Hello, this is Bob Strickland. Thank you for participating in the Wells Fargo third quarter
2009 earnings review prerecorded call.
Before we discuss our third 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 our future financial results and condition, including statements about future nonaccruals, loss content and cash flows from the legacy Wachovia impaired non-impaired loan portfolios, expected credit losses and credit performance generally and in specific loan portfolios, the adequacy of our allowance for credit losses, future levels of nonperforming assets, future levels of capital, the timing and amount of expected merger one-time expenses, cost savings and business and revenue synergies related to the Wachovia merger and other initiatives, and our ability to generate revenue growth and earnings.
These forward-looking statements are based on our expectations, and they are not guarantees of future performance. They speak only as of the date they are made, and we do not undertake to update them to reflect changes that occur after that date. Actual results may differ materially from expectations due to a number of factors, including our ability to successfully integrate Wachovia and realize the expected cost savings and benefits from the merger. There is no assurance that our allowance for credit losses will be adequate to cover future credit losses, especially if credit markets, housing prices and unemployment do not stabilize or improve. For a discussion of factors that may cause actual results to differ materially from expectations, refer to our SEC filings, including the Form 8-K filed today, which includes the press release announcing our third quarter results, and our First and Second Quarter 10-Qs and our 2008 Annual Report on Form 10-K, each available on the SEC’s website at sec.gov.
In this call we will also discuss our Tier 1 common equity and related capital ratios, as well as pre-tax, pre-provision profit. For more information about these measures refer to our third quarter earnings press release, which is accessible on our website, wellsfargo.com, by clicking on “About Us,” then “Investor Relations,” then “Quarterly Earnings.” We have also posted on our website a third quarter 2009 supplement that provides additional information on our loan portfolios and businesses.
I will now turn the call over to CFO, Howard Atkins.
Thanks, Bob. I have a lot of ground to cover in my comments so I want to give you up-front the three key author’s messages about our third quarter.
First, we continued to generate earnings and capital at a record rate in the third quarter despite cyclically elevated credit costs. The main reason is that our diversified business model continued to generate very strong revenue as it has in other environments. Quarterly revenue net of expenses was once again this quarter more than double our quarterly net charge offs, a positive margin of $5.7 billion. We have increased shareholders equity by $23 billion since the merger and have exceeded the SCAP requirement by a wide margin.
Second, Wachovia is already additive to Wells Fargo’s earnings and capital growth, earlier and better than originally anticipated. Revenue synergies have been significant. Expense savings from the consolidation are on track for $5 billion annually by the end of 2011 and we now expect substantially lower merger and integration costs. Credit costs in the aggregate are in line with our expectations at the time of the merger with cumulative Pick-a-Pay losses now expected to be less than originally projected.
Third, we are seeing signs of stability in our credit portfolio and based on our current economic outlook, we expect credit losses to peak in 2010 with consumer losses potentially peaking in first half of the year and gradually declining as the year progresses. We have substantially less exposure to credit cards than our peers with large, national credit card portfolios. Where we do have large exposure, in commercial and commercial real estate, we are comfortable with how the legacy Wells Fargo portfolios were underwritten and are performing and we have previously written down the Wachovia portfolios at close of that acquisition late last year.
Let me elaborate on these three points. Wells Fargo once again achieved record earnings in the third quarter despite elevated credit costs. Our $3.2 billion net income was our third record quarter in a row. We have earned more than $3 billion in each quarter in 2009. Year-to-date earnings in 2009 a record of $9.5 billion were up 75% from a year ago indicating our company’s ability to absorb higher credit costs over the cycle.
After deducting preferred and common dividends, cumulative retained earnings so far this year were $6.9 billion, the main reason we are generating capital internally at a very fast rate. In combination with other internally generated sources of capital and with two of the largest non-IPO offerings of common stock in history, we have more than doubled the company’s equity since before the merger late last year.
There are three main reasons our earnings have been so consistently strong. The first relates to our business model, the second relates to the benefits we are already seeing from the Wachovia consolidation and the third relates to how we manage credit. The key driver of our earnings is revenue. Our third quarter revenue was $22.5 billion, equal to the record revenue we generated in second quarter, and our pre-tax pre-provision profit, total revenue less noninterest expense, was $10.8 billion, a record for the company. Wells Fargo’s revenue was about 92% of the average revenue of the other largest banks in the U.S. even though we are only about 60% of their size based on average assets.
In fact our revenue per dollar of assets, 7.2% before expenses and 3.4% after expenses, is significantly and consistently greater than any of the other three largest U.S. banks. In the third quarter we produced pre-tax, pre-provision profit that once again was more than double our quarterly credit costs. At a time when many U.S. companies are struggling for sales, Wells Fargo had record sales in the third quarter. This is because we are gaining new customers, increasing the number of products sold to existing customers and increasing market share. Core product sales, for example, at legacy Wells Fargo regional bank were 6.84 million in the quarter, a record and up 10% from last year on a comparable basis.
Retail bank cross-sell was 5.90 products per household, a record, and wholesale cross-sell was 6.4 products. The Wells Fargo revenue machine is a direct consequence of the breadth and depth of our diversified business model and our singular focus on earning all of our customers’ financial business. That focus has generated strong and consistent revenue growth over the last 20 years. In any given period some of our businesses are affected differently by the economy or interest rates and some, like insurance, are seasonal, but in combination they tend to produce exceptional revenue.
While mortgage originations and servicing revenue remained high in the third quarter, total mortgage banking noninterest income represented less than 15% of consolidated company third quarter revenue, reflecting the breadth and depth of the Company’s business model. In the third quarter we had linked quarter double digit annualized revenue growth in asset management, auto lending, consumer finance, debit cards, retirement services, SBA lending and wealth management.
Let me highlight some of the key business drivers of our revenue and earnings growth in the third quarter. We have had great success growing deposits and accounts throughout the credit crisis. Combined average checking and savings deposits increased 11% annualized from second quarter and are up 16% annualized since the first quarter, in part due to the conversion of higher rate CDs into lower rate liquid deposits. Checking and savings accounts now represent 83% of total core deposits. Deposit and account growth has been strong across our customer segments.
Consumer checking accounts were up a net 5.2% overall and a net 6.4% at legacy Wells Fargo from prior year. We continued to experience strong consumer checking account growth in California, still our largest deposit state, with a net 9% increase in consumer checking accounts. Core deposits in our Wealth, Brokerage and Retirement business grew 10% annualized and wholesale core deposits grew 25% annualized. We continued to supply credit to U.S. consumers and businesses with over $547 billion of new credit extended to customers through the third quarter this year.
Wells Fargo has extended more credit than any other bank in the U.S. this year through August 2009, including mortgage securities purchased. Because non-mortgage loan demand has been soft so far this year and since we originate conforming mortgages for sale, our significant credit extended has not translated into an increase in assets on the balance sheet but it has boosted loan-related fee income.
Mortgage origination fees of $1.13 billion were up $849 million from a year ago and charges and fees on loans were $453 million, up 70% from last year and up 12% annualized from second quarter. In wholesale banking we continued to add new customers and do more business with existing customers. In a slower economic cycle, commercial loan demand is naturally weaker, but when the economy recovers and loan demand resumes, we will benefit from these additional customer relationships and the deeper relationships we have with our current customers.
Trust and investment fees were up 15% annualized linked quarter, including strong growth in managed account fees, consistent with market trends, and modest growth in brokerage transaction revenue, overcoming typical seasonality. Client assets in our wealth, brokerage and retirement business continued their year-long growth reaching $1.2 trillion this quarter and up 8% from second quarter. Retirement plan assets increased 9% to $271 billion and IRA assets also rose 9% to $231 billion.
Wells Fargo is now the third largest U.S. wealth manager based on client assets and the second largest based on number of financial advisors. The average productivity of our 21,500 registered financial reps has increased each quarter with new financial advisors more productive on average than displaced advisors. This large productive group of financial advisors across the U.S., branded as Wells Fargo Advisors is quickly becoming an important new distribution channel for banking products since the 21,500 advisors nationally have access to and are already selling Wells Fargo’s suite of deposits, trust and other banking products.
Card fees grew 10% annualized from second quarter. Unlike many of our peers, our credit card business remains profitable despite elevated credit losses, which actually were down slightly from second quarter. Consumer spending continued to be dampened by the economy with fewer big ticket purchases in the third quarter resulting in a decline in average transaction size on both debit and credit cards. At the same time, consumers are increasingly using their debit cards for everyday items such as gas and grocery purchases, which is helping to increase overall card volume.
Linked quarter purchase volume on cards was up 22% with the majority of the growth from legacy Wells Fargo debit cards, increased volume from Wachovia debit and credit cards and Wells Fargo Financial. Global Remittance Service is another consumer payments business that continued to generate strong household and volume growth. Transaction volumes were up 22% year-to-date while dollar volume growth increased 5% over the same period. With the Wachovia merger, our presence in the primary U.S. geographies that send remittance payments to Latin America has increased from 54% to 88%. This business is also benefitting from a new online option that supplements the current store and phone bank distribution channels.
The auto business continued to benefit from industry trends, gaining market share in both the new and used car space while simultaneously improving credit quality. Revenues grew 12% annualized from the second quarter. The popular Cash for Clunkers program generated record monthly auto originations of $1.5 billion for August. The loans originated under this program have been high quality with higher levels of cash down and better customer credit scores than existing auto loans in our portfolio. While auto losses typically rise during the second half of the year, losses in our core indirect auto portfolio were actually down slightly from second quarter reflecting the benefit of higher used car prices, with the Manheim Used Car Index at record levels.
We also benefitted from an improved customer mix within our portfolio and the tighter underwriting standards we put in place at the start of this credit cycle. Student lending provided increased lending opportunities and growth in our customer base. We have successfully transitioned our student loan business to leverage opportunities in private student lending across the expanded Wells Fargo footprint. Private loan originations are up 10% year-to-date compared with 2008, driven by seasonally strong third quarter back to school volume.
Originations of government student loans increased 14% over the same time period. Wells Fargo Home Mortgage once again generated strong results in the third quarter benefiting from their business model’s balance between originations and servicing. Origination revenue was down in the third quarter as volumes declined from very high first and second quarter levels, while servicing revenue was up. Total revenue for this business was down modestly in the third quarter from second quarter. Total originations of $96 billion in the third quarter were strong, although down from second quarter.
Lower mortgage rates early in the fourth quarter are currently driving strong application volume, which was up 36% in the first 10 business days of the fourth quarter compared to the same period in the third quarter although the pace of applications will obviously depend on mortgage rates since about 70% of this activity was refinance related. With a 33 basis point decline in mortgage rates during the third quarter, we wrote down the value of the MSRs by $2.1 billion, which was more than offset by economic hedge gains of $3.6 billion.
The economic hedges once again generated solid carry income reflecting the low rates in the third quarter which we expect to continue in the fourth quarter. Future hedge results, of course, will also depend on the amount of servicing that is hedged and the composition of the hedging instruments. The ratio of MSRs to loans serviced for others was 83 basis points at quarter-end, down from 134 basis points a year ago and the third lowest ratio in our company’s history. The average servicing portfolio note rate was only 5.72%. The second key message is that we are seeing a contribution to earnings and capital growth from Wachovia that is occurring earlier and better than originally anticipated.
We are on track to achieve the originally targeted $5.0 billion of annual run rate savings upon full integration which we still expect by the end of 2011. After having begun to consolidate the two banks in the three quarters since we have owned Wachovia, we are now beginning to realize about 1/3 of these savings on a run rate basis. We have very detailed plans to achieve the balance of the savings over the next two years as the systems integration and store conversions are completed in 2011. We now estimate we will spend approximately $5.5 billion in merger costs compared with our previous $7.9 billion estimate.
The projection has been lowered primarily because we are achieving greater proportion of the labor cost savings through attrition rather than severance and because the cost of disposing and/or subleasing owned office space has turned out to be lower than assumed. Of this $5.5 billion, we have spent $1 billion; $559 million through goodwill under purchase accounting and $444 million expensed to earnings including $200 million in the third quarter. A portion of the remaining merger costs will be taken through purchase accounting adjustments to goodwill in the fourth quarter with the balance of the merger costs to be taken as expenses over the next two years.
We will report on these expenses each quarter and we believe these expenses will likely be offset by merger related savings over the next two years leaving us with the full benefit of the $5 billion annual savings once the integration is completed. Our first banking state conversion, in Colorado, is coming up next month. After Colorado we will continue to convert our other overlap markets followed by the non-overlap markets. Once the conversions are complete, we will offer unmatched convenience for our 70 million customers, with similar products on a common system nationwide.
While the banking store branding and system conversions remain ahead of us over the next couple of years, much has already been accomplished in terms of preparing for the conversions and rebranding other major businesses such as Wells Fargo Advisors, Wells Fargo Securities, Wells Fargo Mortgage and Wells Fargo Insurance, as well as beginning to instill legacy Wells Fargo’s sales practices into the new part of our banking franchise. As a result, the cross sell ratio at legacy Wachovia increased to 4.65 in the third quarter, up from 4.55 in the second quarter.
When we priced the Wachovia merger we assumed no revenue synergies but of course revenue synergies are occurring daily. Let me give you four examples of the many areas where synergies are already occurring. In the securities business we are actively marketing Wachovia’s securities placement capabilities to the combined companies’ expanded base of corporate and commercial relationships to win more and more lead and co-lead bond and equity mandates and fees. Wells Fargo always had commercial and corporate customers who needed access to the capital markets.
With the Wachovia merger we now have an outstanding investment banking business to meet our customers’ debt, equity and advisory needs. Parenthetically, this is another great example of how having a diversified model provides revenue in all environments. One reason commercial loan demand has been soft this year is because commercial borrowers are accessing the public markets for financing instead of drawing on their bank lines. Having the securities placement business helps us remain in the flow of our customers’ financings, whether they borrow from the bank or borrow directly from the capital markets.
The 21,500 financial advisors I mentioned earlier opens up an entirely new and significant source for offering Wells Fargo products and services and we are actively making it very efficient for those advisors to be able to access all of our banking product platforms. These financial advisors already contribute to our mortgage originations and deposit growth. To give you some idea of the potential, the 21,500 base of financial advisors compares to over 28,000 platform banker FTE’s throughout our regional banking network.
A third example of revenue synergies with Wachovia would be government and industrial banking, which helps meet the financial needs of government, education, healthcare and tax-exempt organizations by offering credit, treasury services and investment banking solutions. Legacy Wells Fargo had many customer relationships with local and state governments within our community banking footprint and we had recently began to develop a team to better meet their needs. With the Wachovia merger we now have an integrated model providing seamless coordination and delivery of services to this customer base.
Throughout the economic downturn, we have continuously provided credit for government and institutional clients nationwide and have increased loan commitments by 14% since the beginning of the year and the final example of revenue synergies with Wachovia would be Global Financial Institutions and Trade Services, which provides global correspondent banking services, such as payments and trade solutions, trade and working capital financing and deposit products to 1,450 international banks, 2,200 domestic banks and 30 multilateral institutions from 42 locations around the world.
This business is benefiting from the improvement in global economic activity, which drove payment and trade fees up 8% annualized from second quarter and core deposit growth up 13% from second quarter. The combination with a smaller but complementary Wells Fargo team brings new foreign exchange and deposit capabilities to bank clients but more significantly the combined global financial institutions business offers a highly developed network of strong and experienced partner banks enabling every Wells Fargo customer to connect to the world. We are on track, if not ahead, in terms of reducing Wachovia’s credit risk.
We have dealt with this in several ways. At merger closing we built significant reserves for credit losses including conforming credit loss emergence practices to the more conservative practices of Wachovia and Wells Fargo. Second, through purchase accounting we wrote down the higher risk segments of Wachovia’s loan portfolios including the portion of their commercial real estate portfolio with the highest probability of default. Unlike other banks that have yet to incur losses on the highest risk portions of their loans, we have already accounted for these losses.
Overall we believe our life of loan loss estimate originally assumed still holds, with commercial a little higher and Pick-a-Pay lower. In the third quarter we added $184 million to reserves for impaired commercial and commercial real estate loans.
Based on our most recent estimates, life of loan losses for Pick-a-Pay are expected to be below original expectations and accordingly we now expect to add modestly to accretable yield for Pick-a- Pay going forward. Third, Wachovia securities portfolio and trading assets were already at fair value at merger closing, but we wrote off the unrealized losses in OCI as a reduction in the carrying value of these assets. If anything, the unrealized value of these assets has improved significantly since the acquisition closed due to the subsequent decline in long-term yields and recovery of credit spreads.
Fourth, we have also eliminated risk by reducing balances, the identified high risk portfolios of commercial real estate, indirect auto and Pick-a-Pay have been reduced by $5.7 billion linked quarter through write-downs, modifications and sales.
Let me now turn to credit. We provide a lot of detail on our individual loan portfolios in our quarterly supplement which is available in the investor relations section of our website which you should refer to for our detailed analysis of credit performance this quarter. I want to spend my time on the call highlighting a few key credit trends and portfolios. While credit losses and NPAs increased again this quarter, the rate of increase slowed and we have seen signs of stabilization in several consumer loan portfolios.
Consumer loans 90 days past due actually declined $140 million from second quarter and total loans 90 days past due, excluding insured GNMA loans, was up only $8 million, essentially flat. The loss rate in the third quarter for legacy Wells Fargo was 3.37%, below large bank peers. Our overall loss rate of 2.5% reflects the benefit of purchase accounting on Wachovia’s higher-risk loan portfolios at year end. Legacy Wells Fargo net charge-offs were relatively flat from the second quarter reflecting lower losses in commercial and commercial real estate and slightly higher losses in consumer.
Wachovia’s net charge-offs increased to 1.66% of average loans due to some deterioration in its portfolios and the lagging impact of purchase accounting. The increase in commercial and commercial real estate losses in Wachovia’s non-impaired portfolio reflects the lagging impact of purchase accounting with the overall loss rate in the third quarter for Wachovia’s portfolio roughly comparable to Wells Fargo’s high quality portfolio. Over 40% of the increase in Wachovia’s consumer losses came from the non-impaired Pick-a-Pay portfolio, reflecting the lagging effect of purchase accounting.
We expect credit losses to peak in the first half of next year in our consumer portfolio and later in 2010 in our commercial and commercial real estate portfolios absent further deterioration of the economy. Nonaccrual loans were up again this quarter, although at a slightly lower growth rate. Purchase accounting for Wachovia’s loans has resulted in some anomalies in our nonaccrual growth rate.
Here’s one way to think about this. At year end 2008, Wachovia had $20 billion of nonaccruals that were eliminated at closing due to purchase accounting for credit impaired loans. Since then, about $14 billion of the estimated life of loan losses we reserved for under purchase accounting have actually been charged to the non-accretable difference rather than charged off against loans.
If we were to add back the $20 billion in Wachovia’s nonaccruals to the reported nonaccrual total, nonaccruals would have grown from $27 billion at December 31, 2008 (including legacy Wells Fargo nonaccruals) to $41 billion at September 30, 2009. That’s before reducing the September 30, 2009 nonaccruals for a substantial portion of the $14 billion in charge-offs that would have reduced the ending nonaccrual balance. So in effect we believe purchase accounting had a significant impact on the nonaccrual growth rate this year and the impact of the credit deterioration in nonaccruals has actually been less significant than what is implied by our reported growth rate.
The $2.7 billion increase in commercial and commercial real estate nonaccrual loans in the third quarter was down from the $3.1 billion increase in the second quarter. Nonaccrual commercial loans in Wells Fargo’s portfolio were up only $777 million. Wachovia’s growth rate slowed and the $1.9 billion increase in commercial and commercial real estate from second quarter reflects some deterioration in the portfolio, but is in line with expectations post purchase accounting and is reflected in our allowance for credit losses. 50% of the total increase in commercial nonaccruals was from five large relationships and 70% of the increase was driven by four industries (real estate-related services, nonbank financials, media and gaming).
The rate of growth in consumer nonaccruals also slowed with the increase in legacy Wells Fargo’s consumer portfolio only $606 million from the second quarter and the increase in Wachovia’s consumer portfolio was primarily driven by the Pick-a-Pay portfolio. The growth in Pick-a-Pay nonaccruals reflected the inflows expected after purchase accounting write-downs. We continued to be active in modifying Pick-a-Pay loans through the use of troubled debt restructurings, which are expected to temporarily keep nonaccrual levels elevated until the modified loans can demonstrate performance.
Let me highlight three of our loan portfolios. Our $23.6 billion credit card portfolio is only 3% of total loans, significantly less than other large bank peers. Our credit cards are sold primarily to our retail banking customers. We have not focused on being a large national credit card company. The smaller relative size and relationship focus of our portfolio is one reason we now believe our total consumer losses will peak in first half 2010. In fact, the loss rate on our credit card portfolio, while still elevated from historical norms, was actually down slightly from second quarter.
Our $135 billion commercial real estate portfolio, down $2.6 billion from year-end, is larger than our peers, but is well diversified by property type and geography. As expected, losses throughout our CRE portfolio have increased from historically low levels. However, we also believe that our relationship focus and prudent credit discipline build inherently higher quality into the CRE loan book compared with the rest of the industry. Our commercial real estate portfolio is primarily originated through two key channels. $79 billion are in the Wholesale Banking Group, which originates both larger and more complex CRE loans in our Real Estate Banking Group as well as loans to medium-size customers in our Middle Market Real Estate Group and our Commercial Banking Group.
Within Wholesale Banking, the CRE portfolio, which includes C&I loans managed by the Commercial Real Estate Group, can be broken into three portfolios, the portfolio originated at legacy Wells Fargo and two portfolios originated at Wachovia, one credit impaired and one non-impaired. The $34 billion CRE portfolio that was originated at legacy Wells Fargo is led by a seasoned and experienced management team that has worked together for decades including through the troubled commercial real estate market in the early 90s. Underwriting in this portfolio is focused primarily on cash flows and creditworthiness of the borrower, not solely on valuations. Losses in this portfolio actually decreased from second quarter to 1.30%, down from 2.80%.
The majority of Wachovia’s CRE portfolio is managed by a dedicated specialty group focused on mitigating risk and losses utilizing a variety of asset restructuring, disposition and workout strategies and includes the $31 billion of Wachovia originated commercial real estate loans that were not credit impaired. The loss rate on this portfolio is increasing as expected from the extremely low level earlier in the year post purchase accounting.
The third quarter loss rate on this portfolio was in line with the loans originated at Wells Fargo with a third quarter loss rate of 1.28%. The $12 billion of loans originated at Wachovia that were included in the credit impaired portfolio are also being managed by the dedicated specialty group. While the loss rates on the impaired portfolio have been significantly higher than our core wholesale CRE portfolio, they are generally performing as we had anticipated. Charge-offs in this portfolio were $143 million in the third quarter. Since this is an impaired portfolio, resolutions to assets which would normally be reflected as loan loss recoveries are accounted for as either net interest income or non-interest income.
These recoveries totaled $64 million in the third quarter. Therefore the economic net loss on this portfolio was only $80 million, or 2.63%. The $39 billion of CRE loans originated through the Regional Business Banking Group have a smaller average loan size of approximately $600,000 and are geographically diverse. Approximately half of these loans are owner-occupied. The loss rate on this portfolio in the third quarter was 1.28%.
The other portfolio I would like to highlight is the Pick-a-Pay portfolio. We are very encouraged with the performance to date of the Pick-a-Pay portfolio and actually expect lower life of loan losses than we would estimated at the time of merger for both the credit impaired and non-impaired portfolios.
Due to our improved current outlook, beginning in the fourth quarter we expect to recognize a modest yield increase in our impaired portfolio, recapturing a portion of the life of loan purchase accounting marks through net interest income. While the housing market, unemployment and the economy levels will affect future performance, let me explain why we are optimistic about the future performance of this portfolio.
First, we have been actively modifying these loans and have completed nearly 20,000 full-term modifications in the third quarter and over 43,500 modifications year to date, modifying 22% of the loans in the impaired portfolio. Nearly 98% of the modifications completed have decreased the payment materially for the customer, which we believe is the key driver of success. All modifications are re-underwritten, income is verified and the negative amortization feature is eliminated.
For the modifications we completed earlier this year, our re-default rates after six months have been less than half the 41% re-default rates for industry modifications with a comparable amount of seasoning. But, we acknowledge it is still very early in the lives of these modifications and we will continue to report on performance going forward.
Second, we have continued to reduce the size of the Pick-a-Pay portfolio to a total of $87.8 billion outstanding, down $2.6 billion from second quarter and down $7.5 billion from year-end. This decline reflects loans paid in full, loss mitigation efforts and the fact we are not originating any new loans in this portfolio.
Third, while this portfolio is called the Pick-a-Pay portfolio, only 74% of it is Pick-a-Pay loans which have negative amortization potential, down from 86% at year-end, a $22 billion reduction. So, not all loans that we include in our Pick-a-Pay portfolio are pay option loans with negative amortization potential.
Fourth, deferred interest balances declined for the second consecutive quarter due to the combination of lower interest rates and the impact of gradually increasing minimum payment requirements, as well as our modification programs. In September, approximately one-third of the customers who chose to make the minimum payment did not defer interest. While customers’ minimum payments have continued to increase annually, market interest rates have decreased and many customers are at the point where their minimum payment not only covered the interest due, but paid down some principal as well. We expect this trend to continue.
Fifth, the stabilization in the outlook on home prices in certain markets where we have significant exposure benefits the expected performance of the portfolio. Finally, we have observed improvements in delinquency roll rates compared to projections earlier in the year. As you would expect, our non-impaired and impaired Pick-a-Pay portfolios are very different. The non-impaired portfolio has shown stronger credit characteristics. Let me explain the key differences.
The average loan size on the non-impaired portfolio is $227,000, versus $326,000 in the impaired portfolio. A significant portion of the non-impaired portfolio was originated prior to 2006 with an average age of loans of 5.5 years, versus 3.5 years in the impaired portfolio. 49% of the non-impaired portfolio is in California, compared with 68% of the impaired portfolio. The non-impaired portfolio includes a large subset of loans that would be expected to have minimal losses even if they were to go into default with 36% of the portfolio having an updated CLTV of less than 80%.
Our Pick-a-Pay portfolio continued to perform better than the industry. Recent data released by the OCC indicates that as of June 30, 2009, 25% of all industry option ARM loans are at least 60 days past due while only 17% of our portfolio was 60 days or more past due, with most of these loans in the impaired portfolio. These delinquency rates demonstrate, what we have always believed, that our option ARM portfolio is of better quality than the rest of the industry.
Finally, I want to update you on our most recent analysis of the impact of the application of FAS 166 and 167 which is expected to result in the consolidation of certain off-balance sheet assets currently not included in our financial statements. We provided a preliminary analysis in our second quarter 10-Q. Based on our continued refinement of this analysis we now expect approximately $55 billion in incremental GAAP assets to be brought on balance sheet representing approximately $28 billion in incremental risk-weighted assets. This latest analysis is lower than we originally projected primarily due to a reduction in the amount of securitized residential mortgages that will be consolidated.
In addition, we continue to explore the sale of certain interests we hold in securitized residential mortgage loans which would further reduce the amount of incremental GAAP assets and incremental risk-weighted assets. In summary, while the economic recovery continues at its own pace, we are forging ahead and playing to our strengths. One year after the merger agreement with Wachovia was announced, we generated record earnings and capital as we benefit from a diversity of businesses, many of which produce countercyclical performance, and help create sustainable growth in all cycles.
We are seeing a good contribution to revenue from Wachovia as we make progress in laying the groundwork for a nationwide platform to provide the utmost in service and convenience for our 70 million customers. We are seeing signs of stability in the credit portfolio and currently expect credit losses to peak in 2010 with consumer losses potentially peaking in the first half of the year and gradually declining as the year progresses absent further economic deterioration. We are exhibiting strong expense discipline, and bearing the fruit of prior expense initiatives as well as merger efficiencies. We have generated, once again, an industry-leading net interest margin, at 4.36% and we have continued to strengthen the balance sheet, build credit reserves and reduce risk on our balance sheet.
This is our last recorded call. Wells Fargo has always been committed to providing clear, complete, and transparent communication about the company’s results to all of its stakeholders. As we enter the second year of the merger with Wachovia, we will be expanding our quarterly communications to include a live quarterly earnings conference call starting in January for our Q4 and full year 2009 results and we will also host an Investor Day in 2010.
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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