah. Well, one of the reasons why we haven't made a lot of changes in terms of underlying business is that the increase in the rates only happened a few weeks ago and we had a large pipeline that we were working through. As you saw originations in the second quarter were a lot stronger than I think anyone would have imagined. So I think that's going to naturally begin to change because even through $64 billion is a great place to start, it's definite $63 million, it's definitely less than $79 million. And so our guess is that volume and originations will be under the $100 billion mark and we’ll need to go ahead and make some adjustments, but again I think the competitive atmosphere is really fierce, but it's very rational.

Ken Usdin - Jefferies & Company

Okay and my last question Tim, with regard to your favorite slide. Your big delta in provision this quarter and you’re talking about the mortgage banking revenue now is starting to turn from here. So, I know it's hard to say in any given quarter if you could actually be able to grow EPS a quarter ahead, but can you just talk us through again it's hard to see the provision much more and we know that mortgage is kind of tailing. So what do you expect to be the biggest drivers out of the net maybe the other income reverting back up to kind of continue to get that net income moving the right way.

Timothy J. Sloan

Yeah, it's a very fair quarter given the potential decline in mortgage revenues but again let’s make sure we put that in perspective. Mortgage revenues are a little over 10% of our total revenues for the company, that’s number one. Number two, when you look at the breadth of the growth in the company in terms of net interest income growth you saw loan growth, you saw us take advantage of the fact that given the right back up we will invest it more in securities. We haven't invested this much in securities in a long time right even when that we say the backup in the first quarter. When you look at the non-interest or the fee revenues really across the board we saw growth with the exception of some of those areas that were affected by the back up in rates so there’s a good story there. I don’t necessarily think this is the end of the improvement in credit because the factors continue to -- that are driving the improvement in credit haven't bottomed down. And then I think it's likely that we’ll continue to see some improvement in expenses. So when you put it all together, I don’t think it's just one time if it was I’d tell you and you could decide whether or not it would make sense, but the good news for us because of our diversified model we don’t have to rely upon one or two specific areas to be able to make up because make up or decline in any business we’ve seen declines in some of our businesses each quarter now for the last 14 quarters and we still have been able to grow whether or not we can do it in the third quarter I can’t promise you that, but I sure do like our chances to continue to grow earnings over time.

Ken Usdin - Jefferies & Company

Got it.

John G. Stumpf

Tim is absolutely right in that, I mean we are actually focused around here on growth, and it comes from our basic operating philosophy around helping customers succeed financially. And when you’re in 90 different businesses as Tim mentioned not every quarter would be a complete offset to one other one, but over time we believe we have the right business model, the right leaders, the right markets to continue to grow this company and we sure like our chances on that.

Ken Usdin - Jefferies & Company

Thank you very much guys.

Timothy J. Sloan

Thank you.

John G. Stumpf

Thank you.

Operator

Your next question will come from the line of Paul Miller with FBR.

John G. Stumpf

Hi, Paul.

Paul Miller - FBR Capital Markets

Thank you very much. How you guys doing? Just one follow-up question on the MSRs, you talked about you could see some sales; would these be material sales in MSRs I mean what level of MSRs would you like to hold?

Timothy J. Sloan

We’re very comfortable with the level of MSR that we have today. Having said that from a risk management standpoint it's prudent to investigate the sale of any of the assets that you have on the books, whether it's MSRs or otherwise. I think to the extent that we would move forward to sell MSRs we would focus on those MSRs that tend to be to a customer that only has one product that mortgage that we service with the company; that would be where the primary focus would be. I don’t necessarily think it would material because we don’t think we have to do it, but it sure does make sense given the volatility in interest rates to look at all your assets and make sure that you know how to and can execute on sales before you’d ever get to a position that you would have to do it.

John G. Stumpf

Yeah Paul think of it this way, I wouldn’t make more of this than it is, I mean we have a very large and important servicing business. We love that business from time-to-time opportunistically we’ll sell something and reposition, but we like the bounce and we like that business a whole lot.

Paul Miller - FBR Capital Markets

And then on the credit side, I believe your reserve ratio is down around 2%. What do you think you can take that down to with your improvement in credit and improvement in HPI?

Timothy J. Sloan

We don’t have a target, it's a fair question but we don’t have a target, it was 2.01% at the end of the quarter. It's going to be what it's going to be based upon the improvement in the underlying credit trends. I wouldn’t be surprised if it was below 2% the next quarter I mean that’s a possibility. It could be a little bit higher, it could be a little bit lower, but there’s not a specific target that we have because it's really just the results of their underlying credit performance.

Paul Miller - FBR Capital Markets

Okay. Hey, guys thank you very much.

John G. Stumpf

Thank you.

Timothy J. Sloan

Thank you.

Operator

Your next question comes from the line of Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets

Thanks, good morning guys and congrats on a solid quarter.

John G. Stumpf

Thank you, Joe.

Timothy J. Sloan

Thanks, Joe.

Joe Morford - RBC Capital Markets

I guess as you mentioned that the economic data continues to improve with last weeks employment report and the strengthening housing recovery and while you talked about a multiplayer effect, are you seeing much of a pick-up in activity yet at the customer level as well and when might we see this translate into stronger loan growth particularly on the commercial side.

Timothy J. Sloan

Yeah, the primary area’s that we’re seeing and take a hold is on the consumer side. You saw our consumer loans, again we need to back out the impact of the liquidating portfolio but we saw auto growth, we saw credit card growth which was very nice. We’re continuing to see growth in terms of this household formation that’s out there and that allows us to continue to grow deposits, so all those are good trends. There’s no question there’s going to be a bit of a lag effect as it relates to stronger commercial loan growth. Our commercial loan growth again has been pretty strong, which is now the I think the 10th consecutive quarter that we -- wholesale in total has grown and certainly in certain segments and industries within the wholesale portfolio we’re seeing some good growth, but my guess again it will be a quarter or so before we start to see a big pick-up.

Joe Morford - RBC Capital Markets

So you’re not really seeing customers draw down cash at or really make more investments.

Timothy J. Sloan

No. I wish they were but unfortunately not. When you look at line usage in the commercial side it's been pretty stagnant for that.

John G. Stumpf

And you’re right Joe, that happens first. Yes – that’s typically the first thing that happens.

Joe Morford - RBC Capital Markets

And then just on investment banking revenue is up strong from the first quarter. Can you just talk a little bit more about the drivers there and maybe if you could just give an update on the business in general and how it's progressing in market share gains and things like that?

Timothy J. Sloan

Yeah overall the business is performing very well, the primary drivers for the growth wasn’t necessarily in any one specific product type within the business and it was very, very much focused on our existing customer base. The fees were up 40% year-over-year, most of that again was with our existing commercial and corporate customers. I think our market share at the end of the quarter ended up at about 5.8% which was fine. We’re not running that business for any sort of market share, we’re running that business to be able to be there for our customers when they need us and when you look at the growth in the business and the fact that it's primarily focused on those customers it's performing quite well.

John G. Stumpf

Yeah, Joe to add something to that, I make a lot of calls in that area on behalf of our team, and these are existing customers for the most part. They appreciate the skill set and the abilities we have in that business especially if we partner with our retail distribution platform. So we make a compelling offer and our long-term customers appreciate that added service that we have for them.

Joe Morford - RBC Capital Markets

Okay. Thanks very much.

Timothy J. Sloan

Thanks, Joe.

John G. Stumpf

Thank you.

Operator

Your next question comes from the line of Mike Mayo with CLSA.

Michael Mayo - CLSA

Hi.

John G. Stumpf

Hi, Mike.

Timothy J. Sloan

Good morning, Mike.

Michael Mayo - CLSA

I am trying to get just a real simple answer and that is, I heard what you said John about the improving housing market and that was helpful, but the question is; are the benefits in the improving housing market already in the numbers of Wells Fargo and my Column A based on what you said are some headwinds the origination pipeline down 10% to 15% repurchase reserves are all pretty low gain on sale going down and the Column B or perhaps in tailwinds, expenses perhaps going down from the workout costs, in the mortgage platform, the MSRs and the credit. So which is greater; Column A or Column B? And John, in your opening remarks, you said, well, benefits – your grammatical tense was the present tense and I think Tim at one point said Well Fargo benefitted the past tense. So does Wells Fargo still benefit in their bottom line results from the improving housing market or is it all in the numbers?

John G. Stumpf

Yeah, here's the way I look at that, Mike. When housing gets better, it's better for Americans, it's better for the country and that accrues – we had a commitment to residential real estate and commercial real estate for that matter in those companies, because that's what our customers want us to buy. I can't tell you if it's – what's going to happen in the next quarter, but I can tell you this. An improving housing market will benefit customers and us because we're at the end of the day a reflection of our customers. So the benefits are yet to come. It might come in different line items. You're right, if rates rise there will be less refinances. We've been there before, but it also means improved credits, it means improved confidence. Customers start small businesses. We're a big/small business bank. Environmental costs go away. So I would take that trade all day long in improving housing market even if it means less refinances because rates are rising at the same time, that's fine.

Timothy J. Sloan

Mike, the only other thing I would add is I don't think you have enough columns on your sheet of paper. We have 90 different businesses, right? We are not just a – if we were just a mortgage company, then I think the columns and the items that you pointed out would have been absolutely spot on, right? But this is a portion of our business, it's a great business, terrific people, we're helping customers succeed all the time in that business, but we have 90 other – or 89 other businesses in this company that are continuing to grow and you can see not only this quarter but over the last year that many of the businesses have been growing not only as it relates to net interest income but also to noninterest income. So, again, who knows what's going to happen in the third quarter but over time this diversified model is very helpful when you have one business where revenues might be coming down.

Michael Mayo - CLSA

And if I can speak to our language, so I guess you'd say there's 90 horses pulling the stagecoach and as the mortgage horse is slowing down, potentially slows down although it's certainly been stronger for longer, which of those other 89 businesses do you think are most able to pick up the slack?

John G. Stumpf

All of them. It's not just one, Mike.

Timothy J. Sloan

That's what exciting, right? If there was just one, actually we'd be worried about it. But whether – it's a nice analogy. That would be quite a stagecoach that we would have but the mortgage horse has been a big strong horse, right? We've got 89 other horses that are going to be to grow. And again, just look at the numbers this quarter to get a feeling for – we called 10 to 12, there's even more as you pour through the numbers in terms of performance.

John G. Stumpf

We talked in last couple of quarters about how we think we have an opportunity in credit card. I mean we are seeing great increases there. Look at the Wealth, Brokerage and retirement business, now these are not all one horse offset the other horse but when you have a whole team out there, the key is keep the coach running and we like that diversity.

Michael Mayo - CLSA

And last follow-up, just in case the other [NII] businesses don't pick up the slack right away as JPMorgan said on its call earlier that you can't slow down a mortgage but a lag in the expense takeout. Can you just remind us of the expense flexibility that you have outside of mortgage?

John G. Stumpf

We still think there is opportunity on expenses here and I think Tim mentioned that earlier in the call. So as you mentioned on the mortgage side, first of all there is the commission base, so that happens immediately. And then we are very good at sizing the business based on what's going on. We've done that many times. But in other businesses we – for example, we started something called the neighborhood store with 6,200 stores. We opened that first one in Washington D.C. and that operates at 40% less costs of the same functionality. There are tons of opportunities like that; paperless ATM receipts and nickels and dimes in the corners that all add up at the end of the day in addition to the environmental costs.

Michael Mayo - CLSA

All right. Thank you.

John G. Stumpf

Thank you.

Timothy J. Sloan

Thank you, Mike.

Operator

Your next question will come from the line of Nancy Bush with NAB Research, LLC.

Nancy Bush - NAB Research

Good morning, guys.

John G. Stumpf

Good morning, Nancy.

Nancy Bush - NAB Research

I promise I'm not going to ask mortgage banking questions. First, there's been a lot of press around this issue of the kiosk branch that you're introducing, I think, in New York City. Could you talk about that a little bit and whether this signals some sort of broader experimentation with branch types throughout the network or is this something specific to New York?

John G. Stumpf

Well, eventually is Washington D.C. but – so let me tell you first of all, we have about 6,200 stores and the stores have been relatively flat in numbers. And there is a lot of discussion today about in our industry whether stores are still relevant. We think they're enormously relevant even to our millennial customers. And store usage and channel usage frankly is based on many times age, affluence and activity. And when we talk with our customers, even the millennial visit our stores once every year or six months or sometime and places where they go to open their first account, it's where people go. If they can't, they'll go probably any place else and it's a place they take good money in if they come into a trust fund that runs out of whatever the case may be. But here's the key. As long as our customers tell us that destination distribution like a store is important, we're going to built it for them and we're going to have stores. Will they need them? Will they want them? And that's important to growing deposits, to selling products and services to them. If we ever get a time where they say it's not important, then we'll jump that way also. So since stores are important, how do you make them more efficient and how do you build them in a way that allows for the convenience they want, the availability they want but also under the cost structure that makes sense. The neighborhood store we had, it's about 1,000 square feet. During the daytime, it's a full functioning store. It happens to be paperless, it happens to have the cash there is contained within machines that can check down to the dollar. And after hours the [walls] fold in and it's an ATM vestibule. So you can get the best of both. This is a test and learn. We've done a lot of testing and learning around here and in many of those densely populated marketplaces, you can't rent a facility of 5,000 square feet. A 1,000 all you can get, so that makes it available to you. So if this works, we'll do more. It doesn't work, we've got nothing. This is only one test. We have lots of tests going on.

Nancy Bush - NAB Research

But at this point, it's an additive strategy. It wouldn't be where you would take existing branches that are sort of "more normal branches" and change them to traditional additive strategy at this point?

John G. Stumpf

Yeah, it's additive but it might be a replacement strategy for certain stores. In fact, some of what we're doing today is taking two stores and building a new one and consolidating into two depending on customer flows, depending on customer needs. We are a retailer, so most retailers that I respect are always looking at their distribution footprint and model but the long and the short of it is we believe in the store concept but – I mean when I first got in the industry, we had the operations in the second floor and the boardroom on the bottom floor, in the basement. We had to change since that time and still continue to change.

Nancy Bush - NAB Research

Am I right in assuming that the breakeven on these things is like weeks or a few months?

John G. Stumpf

Well it depends on the activity in the store and the activity with customers. Five years ago the breaking was very different than it's today, customers borrowed more.

Nancy Bush - NAB Research

All right.

John G. Stumpf

It's a different margin on borrowing versus depositing. But I wouldn’t say in weeks or months but it's about 40% reduction in cost is the same functionality, that’s a big deal.

Nancy Bush - NAB Research

All right. Second question is this, your improvement in cross-sell from 6 to 6.14 and your ongoing improvements in cross-sell, is this primarily one product, two products, I mean is there sort of still a quote, lead product you guys have that sort of lead the cross-sell?

John G. Stumpf

Yes, it's checking accounts. That’s why when I wake up in the morning I get here, the first thing I look at is the checking account report from the day before. I love checking accounts, I dream about them. I just -- because …

Nancy Bush - NAB Research

John, you’ve been in the business too long, I am sorry.

John G. Stumpf

It's because it's the formational account for a consumer. And the second probably most important is mortgage, and that’s why we’re almost -- we’re obsessive about that, about serving customers.

Nancy Bush - NAB Research

Yeah, and just finally one quick thing and I probably already know what the answer is but I have got to ask it anyway, given that there has been yet one more attempt at Glass Steagall, break them up, you obviously big, you’re bigger now than you were before the financial crisis blah, blah, blah I mean are you -- I would assume that you would be in this group of break them up banks, and I guess my question is, what could you be broken up into?

John G. Stumpf

Well, Nancy this is America, people are free to express their opinion, and that’s one of the beauties of this country. And yeah from my perspective we're thoroughly in the real economy. I mean what we do is to serve customers. Small business, large business, commercial real estate customers, consumers and virtually everything we do has a customer on the other side of it. We take a deposit in, we don’t put it into a vault and (indiscernible) we put it to work. We make consumer loans, commercial loans, small business loans, loans to ranchers and farmers and energy companies and that’s what we do, and that’s proprietary. I mean that’s putting, because we have to manage those kinds of risks, I understand that. I don’t understand how serving customers broadly and deeply including helping them with a public offering whether it be debt or equity, somehow it makes us riskier or weaker or puts depositors at risk more so than making a loan. But I understand that the dialogue, you got to realize the capital that’s been raised, the discipline around risk of all kind is far different than it was just a few years ago. I am proud of this company and proud of what we do and I know that we are helping this economy to recover, to heal and we’ll do all we can do that.

Nancy Bush - NAB Research

Thank you.

John G. Stumpf

Thank you.

Operator

Your next question comes from the line of Andrew Marquardt with Evercore.

John G. Stumpf

Hi, Andrew.

Andrew Marquardt - Evercore Partners

Good morning, guys.

John G. Stumpf

Good morning.

Andrew Marquardt - Evercore Partners

Just a couple of [tiki-tak] questions, first on expenses, environmental costs have come down significantly the last couple of quarters. Is there a lot more room to go from there, I know you had mentioned that, they were not at all behind us, but I seem that we won't go to zero on a lot of these, some of this will be ongoing costs when I’m looking at your Page 13 on your slide deck, how much room should we really think about is left to go?

John G. Stumpf

I don’t know the exact answer to your question Andrew. I think it's a fair question because as you point out we’ve made a tremendous amount of progress over the last few quarters. I don’t think, so if you just pick two items for example, foreclosed asset expenses which were $146 million in the second quarter, that doesn’t feel to me to be the run rate that we would settle in. Could it go up, it could go up or could go down, but I think over time there still is some room for that to decline. And then also I think the contra revenue item that we had which was the MSR servicing and foreclosure cost impact. Again the primary driver there is continued foreclosure timelines in certain judicial foreclosure states, primarily New York and New Jersey and over time that will I think begin – we will continue to moderate. So, I think those in particularly probably little bit more room to run. But you’re correct, the rate of increase is going to slow down.

Andrew Marquardt - Evercore Partners

Okay, okay. That’s helpful, thanks. And then secondly, back to liquidity, just want a clarification, because you had mentioned in an earlier comment about how you may need to raise some additional liquidity. Is that related to the LCR or is that related to the consideration of other things in terms of the OLA additional bailing debt considerations that are out there? Because when we look at LCR, we have you guys in a pretty healthy range of 120 to 140 depending on how you calculate it. So I was just a little surprised by that comment.

Timothy J. Sloan

Well, I think that’s – you hit the nail on the head with your last comment and that it's hard to calculate the answer when you don’t really know what – that all the variables are going to be. We think that we have more than sufficient amount of liquidity be able to operate Wells Fargo, we’ve been able to demonstrate that through some pretty significant downturn. The rules might change a little bit. If that’s the case we have to make some adjustments to the balance sheet, if we do that. That’s fine. We will adjust to that. But it's not that the onset of finalizing the Basel III LCR and any of the interpretation that might occur from our domestic regulators is not impacting the way that we’re running the business today. Meaning that we’re not – we don’t have some money to satisfy that we can’t lend to our customers or we can’t invest in securities because we’re too concerned about that and there is a lot of moving parts. And again, we’re going to we are – we will comply with whatever the final rules are, we will do that in an appropriate timeframe. But it’s not a limiting factor for the Company today.

Andrew Marquardt - Evercore Partners

Got it. And what is the constraining factor when we should think about excess liquidity and the ability to deploy more into securities or loans or what have you? What is the sense that’s …?

Timothy J. Sloan

It is economic growth and the rate of loan growth and when we think about the recovery, as we talked about, we continue to be in a recovery that had to adjust to a tremendous amount of headwinds and it's been from our perspective remarkably resilient, but our loan growth would be a lot stronger as we were at 3% GDP level or 4% GDP level, which is about what I think everybody expected a few years ago when we started to come out of the downturn it’s primarily loan growth, less today in terms of investment, less today rates. That was a big limiting factor for us a year-ago and nine months ago and three months ago for that matter, less today for sure rates, because rates are more attractive today.

Andrew Marquardt - Evercore Partners

Got it. That’s helpful. Thanks.

John G. Stumpf

And the beauty of it, borrowing does start, I mean that – those costs are already embedded. We already have those approved. I mean that’s just all revenue then.

Andrew Marquardt - Evercore Partners

All right. Got it. That’s helpful. Thanks.

Timothy J. Sloan

Thank you.

Operator

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

Timothy J. Sloan

Hey, Betsy.

John G. Stumpf

Hey, Betsy.

Betsy Graseck - Morgan Stanley

Hey, good morning. Couple of questions. One on page 26, you got the PCI accretable yield slide and you indicated the weighted average life is 14.5 years there. So that’s up from last quarter where I think it was like 12.3 or something like that. And I am just wondering what is behind driving that up?

Timothy J. Sloan

A couple of things. One is just that we have a general improvement in the underlying portfolio and the delinquency in the portfolio has come down little bit. So the expectation according to the model is that customers are going to stay in their homes longer. We could be – I mean it could be though that you could reach a point whereas you continue to see home values increasing, that it could reach a point where those customers maybe more comfortable and able to sell their homes or even to refinance and that would begin to bring the average life down. But I wouldn’t read into that change any big change in our assumption during – like that is very variable on a quarter-to-quarter basis.

Betsy Graseck - Morgan Stanley

Okay. But you are basically saying credit quality is improving and that’s why the weighted average life is extending?

Timothy J. Sloan

Yes.

Betsy Graseck - Morgan Stanley

Do you have anything at all in there for prepays, or it’s not rate related at all?

Timothy J. Sloan

No, we definitely do. I mean that's part of the – it's one of the important variables within the model. But again, personally I think that prepaid are going to accelerate over time as values continue to go up, but we haven't seen that yet in the performance level but I think logically it could.

Betsy Graseck - Morgan Stanley

Okay. And which would shorten duration and pull in the PCI a little bit faster?

Timothy J. Sloan

Correct.

Betsy Graseck - Morgan Stanley

Okay. And then secondly, HPI going up significantly in the most recent quarter, it's this level of housing value hold for the rest of the year. How much is that going to be impacting your loan growth? And I know the question's been asked a couple of different times but I guess the real question is, do you feel that the current value of housing price is in Q2's numbers or is there more to come from the HPI improvements that we've seen this quarter?

Timothy J. Sloan

We tend to use a lagged function and we tend to be a little bit more conservative. I mean we're not going to take for example the housing price, the 13% that John mentioned what we've seen year-over-year and assume that's going to continue forever, right? And so you got to be very careful with that. I think we've been and I think the entire industry and the market's been positively surprised at the level at which housing prices have – how resilient they've been, how much they've grown and the percentage that they've grown. So again, I think that we've seen some nice improvement and our expectation is that we're very positively leveraged to home prices. And so we could see some improvement from the results that you see here in the second quarter.

Betsy Graseck - Morgan Stanley

I'm just thinking in particular about home equity, because that to me seems like the area where you should have some of the sharpest swings as HPI has gone up so much recently over the next couple of quarters. But I don't know if that's a fair assessment given…?

Timothy J. Sloan

Betsy, I think you're absolutely right and maybe using the word leverage is maybe even more appropriate there when you think about the impact to a home equity portfolio which the majority of our home equity portfolios are junior leans. To the extent that you got a portion of that that's above 100% home – increasing home values really, really impacts that portfolio.

Betsy Graseck - Morgan Stanley

So are you seeing much in the demand and the origination pipeline for that product yet, or is it too early?

Timothy J. Sloan

I think our home equity originations were up year-over-year but I don't think they were necessarily up significantly from the first quarter. It's a good product. It's underwritten very well today. It's one of the many products we provide. It's a slight uptick but it wasn't one of the drivers for the home equity – or our loan growth we would have called it out.

Betsy Graseck - Morgan Stanley

Got it. Thanks.

Operator

Your next question comes from the line of Chris Mutascio with KBW.

John G. Stumpf

Hi, Chris.

Chris Mutascio - Keefe, Bruyette & Woods

Good morning, John. How are you?

John G. Stumpf

Hi, Chris.

Chris Mutascio - Keefe, Bruyette & Woods

Tim, I had a quick question for you. I'm going to go all the way back to the first question today and I can't promise what Nancy promised. It will be a mortgage question. When you look at the servicing side of the business and how it flows through the income statement, the servicing asset has – the MSR has been written up about $3 billion in the last couple quarters and yet the servicing income is still kind of stuck in that $300 million to $400 million range per quarter. So in order for that natural hedge to fully take hold, if indeed we see a material, and that's my assumption, but a material decrease in refinance activity, do you have to start lessening up on the hedge on the MSR for that to flow through to the income statement and more so than it has?

Timothy J. Sloan

If you wanted to create a natural hedge, you would have to reduce your hedge percentages and then when you're doing that, you would potentially create a lot more interest rate risks – not potentially, you would create a lot more interest rate risks for the company. And we just don't think that that's a prudent thing to do. So I think historically when the business was smaller than it is today, it might have been a little bit more – we might have more flexibility to do that. That doesn't really make sense to us today. So, our hedge ratios are relatively high, which is one of the reasons why you're not seeing one-for-one offset. There will be some benefit there's no question about that. And I think one of the key benefits of the servicing portfolio over time is that the quality of what you're servicing continues to increase because you continue to originate better quality mortgages that are going to pay for a longer period of time and you don't have as much foreclosure impact. I think that in terms of comparing our servicing results over the next few quarters with what we've experienced in the last few quarters, most of the reduction that you've seen has been related to foreclosure elongation and things like that and we're hopeful that that's going to dissipate. But I would not look for the MSR dollar-for-dollar offset and any reduction in revenues from the origination side of the business. There's some natural relation but it's not one-for-one.

Chris Mutascio - Keefe, Bruyette & Woods

And just one quick follow-up. I think John had mentioned or I think both of you mentioned potential MSR sales going forward. And I think, John, you had mentioned – I don't want to put words in your mouth, but maybe there would be kind of one-off type portfolio similar to the reverse mortgage sale recently. Would the pickup paid portfolio be included as a one-off potential sale, in terms of MSRs?

John G. Stumpf

Well, that one we own. I mean we own the asset there. So I wouldn't look for that area per se. I don' want to give guidance here, but I think what you should take away from this is that we like the MSR business. We think it's critical to – well, we not only like it because of the business itself but because of the cross-sell we do out of it. And that we will sell from time to time opportunistically. I think Tim mentioned that we might look at something that has a single product household kind of dynamic here, but we're always looking in all of our businesses is an opportunity here to monetize something that might be more valuable someone else to us, sure, we'll look at that. I won't go for a big change here.

Chris Mutascio - Keefe, Bruyette & Woods

Right, thank you very much.

Operator

Your final question will come from the line of Chris Kotowski with Oppenheimer.

Chris Kotowski - Oppenheimer

My question was asked. Thanks.

John G. Stumpf

Okay, thank you. Thank you much and I know we've run over time a little bit but thank you all for joining our call and we appreciate your interest and your coverage in Wells Fargo. See you next quarter. Thank you much.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you all for participating and you may now disconnect.

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