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Wells Fargo & Co. (NYSE:WFC)

Q2 2014 Earnings Conference Call

July 11, 2014 10:00 AM ET

Executives

Jim Rowe - Director, Investor Relations

John Stumpf - Chairman, President and Chief Executive Officer

John Shrewsberry - Senior EVP, Chief Financial Officer

Analysts

John McDonald - Sanford Bernstein

Joe Morford - RBC Capital Markets

Erika Najarian - Bank of America, Merrill Lynch

Ken Usdin - Jefferies

Mike Mayo - CLSA

Betsy Graseck - Morgan Stanley

Matt O'Connor - Deutsche Bank

Keith Murray - ISI Group

Brian Foran - Autonomous Research

Moshe Orenbuch - Credit Suisse

Paul Miller - FBR Capital Market

Chris Mutascio - KBW

Nancy Bush - NAB Research, LLC

Andrew Marquardt - Evercore Partners

Operator

Good morning. My name is Regina and I will be your conference operator today. At this time, I would 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 would 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 and good morning everyone. Thank you for joining our call today where our Chairman and CEO, John Stumpf and our CFO, John Shrewsberry will discuss second quarter results and answer your questions.

Before we get started, I would like to remind you that our second quarter earnings release and quarterly supplement are available on our website at wellsfargo.com. I would 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 a 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 will now turn our call over to our Chairman and CEO, John Stumpf.

John Stumpf

Thank you, Jim, and good morning to everyone. Thank you for joining us today. The second quarter was another strong quarter for Wells Fargo. We earned $5.7 billion in the quarter by our continued focused on creating long-term shareholder value to meeting our customers' financial needs including growing loans and deposits and deepening our relationships with our customers.

Let me highlight our growth during the second quarter compared with a year ago. We generated earnings of $5.7 billion, up 4% from a year ago and earnings per share up $1.01 per share, up 3% from a year ago. We had strong and broad based loan growth and our core loan portfolio is up $51.3 billion or 7%. Our credit performance continued to improve with total net charge-offs down $435 million or 38% from a year ago, and our net charge-off ratio was only 35 basis points annualized on average loans. Our outstanding deposit franchise continues to generate strong growth. With total deposit up $97 billion or 9%. We've grown deposits by an average of $265 million everyday over the past year. We deepened relationships across our company. Retail banking cross-sell was 6.17 products per household. Wholesale banking cross-sell was 7.2 products and wealth, brokerage and retirement cross-sell was 10.44 products. We reduced expenses from a year ago while we continue to invest in our businesses including strengthening our risk management infrastructure.

We also follow through our commitment to maintain strong capital ratios while returning more capital to shareholders. In the second quarter we increased our common stock dividend by 17% and continued to reduce our share count. We returned our net $3.6 billion to shareholders in the second quarter, up significantly from $1.6 billion a year ago. I am also proud that during the second quarter Wells Fargo was ranked the most respected bank in the world and the 11th most respected company overall according to Barron's Magazine 2014 ranking of the world's most respected companies. This recognition is a result of our dedicated team members remaining focused on our consistent vision and their commitment to meeting our customers' financial needs.

While the economic recovery remains uneven, there are many indicators that economic growth is accelerating and we remain optimistic about the opportunities the recovery provide to Wells Fargo and for our customers. The strong improvement employment in June demonstrated the strength in a labor market with unemployment at lowest level since September 2008. The housing market rebound remained on-track with home prices up 8% from a year ago and up 25% from the low in June 2011. Despite these increases home affordability continued to remain attractive due to historically low mortgage rates and rising household incomes. In June, the conference board's measure of consumer confidence reached a six year high and vehicle sales reached an eight year high. The economy is also benefiting from strong energy production with domestic crude oil production running at the highest level in 26 years and our reliance on foreign energy sources has been falling for nearly a decade.

I am confident that the economic recovery and our diversified business model will continue to provide opportunities for future growth as we remain focused on helping our customers meet their financial needs.

Now John Shrewsberry, our CFO will provide more details on our second quarter results. John?

John Shrewsberry

Thanks, John. And good morning everyone. My comments will follow the presentation included in the quarterly supplement starting on Page 2. John and I will then answer your questions. Wells Fargo had a very strong quarter as demonstrated by fundamental drivers of long-term growth. We earned $5.7 billion in the second quarter; down a $167 million from the first quarter but keep in mind our results last quarter included a $423 million discrete tax benefit and $0.08 per share impact. Our pre-tax income grew $303 million from the first quarter. Revenue grew from first quarter including both net interest income and noninterest income. Core loans grew 8% annualized and average deposits grew 9% annualized. We grew pre-tax, pre-provision profit for the third consecutive quarter and credit quality continued to improve. Capital remains strong and we returned more capital to shareholders. I will highlight the drivers of this growth throughout the call today.

As John highlighted and as you can see on Page 3, we had strong year-over-year growth in loans and deposits. Our growth in EPS and net income reflected this benefit along with the reduction in expenses and an improvement in credit quality. Our results were driven by momentum across many of our businesses. One way to demonstrate this business momentum is through noninterest income growth. Mortgage fees while up from first quarter were down $1.1 billion from a year ago due to lower refinancing volume. Excluding mortgage fees, fee income was up 9% from a year ago reflecting broad based growth in retail brokerage, deposit service charges, card fees, commercial real estate brokerage commissions, trust and investment management, merchant processing and market sensitive revenue. That's the benefit of our diversification. We have over 90 businesses focused on meeting our customers' financial needs. We also grew net interest income from a year ago. And as you know growing net interest income measured in dollars has been our focus as deposits and other sources of liquidity have growth more rapidly than loan demand or other attractive investment opportunities.

Page 4 highlights our revenue diversification. While our balance between net interest income and noninterest income has been consistent, the drivers of noninterest income can vary each quarter. For example, equity investments were 9% of our fee income in the first quarter but declined to 4% in the second quarter. Other businesses such as deposits, investment banking and mortgage contributed more to fee income this quarter resulting in overall fee income growth demonstrating the benefit of diversified business model.

Let me highlight some of the key drivers of our second quarter results from a balance sheet and income statement perspective starting on Page 5. Our balance sheet is never been stronger, capital liquidity, asset quality, funding mix are all exceedingly strong. We increased average earnings assets by 3% from the first quarter by growing loans, increasing short-term investment in trading assets and purchasing securities. In addition, our credit quality continues to improve. Investment securities increased $8.7 billion from first quarter reflecting $17 billion of purchases primarily U.S. Treasuries and federal agency debt partially offset by run off. We also improved our liquidity position in response to continued heightened regulatory expectations. We issued $7.8 billion of liquidity related long-term debt and increased liquidity related short-term funding by $5.9 billion. Total short-term investments grew to $238.7 billion which helps us meet our regulatory obligations and provides dry powder to grow loan and invest in securities.

Turning to the income statement on Page 6, revenue grew $441 million with growth in both net interest income and noninterest income. The $246 million growth in noninterest expense was primarily due to higher revenue based incentive compensation and deferred compensation expense and an increase in operating losses primarily from litigation accruals related to various legal matters. I'll explain the drivers of our expenses in more detail later on the call.

Income tax expense increased from the first quarter which included $423 million discrete tax benefit. As shown on Page 7, we continue to have strong, broad based loan growth in the second quarter. Our 12th consecutive quarter of year-over-year growth even with the continued reduction in our liquidating portfolio of $56.5 billion over the same time period. Our core portfolio which excludes our liquidating portfolio grew by $51.3 billion or 7% from a year ago and was up $15.2 billion or 8% annualized from the first quarter. Period end loans were up $29 billion or 4% from a year ago and up $2.5 billion from the first quarter. This growth was impacted by the transfer of $9.7 billion of government guaranteed student loans to held for sale which removes them from total loans. These student loans have been included within our liquidating portfolio since we stopped originating them in 2010. We transferred this portfolio to held for sale at the end of the second quarter reflecting our intent to sell our entire government guaranteed portfolio. However, we remained committed to the private student lending business. Excluding this transfer, total loans would have increased to $12.2 billion or 6% annualized linked quarter.

On Page 8 we highlight how broad -based our loan growth continues to be at Wells Fargo. C&I loans were up $19.4 billion or 10% from a year ago as we successfully grew loans across our commercial businesses including asset backed, corporate, government, commercial and asset based. Real-estate 1 to 4 family first mortgage loans grew $7.3 billion or 3% with growth in high quality nonconforming mortgage primarily jumbo loans. Foreign loans grew $6.2 billion or 15% from a year ago reflecting growth in trade finance and the U.K. Commercial Real Estate acquisition we completed in the third quarter of last year. Auto loans were $5.5 billion or 11% reflecting strong origination as we remained the number one auto lender in the country while maintaining our focus on pricing for risk. Commercial real estate loans were $4.4 billion or 4% reflecting new origination and an acquisition in the third quarter of last year. Credit card balances were $2.4 billion or 10% with new accounts up 4%. Our growth rate has been above the industry average reflecting new account growth, product enhancement and increased usage among our existing customers. Deposit growth also remained strong in the second quarter with average deposits growing $91.7 billion or 9% from a year ago and up $24.2 billion from the first quarter, up 9% annualized. Average deposits totaled $1.1 Trillion and we benefited from strong growth in both commercial and consumer balances. Our average deposit cost declined to 10 basis points in the second quarter, down 1 basis point from the first quarter and down 4 basis points from a year ago. Our ability to generate strong deposit growth while reducing deposit cost demonstrated the fundamental strength of our outstanding deposit franchise. We have been able to grow deposits by offering best in class products and excellent customer experience and robust multi channel option. Our primary consumer checking customers were up 4.6% from a year ago. Our ability to grow primary customers is important to our results because these customers have more interaction with us, have higher cross-sell and are more than twice as profitable as non primary customers.

As shown on Page 10, tax equivalent net interest income increased $184 million from first quarter benefiting from an additional day in the quarter organic loan growth in higher mortgages held for sale in trading assets. Our NIM declined from the first quarter to 3.15% driven by customer deposit growth which essentially neutral to net interest income but reduced the margin by approximately five basis points. Liquidity related actions we took in the second quarter to meet increase regulatory liquidity expectations reduced the margin by one basis point however higher income from variable sources including higher PCI resolutions and periodic dividends offset this decline. Balance sheet repricing in growth once again did not impact the NIM this quarter as the majority of the repricing from the higher rate environment to the current rate environment is behind us.

Noninterest income increased $265 million from the first quarter with growth across our diversified businesses including mortgage banking, investment banking, deposit service charges, card fees, retail brokerage, commercial real estate brokerage and insurance, offsetting a $460 million decline in market sensitive revenue. Market sensitive revenue declined 34% from first quarter while all other noninterest income grew 8%. Trust and investment fees increased $197 million or 6% from first quarter on higher investment banking and retail brokerage asset based fees. Mortgage banking grew $213 million from first quarter, up 14% with growth in both originations and servicing. The second quarter benefited from a seasonally stronger purchase market with 74% of our originations coming from home purchases, up from 66% last quarter. Total originations increased to $47 billion, up 31% are unclosed pipeline increased to $30 billion at the end of the quarter, up 11%. We also continue to see improvement in our net servicing results for servicing revenue up $97 million from the first quarter reflecting higher MSR hedge performance and an increase in net servicing fees reflecting the benefit of lower servicing and foreclosure costs.

As shown on Page 12, expenses were up $246 million from the first quarter while our efficiency ratio remained at 57.9% reflecting our revenue growth. The key drivers of our expenses included personnel expenses declined $106 million from the first quarter which included seasonally elevated incentive compensation and benefit cost, salary increased as expected due to annual merit increases and one extra day in the quarter. Personnel expense included $130 million of higher revenue based incentive compensation in the second quarter which is a type of expense increase we like to see because we are growing the top line. Additionally, personnel expenses were impacted by $84 million in higher deferred compensation expense which offset in trading revenue. Outside professional services and advertising expense increased from the first quarter levels which tend to be seasonally lower. And operating losses increased $205 million from the first quarter largely due to litigation accruals for various legal matters. We remained focused on managing expenses and we expect our efficiency ratio will remain within our target range of 55% to 59% for the third quarter.

Turning to our business segment starting on Page 13, community banking earned $3.4 billion in the second quarter, up 6% from a year ago and down 11% from first quarter primarily from higher taxes. Retail banking cross-sell was 6.17 products per household, up from 6.14 a year ago. Our debit and credit card businesses continued to grow benefiting from account growth and higher usage. Debit card purchase volume was up 8% from a year ago driven primarily -- driven by primarily checking customer growth. Credit card purchase volume was 16% from a year ago with new account growth and more active accounts. Active accounts were up 14% as the Wells Fargo credit card is becoming more top- of-wallet for our customers. Credit card household penetration increased to 39%, up from 35% a year ago. We remained committed to serving our small business customers at an increased primary business checking account customers 5.2% from a year ago. During the second quarter, we launched Wells Fargo Works for Small Business, an initiative that provides guidance and services to small business owners. This new initiative is resulted in strong engagement with small businesses across the country including millions of views of our online video series and increased traffic to wellsfargoworks.com.

Wholesale banking earned $2 billion in the second quarter down 3% from a year ago and up 12% from the first quarter. Loan growth remained strong and broad based across businesses, up 8% from a year ago and up 2% from first quarter. Capital finance increased $2 billion from first quarter driven by higher utilization rates, new customer growth and growth in factoring assets. Commercial banking grew $1.8 billion from the first quarter with widespread growth across geographies and industries. Commercial real estate grew $1.4 billion driven by new loan originations including customer M&A activity. In addition, corporate banking, government and institutional banking, asset backed financed and equipment financed portfolios all grew from the first quarter. Revenue increased 7% from the first quarter reflecting diversified growth across a number of wholesale banking businesses. Investment banking revenue growth was broad based across product categories. Eastdil Secured, our commercial real estate brokerage business increased revenue, strong performance in public and private markets. Asset management fees grew -- from increased market valuation and in flows. Total assets under management increased $35 billion from a year ago. Long-term assets including equity and fixed income strategies were up 12% while money market funds have declined by 4% from a year ago. The shift out of money market funds moderating growth in total asset under management but revenue benefited from the shift to higher fee generating long-term assets. Wholesale banking revenue also benefited from the sale of 40 insurance offices in the quarter.

Wealth brokerage and retirement earned $544 million in the second quarter, up 25% from a year ago and up 15% from the first quarter. The strong year-over-year results reflected 9% revenue growth driven by recurring revenue. Net interest income was 11% from a year ago and asset based fees were up 14% benefiting from market performance and continued client demand for plan based advisory solutions. Our brokerage advisory assets have grown to $409 billion, up $78 billion or 24% from a year ago. Loan growth remained strong with average loans of 12% from a year ago driven by growth in high quality nonconforming mortgages in security based lending. We also benefited from the partnership involving WBR and community banking to better meet our customers' saving retirement planning and investment needs and we increased the number of private bankers in our banking stores by 22% from a year ago.

Turning to Page 16, credit quality continue to improve with second quarter credit losses down $108 million from first quarter and the net charge-off ratio decline into 35 basis points of average loans. Losses in our commercial portfolio were only 3 basis points of average loans and consumer losses continue to decline to 62 basis points. Nonperforming assets have declined for seven consecutive quarters and were down $686 million from first quarter although the pace of improvement is slowed. We had a $500 million reserve release is same as in first quarter. We continue to expect future reserve releases, absent a significant deterioration in the economy but expect a lower level of future releases as the rate of credit improvement slows and the loan portfolio continues to grow. Our estimated common equity Tier 1 ratio under Basel III using the advanced approach fully phased-in increased to 10.09% in the second quarter. Our share count declined in the quarter reflecting the repurchase of 39.4 million common shares and we executed a $1 billion forward repurchase contract which expected to settle in the third quarter for approximately 19.4 million shares. We expect our share count to continue to decline throughout 2014 as a result of anticipated net share repurchases. We also increased our dividend to $0.35 per share in the second quarter a 17% increase. Our net payout ratio in the second quarter was 66% in line with our recent guidance of 55% to 75%.

In summary, our results in the second quarter demonstrated the momentum across our fundamental business drivers including growing loans and deposits, increasing both net interest income and noninterest income while credit improved and capital remained strong. While we've demonstrated our ability to grow during the variety of economic and interest rate environments, we are well positioned to benefit from an improving economy and higher rates. Our diversified business model provides us with many opportunities to better meet our customers' financial needs as economic growth become robust. Our strong balance sheet with our large balance of short-term investments primarily driven by our strong deposit growth provides us the ability to further grow loans and invest in securities. We are optimistic that our outstanding franchise and our focus on serving the real economy will continue to produce strong results.

We will now open up the call for questions. Jim?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question will come from the line of John McDonald with Sanford Bernstein. Please go ahead with your question.

John McDonald - Sanford Bernstein

Hi, good morning. John, was wondering on the legal side of things. Can you give us a sense of what type of legal issues you are building reserves for? And also can you comment whether you are having discussion with the DOJ and mortgage task force, made up of state AGs that other banks are having discussion with?

John Shrewsberry

The best disclosure for our legal activity is found in our Q and K where there is great detail on item that are probable and estimable and frankly even more matters, we can't comment on anything specifically. The items that I referred in the expense section or variety of matters that essentially added up to the number that you saw.

John McDonald - Sanford Bernstein

On the loan growth, can you comment what you are seeing in terms of utilization of lines by customers, is that getting better and what's driving what appears to be slight kind of acceleration in the loan growth you saw this quarter.

John Shrewsberry

Well, we called out one area where there has been an increase in utilization in the comments that was in capital finance but overall in wholesale banking utilization is relatively flat, it's ticked up just a little bit. So this is -- this loan growth isn't just driven by that.

John Stumpf

John, the nice thing about the loan growth is broad based. If you look at it's consumer, it's private banking area, commercial and cross so it's really broad based, it is one of the -- I think the strengths in what we have been doing the last number of quarters especially this quarter.

John McDonald - Sanford Bernstein

Okay. And then last thing for me John on the net interest income side of things. Do you know at this point is the liquidity building you have been doing, is that done or you are not sure yet on that front?

John Shrewsberry

We think that where we stand today is probably about where you need to be and if the final rule making around LCR comes in a little bit differently then the actions that we have to take shouldn't materially change things so we are about where you need to be.

John McDonald - Sanford Bernstein

Okay. And seems that the churn has stopped with your reinvestment rates kind of looking like they match your roll-off rates. So I guess from -- with that perspective in mind, are you looking to grow an interest income dollar kind of in line with loan growth from here or there are other factors we should think about?

John Shrewsberry

Well, you should be -- should look at the balance sheet at every period and assess what types of inflows we have of additional liquidity and what we have done with it. Some of will be loan growth, there will be more security growth; there will be some that sits in cash while we wait to make decision about securities investments. So the facts and circumstances will lead it on that path but back to your question about roll-off and roll-on, it appears that the NIM hasn't been diminished by a change in pricing scheme with respect to loans or securities for that better because of what you described.

John McDonald - Sanford Bernstein

Okay. And you are still looking to grow net interest income from the current levels? Do you still think you can do that?

John Stumpf

Absolutely

Operator

Your next question will come from the line of Joe Morford with RBC Capital Markets. Please go ahead with your question.

Joe Morford - RBC Capital Markets

Thanks, good morning, everyone. Hi, there. I guess first was just on-- upon -- question on the loan growth. I guess specifically in C&I end of period loan were up little over $9 billion or almost 5% sequentially, the strongest increase to the past year. I was just curious little bit more what's driving that? Are you are seeing signs of increase confidence among borrowers and may be more of a willingness to make investment?

John Stumpf

Joe, this is John Stumpf. We are seeing that. As I am always talking with customers and our talking with our team, there is as I mentioned in my opening comments, there is more optimism. I think consumer confidence is at six year high. It is not breakout but it's -- we are having more discussion with more customers about buying homes, buying autos, investing in infrastructure if you are a business, buying something so we are real economy company. We are in the real economy and there are certain sectors of economy that are doing very well. We are big energy lender both on renewal side and the hydrocarbon side, plus the real estate has been very good for us, little market such it's very broad based.

Joe Morford - RBC Capital Markets

Okay, that's great, thanks. I guess the other question was just if you could talk a little bit more about what's your experience has been in mortgage with the spring selling season. And how do you feel about both volumes and staffing levels for the rest of the year there?

John Shrewsberry

Sure. Well, we've been pretty clear on the record that we found the spring selling season to be little less than we have originally imagined, although it is nice growth from the first quarter just based on the time of year. And our view on the whole year in terms of mortgage origination is not inconsistent with the MBA and other published metrics. So you can see our pipeline going into the third quarter higher than it was going into the second. So that's probably means good things for the third quarter relative to the second quarter. The margins are holding in there. But we are not seeing -- we are not seeing a breakout returns to pre crisis levels of the enthusiasm around home ownership and so the purchase market is softer than we thought that it would be.

Joe Morford - RBC Capital Markets

And is that like to drive any other right sizing on the staffing side or do you feel pretty good about where you stand there?

John Shrewsberry

I think -- we have been very good at being flexible about that work force. And adding as we needed to as production volumes increased and then making changes as production volume decrease. So I think we are keeping that in sync with the production opportunity.

Operator

Your next question will come from the line of Erika Najarian with Bank of America, Merrill Lynch. Please go ahead with your question.

Erika Najarian - Bank of America, Merrill Lynch

Good morning. Hey, my first question is a follow up to John's line of questioning. The first is you feel like you in are where you need to be in terms of liquidity. And the majority of the repricing from the high interest environment as you said John to the current interest rate environment is behind you. Can we assume that Wells Fargo's net interest margin is close to the bottom with the wild card being deposit growth being stronger continuing to be stronger?

John Stumpf

I would say this way Erika. Again, we don't manage to the margin; deposit growth has an impact on the margin. What we say -- what we are saying is we are focused on growing net interest income and we believe we can do that. And loan demands been good and that is good for growing net interest income. Secondly, we have millions of dollars available in that cash flow if you will, to make investments at the right time so we are optimistic about growing net interest income over the long term. The margin will be impacted by -- cost growth has a big influence on that. And again most at neutral to income if not neutral to the margin.

Erika Najarian - Bank of America, Merrill Lynch

And the second follow up question just as we think about the next quarter's earnings power, I know that it is in the appendix that you did reclassify about $2 billion from nonaccretable difference to accretable yield and you are expecting the yield on the Pick-a-Pay portfolio or the accretable percentage to be 6.15% from 4.98% this quarter, is that going to have a positive impact on net interest margin as sequential basis as we take into account all the different components of the core balance sheet that we talked about so far in this call.

John Shrewsberry

You should think about that as worth about $65 million per quarter in terms of incremental accreted interest income. It's related to the $1.9 billion re-class from nonaccretable yield to accretable yield and over the life that it will accrete under and based on the balance it's related to. Helpful?

Erika Najarian - Bank of America, Merrill Lynch

Got it. And just -- yes, and the third follow up question is another follow up to John's. I know you are not going to answer any questions about litigation in depth but I guess as we think about further accruals in your litigation reserve, can we expect as we think about the next few quarters Wells Fargo continuing to maintain at 55% to 59% efficiency ratio despite potential higher operating losses from legal accrual?

John Shrewsberry

I would say that given everything that we know we anticipate operating between 55% and 59%.

Operator

Your next question will come from the line of Ken Usdin with Jefferies. Please go ahead with your question.

Ken Usdin - Jefferies

Thanks, good morning. First question just on the mortgage business. I am just wondering John, two things. First of all, just your general sense of the gain on sale environment, obviously it is continue to reset lower but do you think we've gone to more stable kind of base here?

John Stumpf

Yes, I do. I think the margins have been running in that 140 to 160 range and from what we see there is rationality in pricing. And those margins are look reasonable to us. We have no reason to believe it will be markedly different from that in the near future.

Ken Usdin - Jefferies

And my second mortgage question and the servicing fees line, it had a nice expansion but with the book not growing and rates back down, so I am wondering can you give us some context of what the growth driver has been underneath that servicing fees line?

John Shrewsberry

Well, so it's -- it has a lot to do with servicing expenses. So fewer on reimburse expenses coming through, fewer foreclosure and default expenses so it is more efficient servicing operation and more of the net fees flowing to the bottom line.

Ken Usdin - Jefferies

Okay. So we will see that all in the Q?

John Shrewsberry

Yes.

Ken Usdin - Jefferies

Okay. Then my third question is just on capital and capital return. Clearly $0.35 dividend, you earned $1.01; so above the 30% threshold that we've known to be the benchmark. So given that we are now past this year's stress test, can you just give us your thoughts around flexibility around and above that 30%? And kind of your post-game on how you have looked at this year's stress test process in that regard.

John Shrewsberry

We think 66% payout ratio comes with the combination of repurchase and dividend is an excellent spot to be in. It is between the goal post that we set up 55% to 75%. Can't be much more precise than that but we hear our shareholders loud and clear that they want more return of capital. We are committed to executing on that so that's about all the rest to say. And we look forward CCAR process.

Ken Usdin - Jefferies

Okay. Then my last tiny one related to that is just -- the buyback was bigger, the share count just dripped lower. How close are we to finally getting that average diluted share count really starting to move downward?

John Shrewsberry

That's a good question. You can see the point-to-point numbers that have changed. The average is what it is just because of the timing in the quarter between when we issued shares to our benefit plans and when shares were repurchased with repurchase was little bit more even throughout that -- throughout the quarter and the issuance was a little bit more front end loaded. So the average didn't change as much as the point-to-point but it will be probably be like that during quarter where there is slightly heavier issuance but yet we expect the net number to trend down the way we've described it.

Operator

Your next question will come from the line of Mike Mayo with CLSA. Please go ahead with your question.

Mike Mayo - CLSA

Hi, what was the amount of gain on the sale of the 40 insurance branches?

John Shrewsberry

About a $100 million

Mike Mayo - CLSA

Okay. And conceptually was there anything that offset that? I guess you had the increase in litigation accruals of $200 million. Anything else that would be kind of nonpermanent?

John Shrewsberry

It's tough to describe expenses as permanent and non-permanent. I know you are looking for an offset for that non recurring revenue but the expense story is the efficiency ratio story, if we've got for example this quarter higher incentive compensation related to revenue growth that's going to move things around. We've got our deferred comp hedging that moves things around. So it is hard to give you a neat offset to that.

Mike Mayo - CLSA

How about the run rate in minority expense? There was a decline and that helped a little bit. Is that permanent?

John Shrewsberry

It's hard to say whether that's permanent or not. We will work with Jim Rowe and get you something specific. So we can responsive to that

Mike Mayo - CLSA

Okay. And then the increase in investment banking linked quarter was up a lot. Can you give any context to that?

John Shrewsberry

It's broad based so there is some equity capital market, debt capital markets, loans indication, M&A activity, it was just a busier quarter, I think that our investment banking share might have picked up a little bit but the whole market was busier in the second quarter than it was in first quarter.

Mike Mayo - CLSA

And mortgage originations, as you mentioned they were up linked quarter. And it seemed a little bit better than what you were saying at the Investor Day. So were things a little bit better? And if so, why? I know it's not as much as you originally thought for the spring selling season. But that's a little bit of a bump and I guess you expect a little more of a bump in the third quarter.

John Shrewsberry

Well, the gain was at the low end of the range which is how we thought about and described in Investor Day. In terms of volumes they were -- I think we feel about the same as we did six weeks ago which it is was less than we had originally anticipated. So we feel about the same. We are glad the results are good. They are certainly up seasonally quarter-over-quarter. But we might have imagined a little bit more going in to year.

John Stumpf

Mike, about 74% of our originations are production this quarter was purchase money and that really plays into our hand. We have long-term relationships with realtors and builders. We have a wonderful crew of people who are our team members are out calling so we should expect to do better vis-à-vis because others who don't have a sales force on the ground.

Mike Mayo - CLSA

Okay. And then last question. I guess what -- I'd ask two sides of the same question. Are you taking too much risk in an area such as auto lending, where the loans are up 10% year-over-year? You have had some cautionary language from regulators, and it seems like every bank is expanding in auto lending. So are you concerned about that? On the other hand are you taking enough risk? Because based on our models which go back a couple decades, it looks like your net charge-off ratio for the firm is the lowest ever in modern history. So that would say take more risk. So where do you come out on that decision?

John Stumpf

Well, Mike, you hit both side right. I mean it is I think 35 bases -- it is loss - I remember in my 37 years with the company and in the auto area specifically we looked carefully at what's going on with FICO scores and we look at delinquencies and a whole bunch of things there. So no I don't think we are taking inappropriate risks. Is that going for taking the right risks and we are finding the right place? And after all this is a business that we have been in long time and we don't come and show up and leave and secondly it is a short -dated asked that we know a lot about --

John Shrewsberry

And you probably recall at Investor Day we had a specific slide on disclosure on the growth in the auto portfolio in particular that showed among other things over a long period of time what's been going on in our portfolio with FICO scores, average loan to value and payment to income ratio of our auto customers. And each of those has improved, not only over the last five years but improved meaningfully from pre crisis levels. So the portfolio actually looks really good. Our relationship with -- and autos and our business proposition there is that we own the relationship with dealers. We banked the dealers directly, we provide them with floor plan financing, and we provide them with real estate financing. We bank them personally and we are a very reliable takeout for indirect auto paper and we get more than our fair share as a result of the paper we want and the portfolio composition reflects that.

Operator

Your next question will come from the line of Betsy Graseck with Morgan Stanley. Please go ahead with your question.

Betsy Graseck - Morgan Stanley

Hi, thanks much. A couple questions. One is on the mortgage origination side. And I think you were doing some rollouts on July 1. Just wanted to see how those executed, and now that that's behind you, are there any opportunities to make that side of the business more efficient.

John Shrewsberry

When you say rollout, do you mean changes in headcount?

Betsy Graseck - Morgan Stanley

Well, there were some technology changes and some systems-related changes, process-related changes that you did effective July 1.

John Stumpf

Well, Betsy, we have been doing a number of those over a period of time, be more efficient and to give our sales force more information upon sale but that's not a big issue. I mean those things happen, that haven't any impact on the business.

Betsy Graseck - Morgan Stanley

Okay. And then just looking forward a little bit less positive on the outlook for volumes for the full year. Is there any opportunity to peel back some of the investment in the production side of the business? Or are you sticking with your current plan at this stage?

John Shrewsberry

We are very flexible about that. And constantly reading what we think we need in terms of capacity. As you know, the work force in that line of business has become flexible work force just because of the ebbs and flows of origination patterns as a refinancing opportunity comes into the money and then goes away. So I think we are very real time in responding and what we think we need. And if we think that we need more because the third quarter opportunity seems bigger then we will staff it up and if we think that we need less then we will dial it back.

John Stumpf

Betsy, you are on important point and I think it has been asked couple of times this morning. In the mortgage's business besides having to be good underwriter, good servicers, and all those things, good at flexibility, wrapping up and wrapping down is a core competency here. And if you are in this business and you have to be good at that.

Betsy Graseck - Morgan Stanley

Okay. One other thing --

John Stumpf

No. You never know what the volumes are going to be.

Betsy Graseck - Morgan Stanley

Sure; no. Then one of the things you did mention at Investor Day is that Mel Watt obviously had some suggestions for underwriting and potentially changing some of the elements of the grid and I know that you had indicated that there were several meetings that you were going to be taking -- that were taking place with you and others in DC around those suggestions. Can you give us any sense as to how those dialogues have been going? Any update on how you're thinking about underwriting in the credit box?

John Stumpf

Well, those meetings with our mortgage company continue with Mel Watt and his team and others. I think the goals here is to get more credit corporately to borrowers who want to own homes and who can afford homes. And that's in the interest of borrowers; it is in interest of lenders like us, and interest in investors and the country. So we are trying to harmonize that. Some things in the past created less harmony. You low rates at one side encouraging borrowing and you have put backs from the GSEs on the other side that make lenders less willing to lend money. So we are trying to get everybody on the same page. I think he has been helpful in that and obviously we are participating in that. So and as we get more clarity there we can make loans, confirming loans that serve more customers. That's the goal there.

Betsy Graseck - Morgan Stanley

Okay. As I know you'd spent a lot of time with the FHA, and that at the margin helped open the credit box in certain parts. I mean do you feel like you're at the stage where we're likely to see any changes come this year? Or it's really more of a next-year event with the GSEs?

John Stumpf

Well, I'll tell you predicting what happen in Washington on legislation is -- that's way above my pay scale so but the important point is here is that there are some incremental changes happening and that's helping open the credit box a bit and corporately so we are still doing full underwriting and those sort of things. But I hate to venture a guess on when GSE reform will become law.

Betsy Graseck - Morgan Stanley

Right. No, I was asking really more about when your credit box on GSEs would loosen up potentially versus what had happened at the FHA where you have already loosened up a little bit there so --

John Stumpf

I understand, okay. Well, we are just -- we're keep working on that and I think there is lot of emphasis on may be sure again corporate customers get loans that they can repay.

John Shrewsberry

And capturing that first time buyer that lower credit quality customer may be very -- will be very important to that customer when credit becomes available but not likely to change the overarching view of what the size of the mortgage market is in 2014 or 2015. And it is not likely to have a big impact on earnings of mortgage originators. There is not that much going on there. It is very important to them but there aren't enough for those loans at 140 basis points to make a giant different.

Operator

Your next question will come from the line of Matt O'Connor with Deutsche Bank. Please go ahead with your question.

Matt O'Connor - Deutsche Bank

Good morning. It seems like from here the efficiency ratio will be increasingly important, just given how low the credit costs are at these levels and you talked about maybe some less reserve release going forward. So just as we think about that efficiency ratio and being closer to the higher end, is there opportunity to migrate down in this environment? And if so, how do we think about the expense opportunity versus growing revenues?

John Shrewsberry

Sure. Well, we are -- I will stand out by saying we are sticking with our 55% to 59% because that's where we think we will be through the cycle. We constantly focus on our efficiency, we spend a lot of time in that many programs designed to root out and to get the bottom of the most efficient use in resources that we can have. And that's important because there are areas where we continue to spend and invest money to have the right people facing customers and investing the right product for customers. And there are also areas like risk management, compliance, technology etcetera where we are making increasing investment to build the better company for the future. So all that's going on at the same time. And it would arrive that this 55% to 59%. You can rest assure that we are doing what we can to keep expense as efficient but I wouldn't count on a big lever there moving down closer to 55% all other things being equal to drive near-term performance.

John Stumpf

So couple examples of things that we are doing. As you know about since the merger five years ago we've reduced the number of square feet that we used to house our people and through our stores and so forth from 100 let say 15 or 17 million square feet to 94-95 million square feet. We are testing and successfully so a new urban store if you will, neighborhood store, we have now three of those in the Washington area, have a very different expense component but still just as productive. So there is a lots of things we are working on. So we can use those dollars and savings to invest in other areas of business that John mentioned. Expense -- there is lot of focus on that here but not -- again I have said in the past we are not slavish to it. If our expenses grow because revenues growing up, that's a good thing. And we will make the investment that we believe will make-- need to make for the long-term success of the company.

Matt O'Connor - Deutsche Bank

Okay. So if I am hearing you correctly, as we think about the efficiency ratio going forward, there may be some opportunities for it to tick down a little bit, more dependent on revenue.

John Stumpf

I would say yes surely, it is a ratio. So no matter it is denominator, we are working both side of it.

John Shrewsberry

And as we've said publicly in the past to the extent that we had revenue increases as a result of rates moving up. We probably migrate to the lower end of efficiency ratio because those dollars of revenue don't have expense attached to them.

Matt O'Connor - Deutsche Bank

Okay. Yes, I'm harping on it because the efficiency ratio hasn't really moved the last several quarters. As we start thinking about the back half of the year and going forward the mortgage revenue comps get a lot easier and it feels like we could start seeing some improvement there so --

John Shrewsberry

Have you noticed that were best in class at the ratio where we currently operate?

Matt O'Connor - Deutsche Bank

Understood. Fair point. Just separately on the tax rate, last quarter came in low; you called out that gain both at the time and then again today. But today's or the second-quarter tax rate seems a little bit higher than at least what we were looking for. What is the outlook? Should we pencil in the 32% going forward or --?

John Shrewsberry

Yes. You said pencil today's effective rate going forward.

Matt O'Connor - Deutsche Bank

Okay. and then just lastly, I had a follow-up on an earlier question. The mortgage servicing revenue that is coming from the MSR gains, that is writing up the MSR because the expenses to service the loans are coming down?

John Shrewsberry

That's right. The future cash flows are higher as a result of future expenses coming down, current and future expenses coming down.

Matt O'Connor - Deutsche Bank

Okay. And is there still I feels like there is still opportunity to reduce the cost of servicing going forward, which therefore would increase the value of the MSR. It feels like there is still more of that opportunity there.

John Shrewsberry

There maybe. We are probably in that middle innings of perfecting servicing over time. There are still -- and more of elevated level of troubled loans out there compared to what we hope to steady status years from now. And when that happens it will be in the future and the benefit of will be the discounted than future benefit of it but you are right, it is probably opportunities at some point in future.

Operator

Your next question will come from the line of Keith Murray with ISI. Please go ahead with your question.

Keith Murray - ISI Group

Thanks a lot. Can you spend a minute on cards? So you obviously have increased penetration impressively on the card side. Just a question: From penetration to actual usage, how long does it take? Obviously you guys have shown very solid loan growth on the card side. But how difficult, once they get a card from Wells, to get them to start using it, to move up the pecking order versus other cards?

John Stumpf

This is an area that I think is one of our biggest opportunities in the company. If you look at Wells being as we all talk about in the real economy, we have leadership roles in variety of lending classes, whether autos, in consumer, small business, real estate and we are just passionate about helping our retail customers understand the value of having a Wells Fargo card and not only in their wallet but top of wallet. And there were some areas that we were under serving, especially our affluent and emerging affluent customers and our partnership with American Express is off to a very good start. Obviously, we do a lot of things, it was with VISA, and important in Master Card partners of ours. So we can sell a card to a customer at a fraction of the cost of someone else in the outside. We know these people better, we give them better products, and we have a lot of exciting benefits that we are giving as part of the card offering. And it is not only having the balances there. It's being involved with the customer on the payment side. So when we merge the two companies over five years ago, Wachovia came without a portfolio because he had sold their card business off so we are at about 22% penetration rate. Today we are at 39%. I always tell our people, do you know how many of our consumers have credit cards they all do. In fact, they have more than one card. Now, I don't know that we didn't get to 100% but we are marching smartly up the line and you are right, it is not only about the number of plastic cards we have outstanding, it is one that have been used. So I am thrilled with what we are doing. We have still lot more work to do. Big opportunity for us.

John Shrewsberry

That's right. And it is both in the balances as well as interchange and utilization.

John Stumpf

And it just works beautifully.

Keith Murray - ISI Group

Okay. Just switching gears to OLA, you had given us your thoughts on that on Investor Day. Obviously you guys issued some long-term debt this quarter. Do you feel like you're getting close to where you're going to wind up needing to be, for OLA? Or any updated thoughts and things you're hearing from Washington on that?

John Shrewsberry

I wouldn't -- there is no real updated intelligence. We still are hearing and are of a mind that the range that will probably published at some point in the future is in the high teen to low 20s in terms of loss absorption cushion. We see ourselves on a risk based approached at the low end of that range and at or within striking distance of that range. So based on everything that we know today, we don't anticipate it having material impact on Wells Fargo.

Keith Murray - ISI Group

Okay. And then just finally for me, we have read a lot about the SNC review and regulators focus on leveraged loans, etcetera. Just can you give us any thoughts related to that? And any changes you have seen this year in how the regulators are approaching it versus past years?

John Shrewsberry

Well, they are talking about it lot and there is multiple regulators talking about it little differently so I think there is an effort to harmonize their points of view. But obviously they've got a big focus on what's going on with leverage lending inside of banks and banks mean different thing depending on which regulator and which firms are covering. So I would anticipate more clarity some time later this year or maybe beyond that but it really isn't enough for to understand what's going on and at some level to encourage certain types of behavior and discourage others. The big emphasis is on the most levered and most collateral free leverage lending. We don't anticipate having an extraordinary impact on Wells Fargo based on our business mix.

Operator

Your next question will come from the line of Brian Foran with Autonomous Research. Please go ahead with your question.

Brian Foran - Autonomous Research

Hi, I was wondering if I could ask about deposit growth in the rising-rate scenario. And I guess if I oversimplify the two schools of thought or the two ends of the spectrum are deposits have only shrank industry wide in 2 of the past 90 years, and those were pretty marginal declines; so you can kind of bank on industry deposits growing. And then I guess JPMorgan was pretty explicit about the other end, where they feel like some of the need to drain liquidity out of the system as rates rise could drive deposits down as much as 10%. So I know there is a lot of uncertainty. Part of it depends on how the Fed acts. But as you think about liquidity planning and stress testing you do internally, any thoughts on the range of best-case and worst-case deposit growth you think about?

John Stumpf

Let me just give overall view how we think about it. I think one of the things that -- is may be under appreciated about Wells today is the quality of our deposit franchise. And we have $1.1 Trillion of deposit at 10 basis points. About a $1 Trillion of core deposits and many of these -- most of these deposits what I would call transactional mean that people use these deposits either are they are checking accounts or saving accounts, we only have 30 to 40 billion [AR] of CDs, we have a very high quality deposit base. We are also growing primary checking accounts. Think about that. The primary account by between 4.5% and 5%, lower 5% depending whether it's small business or consumer. And in fact these some of the strongest growth number we-- I have ever seen. So because of the quality of our deposit franchise, the quality of omnichannel delivery system. And no one knows of course, it will become fact in history what happens with disintermediation about when rates rise and so forth. I am of the opinion that you are going to see at least for the first couple hundred basis points move up in rate, probably very little movement in disintermediation. You can make the argument that the squeeze down your M1 and M2 and some of the liquidity about the system. We found over time as you suggest early that deposit generally grow. And it might not grow as fast as but I am very confident about how all our deposit franchise will perform in a rising rate environment.

Brian Foran - Autonomous Research

That's very helpful. Maybe on the student loan sale, what's your thought process on the decision to sell as opposed to I guess the alternative of just letting it gradually run down over time? Is it a capital free-up or a regulatory? Or what's the benefit of selling out of it now?

John Shrewsberry

Sure. Well, we had designated -- that the government guaranteed student loan business which is distinct from our private student loan business that we are very committed to over the long term. We had separated after government guaranteed part of the portfolio into liquidating portfolio in 2010 when we stopped originating those loans as that market changed. So they have been part of our run off portfolio for that period of time and amortizing down a little bit. We see the opportunity in the market to move those loans off the book. They are relatively low yielding. They are not strategic. We don't have bigger relationships with most of those customers and that's the decision. So we have transferred them all to held for sale status to signal this intend to sell, we are going about the process in the next quarter or so.

Brian Foran - Autonomous Research

If I could sneak a last one in on MSR hedging -- or I guess more specifically the line item you give of $475 million, the market-related valuation changes net of hedge results. I feel like -- I always strip that out of core EPS; I always set it at zero and then I always end up being too low. It's almost always a positive number. Is that a number that through the cycle you would expect to be kind of a wash? Or am I just missing that there is a carry component to it because of the way you structure the hedge and things like that? Through the cycle it actually -- over the past 5 years it's averaged $200 million a quarter. And there is a volatile component to it, but through the cycle it should be some positive nonzero number?

John Shrewsberry

It is a carry component. The bundle of instrument that we use to hedge the asset to create the right duration profile as rates move up or down that we think the value is -- changing value is neutralized. That bundle of instruments throws out positive carry. It will depend on the shape or the slope of the yield curve at different points in time. And of course in the past it has been impacted by other expense items that have been flowing through, they are less of them today. So it is a little bit more standout in terms of its net. And then there is also the influence of what happens when rate speed up or down -- prepayment rates speed up or not, and of course we have gone through a period recently where the asset is linked-in. So there is a lot of different things going on there. And it is not currently what through the cycle actually mean in this context because as rates move you are in different places and as the shape of the curve moves you are in different places that are different than a business cycle or credit cycle. But you can look at the performance over some period of time and set whatever average you think is right. But I think zeroing it our is probably conservative.

Operator

Your next question is will come from the line of Moshe Orenbuch with Credit Suisse. Please go ahead with your question.

Moshe Orenbuch - Credit Suisse

Great, thanks. Most of my questions have actually been asked and answered. But one quick thing, that the -- you have taken a big step up in capital return. Just talk a little bit about what might influence you to go to the very high end of your range or to the lower end of your range, in subsequent periods.

John Shrewsberry

So we are setting our expectations in our levels internally from one key card process to the next based on how we anticipate that we are going to earn and the negotiation if you will that we are having with regulators which -- it is part of what constructs the balance between dividend and repurchase. And if you think about an annual payout or if we thought about an annual payout based on the annual number, it would be a calculated number in that range. From quarter-to-quarter as I mentioned earlier with respect to what happen to share count, we've got different things going on with share issuance so that the net buyback will be bigger in some quarter than it is in others which is going make us look like we are dancing around inside the range. And that's the reason for moving around inside the range. Now, more importantly if growth opportunities began to emerge in a more meaningful way where we needed to retain more capital to put it work then that would also be a driver, I think Investor Day you probably recall that Paul Ackerman went through an analysis of the amount of capital that we thought was appropriate to set aside for asset growth and that's amount that was -- the amount of earnings necessary are available to distribute. So that's the starting process.

Moshe Orenbuch - Credit Suisse

Just as a follow-up to that, any thoughts on portfolio acquisition opportunities in the current environment? Anything standing out?

John Shrewsberry

I wouldn't say anything standing out. We are at there looking in both consumer and commercial and commercial real estate assets. We've -- I mentioned in the loan growth context that we have done a couple of commercial real estate acquisition. These are all announced but that have happened in the quarter. Pardon me, that is happened in previous quarters. So we are looking at those. We have talked about card programs like the Dillard's program where we will be picking up a portfolio receivable in addition to managing that card program going forward with more opportunity there. So we are looking at lots of things. Some things make more sense than others but that's an interesting way for us to add both assets and new customers to the bank.

Moshe Orenbuch - Credit Suisse

Got you. Very last thing. Just on that up sale, just two quick questions. Do you think you will sell it in one piece, or do you think you'd break it up into pieces? And do you service that portfolio?

John Shrewsberry

With respect to the first half of the question it depends, we would be willing to sell at one piece. It is a big number. So it may happen in component pieces. And on the second half, we do not service those loans.

Operator

Your next question will come from the line of Paul Miller with FBR Capital Market. Please go ahead with your question.

Paul Miller - FBR Capital Market

Yes, thank you very much. On the mortgage production side, the $47 billion that you guys produced, how much did you sell into the MBS market, and how much did you portfolio?

John Shrewsberry

I don't have that number handy. I think the lion share of that was sold.

Paul Miller - FBR Capital Market

Okay. Do you have handy with you what was jumbo?

John Shrewsberry

About $8 billion, nonconforming mortgages increased $8 billion to about $96 billion.

Paul Miller - FBR Capital Market

Then my guess is you put portfolioed all those nonconforming jumbos.

John Shrewsberry

That's correct.

Paul Miller - FBR Capital Market

Go ahead.

John Shrewsberry

The question is whether that $8 billion is part of the $47 billion because if it then that answers the question at what we sold. So we will confirm that.

Paul Miller - FBR Capital Market

Okay. That makes sense given the MBS issuance data that has been out. I don't have June; but given May and July I think you probably issued probably somewhere between 33 and 35, so that would coincide with some of that. Have you been portfolioing any conforming loans on your residential portfolio? Or has it just been nonconforming jumbos?

John Shrewsberry

Nonconforming, not portfolio conforming.

Paul Miller - FBR Capital Market

Yes. Can you talk a little bit about the pricing of the jumbos? Are they 4.25%, 4.5%? Are they mainly 7/1, 10/1s? Are you portfolioing any 30-year?

John Shrewsberry

So it's a mix 5/1, 7/1, 10/1 and 30 year and they are priced for their point on the curve.

Operator

Your next will come from the line of Chris Mutascio with KBW. Please go ahead with your question.

Chris Mutascio - KBW

Good morning, John. John, how are you? As a happy Wells Fargo deposit customer, I got a letter in the mail several weeks ago, and I wanted to get your thoughts on it. It was changing the overdraft, no longer going from processing it from a high to low but going now to first received. I thought that already happened. I guess I was wrong. So I guess my question is: Will this have an impact on deposit service charges going forward with the change in the overdraft processing?

John Stumpf

It is not going to be meaningful, no.

Chris Mutascio - KBW

Okay. But has it happened in certain parts of the country? Because I'm here in Baltimore, Maryland; I thought it was the old Wachovia franchise. Has it happened in certain parts of the country? In other words the shift to first received and now we are converting other parts of the country? Or this is throughout the whole franchise?

John Stumpf

Repeat that one. This is really as a process we are able to with debit; we are able to do it on a real time basis. And it was more incorporating that into that hierarchy with checks to get them synchronized and that was the reason for making that change.

Chris Mutascio - KBW

Okay. So again but the end result of that, this isn't any impact to deposit service charges going forward?

John Stumpf

It is not to be meaningful.

Operator

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

Nancy Bush - NAB Research, LLC

Good morning, guys. A question about the spring survey from the OCC, where they made some fairly pointed comments about deterioration in credit quality, not only in leveraged lending. I think there was sort of a loosening of loan standards; I mean, there were a whole bunch of bullet points that were somewhat alarming from a credit-quality standpoint. Do you guys see that this is at an inflection point in credit quality? And do you feel or are you feeling increased pressure to maybe start building reserves rather than continuing to let them draw down?

John Shrewsberry

So at least two different questions there. The first part on the competitive environment for loan. And it is a more competitive environment. There are lots of people out there. Lots of banks out there with a lot of liquidity competing for loans. And we do see more competitive -- more borrower friendly structures that we have to react to from one asset category to another. Now in some like in mortgage for example, part of it is just getting more clarity on what the rules are and what's going to work and what's saleable to agencies and things like that. And for other things -- for other types of assets, we mentioned auto earlier, there are people out there who for example are extending the terms on auto loans, so links that you might not seen in past. And of course we are all leverage lending is probably the most visible because it's pretty easy to measure the aggressiveness based on leverage multiple for example. So those things are happening. Our front line and relationship managers and others are confronted with having to make decisions about where we want to be in, where we don't want to be. We think we are very good at spotting that. And managing credit risk has been strength at Wells Fargo as you know for a very long time. With respect to reserving, we are looking at our risk allowance for credit losses every quarter and it reflects and its change reflects what's going on in the portfolio. When its bottom up analysis of what's in the portfolio, what it looks like, what's risk rated, how it is performing and what our expectations is for near term credit losses. And as we said here, we anticipate reserve releases declining over some period of time in part to reflect -- from 35 basis points it's hard to argue that whether it can get much better from there or sort of bounded by zero on the one side and would expect to gravitate more towards some whatever normalized means with some higher level of net charge-off. So that's going on the one hand and then there is portfolio growth. As we said, we had a lot of new loans put on and all things being equal at some point, our reserves will have to grow to reflect the increased loan balances which we think is a great thing because we want those loans on the books serving customers, earning interest and creating the environment to cross sell those customers. That's how I see them.

Nancy Bush - NAB Research, LLC

Do you think you will have an ability to telegraph the change that will actually happen when you have to start building reserves? Because my guess is that the industry is going to be -- or Wall Street is going to be somewhat shocked when that starts to happen.

John Shrewsberry

As I look at the industry data so what's going on with reserve releases from other banks, they have been trending and it begun to trend with a few exceptions back up towards zero. So I think people see that coming and it's a reflection of asset growth on one hand which is a good thing and then of course the big reserves that we put on at the -- in the heat of the crisis that in some cases were more than relative what was necessary. So we look at quarter-by-quarter, just to be clear, this is a gap exercise, we built it up based on what's actually in the portfolio and the experience that we are managing. As you have seen in the data right now our allowance for credit loss is pushing 5x what our actual charge-off experience is right now.

Operator

Our final question will come from the line of Andrew Marquardt with Evercore. Please go ahead with your question.

Andrew Marquardt - Evercore Partners

Good morning, guys. Thanks. Just a couple follow-ups here. Just to be clear on the line of questioning from Nancy on credit quality, so just looking -- it feels like, to your point, maybe it's hard to get much better than 35 basis points in aggregate and recovery seem to be less robust and maybe it's a very modest uptick in C&I. Like, how should we think about the level? I mean, should we think about it in this very low range for a period of time, and we're still very far from what you've previously deemed as normalized, the 75 to 85 basis points? How should we think about maybe that near-term?

John Shrewsberry

I think it's going to be hard for the 35 basis points to move rapidly to any much higher number. And we know what kind of assets we have been putting on the book for the last few years which I think we all believe are very high credit quality particularly on a historical basis. So normalization will happen over some period of time but at least from our perspective we wouldn't expect it to be an abrupt move. Credit is still quite strong.

Andrew Marquardt - Evercore Partners

Got it. Then just a little ticky-tack on the reserving. So not only for the loan growth that's picking up and relief from legacy issues for the industry, there is also this upcoming change in accounting at some point. Any update or thoughts on the CECL coming through, and when one might need to start thinking about that for the industry in general?

John Shrewsberry

Yes. So what we know about that is that it sounds like it is going to happen. It is not final but we are going to be hearing about it from the Fed in the coming quarters. And at least the way I read it there is not going to be much of an opportunity to change anyone's mind. But of course for anybody who is included into this, this is life of low-- essentially life of loan reserving. The expectation, our expectation is that would begin to phase in the 2017 timeframe or later. And so it's not really today's issue and just for the avoidance of doubt, our reserving practices today do not reflect that future contemplated life of reserving -- life of loan loss approach. So it's out there, let's call it 2017 plus and something wrong and have to figure out how to adapt to.

Andrew Marquardt - Evercore Partners

Great, that's helpful. Then lastly just following on the balance sheet dynamic questions and the NIM optics and issues around deposits. Can you maybe just re-clarify in terms of deposit velocity in a higher rate environment that Brian had brought up earlier? How much -- I mean, do you if at all consider ring-fencing 5%, 10%, 15% of deposits maybe at risk of reversing in a higher rate environment as some institutions have indicated?

John Shrewsberry

I wouldn't say that we don't describe it in our deposit stress testing internally in quite that way. And we talk about the types of deposit accounts that we have and we assigned what we think are the right level of behaviors to those accounts and through that we assess what we think the right level of liquidity is to carry and that liquidity comes in the form both of cash and cash equivalent which are extraordinary at Wells Fargo today as well as our securities are relatively liquid securities portfolio that we in a pinch would consider to be saleable or financeable. And answering a slightly different question, the sum of those two things is such a significant part of our balance sheet today that it seems like ample coverage for whatever portion of deposits might be -- might unexpected retract or disappear in the event of move up.

John Stumpf

And I think as I mentioned before I think we are going -- our deposit franchise will out perform competitors because of the nature of the kind of deposits we have and the amount of core deposits (inaudible) amount of retail core and I think there is going to be surprise, I think we will surprise ourselves and how well it's going to do.

John Shrewsberry

That's right. We have the relationships that we have with our deposit customers is cemented by the tools that we have that we use, that the products that we offer them and allow them to manage their money. So whether it's a consumer or a business customer, we've got the best in class interface that allows them -- and frankly it is hard to move away from -- in terms of moving money, analyzing money, investing money etcetera, the mobile convenience, the online convenience what we have referred to as this omnichannel relationship. It's not easy or convenient to want to change that. So something really has to be compelling about an individual depositor circumstances or we would have to really be tone deaf to what deposit pricing needs to do in order to retain our balances. So we feel really good about that.

Andrew Marquardt - Evercore Partners

Thanks, that's helpful. Then if you don't mind, just in terms of -- you've mentioned a couple quarters now how you've had this great continued growth in core deposits. But it's optically impacted the NIM but hasn't really negatively impacted the NII. Would a similar dynamic be envisioned in a higher rate environment if in fact the velocity was greater than one envisioned? In terms of it could go the other way and you could have an optically better net interest margin; but the NII could remain relatively stable despite all that. Or how should we think about that? Or how do you think about that?

John Stumpf

What's happened in the past is typically what happen is that the margin will increase and net interest income increase because assets have reprised faster than liabilities will. So I mean – hypothetically we will wait to see what happens at that time.

Andrew Marquardt - Evercore Partners

Got it, great, thank you, guys.

John Stumpf

All right. Well, thank you much everybody. We appreciate your interest in Wells Fargo. Thank you for joining the call. Excellent questions and we will see you next quarter. Thank you very much.

Operator

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

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Source: Wells Fargo's (WFC) CEO John Stumpf on Q2 2014 Results - Earnings Call Transcript
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