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Wells Fargo & Company (NYSE:WFC)

Q2 2008 Earnings Call

July 16, 2008 8:30 am ET

Executives

Howard Atkins - Chief Financial Officer

Bob Strickland - Director, Investor Relations

Bob Strickland

Thank you for calling into the Wells Fargo second quarter 2008 earnings review prerecorded call.

Before we discuss our second quarter results we need to make the standard securities law disclosure. In this call we will make forward-looking statements about specific income statement and balance sheet items and other measures of future results of operations and financial conditions, including statements about future credit quality and losses generally, and specifically that we expect higher losses in the home equity portfolio until home prices stabilize, that we believe we can mitigate losses by working with customers who are experiencing financial stress, and that, based on the current interest rate environment, most of our adjustable rate mortgages at Wells Fargo Financial scheduled to reset during the remainder of 2008 will reset at or below their current rate.

Forward-looking statements give our expectations about the future. They're not guarantees and results may differ from expectations. Forward-looking statements speak only as of the date they are made and we do not undertake any obligation to update them to reflect changes that occur after that date. For a discussion of some of the factors that may cause actual results to differ from expectations, refer to our SEC filings, including the 8K filed today, which includes the press release announcing our second quarter results, and to our most recent annual report on Form 10K and quarterly report on Form 10Q, filed with the SEC and to the information incorporated into those documents.

Now I will turn the review over to our Chief Financial Officer, Howard Atkins.

Howard Atkins

Wells Fargo earned a $1.8 billion profit or $0.53 a share in the second quarter. Our credit-related expenses, including a $1.5 billion credit reserve build, were $3 billion in the quarter, up $2.3 billion from a year ago. But nevertheless, we continued to grow our company profitability at a time when many of our peers are losing money and shrinking, we continued to shift our asset portfolio toward lower-risk, higher risk-adjusted return business and, even with 15% annualized linked-quarter growth in earning assets, we increased our capital ratios.

Here are some of the metrics that highlight the profitable growth we've achieved year over year and the further strengthening of our balance sheet this quarter: pre-tax pre-provision income up 34%; total revenue up 16%; average earning assets up 20%; average loans up 18%, with consumer loans up 13% and commercial loans up 27percent; fee income up 10%, reflecting continued growth in cross-sell; record retail cross-sell of 5.64 products and record commercial cross-sell of 6.3 products; net retail checking accounts up 5.5%; mortgage servicing of $1.5 trillion, up 7%; mortgage originations of $63 billion and new mortgage applications of $100 billion, almost entirely in agency conforming and government guaranteed mortgages; Wells Trade assets under management up 8%; positive operating leverage, with expenses up only 2% versus 16% revenue growth, resulting in a 51% efficiency ratio; net interest margin of 4.92%, up 23 basis points in the quarter; net interest income up $1.8 billion year-to-date from the first half of 2007, largely offsetting the increase in net charge-offs for the same period even after adjusting charge-offs for the impact of our National Home Equity Group's new charge-off policy; reserves to total loans of 1.88%, the highest this ratio has been in five years; and Tier 1 capital of 8.24%, up 32 basis points in the quarter and up 65 basis points since the year end, reflecting our 14.6% rate of internal capital generation, among the highest in the industry, as well as two successful nondilutive capital raises since the year end 2007;

And finally, Tier 1 capital plus allowance for loan loss equal to 9.7% of average earning assets, up 87 basis points from year end. The growth, profitability and balance sheet strength reflects the benefits of our diversified business model as well as the unprecedented opportunities the credit crisis itself has created to add attractive assets at wide spreads, to add new customers, and to add market and wallet share. In Wells Fargo's case, the benefit of the credit crisis in terms of higher assets at higher spreads has so far largely offset the negative impact of higher charge-offs. We believe we are one of the few banks that have the capacity to take advantage of such opportunities.

We announced today that the Wells Fargo Board of Directors increased the quarterly common stock dividend by $0.03 to $0.34 per share, an increase of 10% from the previous quarterly dividend. This is the 21st consecutive year that Wells Fargo has increased its common stock dividend.

Let me now describe in more detail the business growth we achieved this quarter, and I'll end with a review of credit quality and capital management.

First, the Commercial business, our Wholesale and Commercial Banking Group, which serves primarily middle market customers and select niches in the large corporate market, and double-digit loan and deposit growth. Revenue grew $191 million or 8% from the second quarter of 2007. Businesses that generated strong revenue growth included lending businesses, deposit services, foreign exchange, institutional brokerage, financial products and insurance. Commercial real estate brokerage fees and capital markets revenue declined from an exceptionally high level a year ago.

During these uncertain times, Wells Fargo is viewed as a consistent and reliable source for financial advice and products by our commercial customers. Our long-term focus on doing the right thing for our customers has resulted in our ability to earn more of our customers' business and add new customer relationships. This success was reflected in second quarter's record cross-sell of 6.3 products per wholesale relationship and 7.8 products per middle market commercial banking relationships, and we continued to grow fee income during the quarter.

Wholesale Banking's average loans increased 32% from the second quarter of 2007 as we gained more loan business from our customers, added more loan production offices in select cities around the country, and added new customers directly or through opportunistic, attractively priced acquisitions such as the CIT Construction portfolio and a portfolio purchased by Foothill.

Loan growth was broad-based across many of our Commercial businesses, including double-digit growth in asset-based lending, middle market lending, international, commercial real estate, and specialized financial services, which includes our capital markets activities and relationships with Fortune 500 companies. We saw an increase in loan spreads for new business across many of our Commercial lending products.

Within Wholesale Banking, the Commercial Real Estate Group had $29.5 billion of commercial real estate loans outstanding at quarter end, up 9% from the first quarter. The disruption in the capital markets makes Wells Fargo a reliable source of funding for our existing and high-quality new customers. This growth was diversified by property type, with the largest concentration in office buildings - 28% of new loans.

This portfolio is geographically diverse, with commercial real estate lending originated through offices nationwide. The commercial real estate loans we added to our portfolio were at better spreads with stronger covenants and largely with customers we have done business with over many years and many cycles.

Wholesale's average core deposits were up $8 billion or 14% from second quarter of 2007. This growth came primarily from our relationships with large corporate, middle market and correspondent banking customers.

Our Asset-Based Lending business continued to grow during these challenging economic times. We have been in this business almost four decades, and we are one of the nation's largest asset-based lenders. This is a business that's been successful through a variety of business cycles. Loans grew $5.4 billion, up 34%, and revenue grew 21% from a year ago. During the quarter, Wells Fargo Foothill acquired 80 loans with approximately $1 billion outstanding from a national competitor. Foothill had an existing lending relationship with 59 of these customers, a great example of how we have been able to grow quality assets with both new and existing customers in this environment.

Our International Group also had double-digit revenue growth. Foreign exchange revenue was up 28% from the second quarter of 2007 and quarterly sales were up 32% from a year ago. This increase in foreign exchange sales is due to the fact that many of our middle market commercial customers require currency transactions as a result of their increased exports and increased hedging needs as well as the increased demand by our customers for international investments as an alternative asset class. Foreign exchange revenue growth through our International teller sites located in our banking stores increased 44% from a year ago. Despite a weak dollar, Wells Fargo customers continue to travel overseas, with bank note revenue up 53% from the second quarter of 2007.

The Insurance Services Group had another quarter of double-digit revenue growth. Our Consumer and Small Business Insurance Group grew revenue by 12% from the second quarter of 2007, driven by sales of identity theft protection, debt cancellation and crop insurance products.

Crop insurance continued to benefit from high commodity products. Our analysis of the recent Midwest flooding currently indicates that damage was not as widespread as it first appeared, nor was it concentrated in counties and states where we had significant exposure. Therefore, no special provisioning was required in the second quarter; however we will continue to monitor crop conditions throughout the growing season.

It is important to remember that the vast majority of our risk is borne by third parties, including reinsurers and government agencies. Our middle market commercial insurance company achieved 27% revenue growth, adding 13 new insurance brokerage businesses across the country over the past year.

Wells Fargo Financial Products Group helps our customers manage their exposure to commodity prices, equities, credit, interest rates and currencies, and creates customized commodity, interest rates, equity, credit and currency solutions for customers who want to add tailored investment alternatives to their portfolio.

The continued volatility in interest rates and credit and equity markets in the second quarter created opportunities for our Financial Products Group to expand customer sales and earn higher spreads, more than doubling revenue from a year ago. While equity capital gains declined from a year ago, equity and commodity trading areas and customer derivative sales were all very strong this quarter. Our institutional brokerage company produced record sales of fixed income products.

Wholesale Banking continues to invest in better distribution to meet our customers' needs. We are the only provider of browser-based mobile banking for commercial customers, and we've added wire transfer services and image-positive pay functionality to the CEO Mobile service. CEO Mobile is a streamlined mobile optimized version of the Commercial Electronic Office portal. We added this functionality because our customers told us they wanted to handle wires and check exceptions without being at their desks.

During the past year, Wholesale Banking added 26 offices across 16 states. Acquisitions over the past year included CIT Construction, ABD Insurance, as part of the Greater Bay Bancorp transaction, insurance premium finance company Flatiron Credit Company, and Transcap Associates, Inc., a factoring and trade finance business. These acquisitions expanded our capabilities and give us further opportunities to better serve our customers.

Let me now shift to the Community Bank. The Community Banking Group, including regional banking, wealth management, home equity, mortgage banking and retail Internet had double-digit revenue growth, up 22% from the second quarter of 2007, driven by 17% earning asset growth and 16% fee income growth in retail banking and mortgage.

Net income declined $268 million from a year ago, reflecting a pre-tax credit reserve build of $1.1 billion. Core product sales, what we call solutions, were $5.7 million in the second quarter, up 18% from the second quarter of 2007. California continued to be one of our fastest-growing states, with a 21% increase in core product sales from a year ago.

Sales growth continued to be driven by improved customer service, higher sales force productivity and new product development. We continued to add more salespeople with platform banker FTE up 8% from a year ago, while sales grew at more than twice that rate. In the second quarter, core sales per platform banker FTE, a key measure of our productivity, were 5.24 per day, up from 4.78 per day a year ago, a 10% increase.

Once again, regional banking achieved record cross-sell. Our average retail bank household had 5.64 products with Wells Fargo, up from 5.4 products a year ago and up from around 3 products 10 years ago. Twenty-three percent of our retail bank households had over 8 products with us - our long-term goal - nearly double the amount of households who bought 8 products five years ago. In our top region, 32% of our retail bank households had over 8 products with us.

We have had strong growth and better customer penetration across many product lines, including Wells Fargo packages which include a checking account and at least three other products, such as a debit card, credit card or savings account. Package sales were up 33% from the second quarter of 2007, purchased by 72% of new checking account customers and up from 66% a year ago.

Total card fees, including credit and debit cards, were up 14% from the second quarter of 2007 as we earned more of our customers' business. Thirty-eight percent of our Retail Bank consumer households had a Wells Fargo credit card, up from 36% a year ago and up from 27% five years ago. Purchase volume on consumer credit cards was up 13% from the second quarter of 2007. Ninety-one percent of our consumer checking account customers had a debit card, up from 86% five years ago. Debit card purchase volume growth slowed in the second quarter, up 3%.

Consumer checking accounts were up a net 5.5%, the highest growth in over three years, and small business checking accounts up a net 2.4% from last year. California continued to be one of our fastest-growing markets, with consumer checking accounts up a net 6.7%. This was the 12th consecutive quarter where net new accounts in California exceeded the average across our 23 Community Banking states. Texas also had strong growth, with consumer checking accounts up a net 6%.

While deposit pricing in many of our markets remain competitive, we continue to be disciplined in deposit pricing, with the average rate on our interest-bearing core deposits declining 86 basis points from the first quarter. Our short-term CD rates in particular have been less aggressive than many of our peers. On the other hand, the steepened yield curve has allowed us to attract longer-term deposits from retail customers at attractive rates. Our highest-yielding CDs are at maturities greater than 12 months for the first time in eight quarters. Average retail core deposits, which exclude wholesale banking and mortgage escrow deposits, were up 5% from a year ago and 4% annualized on a linked-quarter basis.

We continue to increase the number of small business customers we serve and to better serve our existing customers with store-based business solutions, which were up 18% from the second quarter of 2007. Sales of Wells Fargo Business Services packages, which include a business checking account and at least three other business products, such as a business debit card, credit card or a business loan or a line of credit, were up 31% from the second quarter of 2007 and were purchased by 48% of new business checking account customers. Loans to small businesses, loans primarily less than $100,000 on our business direct platform, grew 10% from the second quarter of 2007. Business banking household cross-sell was 3.6 products, up from 3.5 products a year ago on a comparable basis.

Our Wealth Management Group achieved record results, with revenue up 13% and net income up 29% from second quarter 2007. These strong results were driven by double-digit loan and deposit growth. Private banking, servicing our highest net worth customers, was the group's fastest-growing segment. Private banking revenue increased over 50% from a year ago and net income grew 85%, driven by very strong deposit and loan growth. This shows we're seen as a premiere provider of financial services, enabling us to gain more of our customers' business and attract new high net worth customers.

Wells Trade, our online brokerage service, had double-digit revenue and net income growth and continued to attract and retain customers, with account levels up 14%. Wells Trade assets under management grew 8% from the second quarter of 2007; strong growth considering the S&P 500 dropped 15% during the first half of 2008.

Internet sales are an important channel for overall sales growth, with core consumer product sales up 16% from the second quarter of 2007. We had 11 million active online consumers, up 14% from a year ago. Sixty-seven percent of all Wells Fargo consumer checking accounts are online. We now have over 1 million active online small business customers, up 20% from a year ago. Core small business product sales were up 44% from a year ago, driven by strong growth in deposit products.

We opened 19 banking stores during the second quarter, and we are now serving our retail customers through our 3,330 stores in 23 states. We welcome the customers and team members from United Bancorporation of Wyoming, a banking acquisition we completed on July 1st. We are now the largest bank in Wyoming. Through acquisitions and internal growth, we added a total of 350,000 net new retail bank households from a year ago, with 219,000 added since December 31, 2007. We also added 26 webATM machines, brining our network total to 6,950, and we converted 24 to Envelope-Free webATM machines.

The housing market slowdown and home price depreciation continued to significantly affect many mortgage companies in the second quarter, but our mortgage business continued to benefit from its premiere reputation and leadership position in the industry, resulting in a high level of originations of high-quality products at improved margins.

Mortgage banking non-interest income was $1.2 billion in the second quarter, up $566 million from the first quarter and up $508 million from a year ago. While total retail mortgage originations were basically flat from a year ago at $31 billion, our origination of conventional, conforming and government guaranteed mortgages increased 40% from a year ago and represented 95% of our total home mortgage originations, up from 60% of originations a year ago. Total originations, including both retail and third-party channels, of $63 billion were down 22% as we intentionally pulled back our third-party mortgage and home equity originations over the past year.

The fact that originations have remained relatively strong from a year ago while we've continued to tighten our pricing and underwriting standards demonstrates the opportunity we're realizing in the marketplace to add high-quality business and top producers during a period when many mortgage companies have decreased their capacity or exited the business entirely.

Mortgage applications were down from last quarter and a year ago, but still a very high $100 billion. Forty-four percent of these applications were for refinancing, down from 62% in the first quarter. The volume in purchase applications increased to $56 billion in the second quarter, up from $50 billion in the first quarter but down from $68 billion in the second quarter of 2007. We ended the second quarter with an unclosed pipeline of $47 billion.

The $566 million linked-quarter increase in mortgage non-interest income reflected a $609 million increase in net gains on mortgage loan originations and sales activities and a $52 million decline in servicing income. The $609 million net gain on origination sales activities reflected wider margins, lower levels of additions to the repurchase reserve, lower write downs of repurchased mortgage loans, an increase in the value of commercial mortgages held for sale, and an increase in the servicing value of the mortgage warehouse and pipeline. These improvements were largely driven by higher interest rates and more stable liquidity in the mortgage market.

The decline in servicing income reflected a loss of $65 million that consisted of just over $4.1 billion increase in the fair value of MSRs, offset by a corresponding $4.2 billion loss in the value of the economic hedge. The increase in the fair value of MSRs and the decline in the value of hedges were influenced by a 50 basis point increase in mortgage market rates and the resulting deceleration in prepayment speeds and the movement of a large portion of the servicing portfolio to being out of the money for refinancing. This was partially reflected in the drop in refinancing activity in our mortgage applications this past quarter.

At the end of the quarter the ratio of capitalized MSRs to total mortgage loans serviced for others was 1.37% compared with 1.42% a year ago and 1.08% at the end of the first quarter. Some of the increase in this ratio is mix related since our servicing portfolio now has a lower percentage of ARMs, more FHA mortgages, and less jumbo mortgages. Our owned servicing portfolio grew 7% from a year ago. That's somewhat slower growth than prior periods as we continue to reduce third-party originations and purchase substantially less subprime and Alt-A servicing rights. Over 90% of the mortgage loans we service are for prime customers.

Reflecting the continued stress on the housing market, the foreclosure rate continued to increase to 1.06% at quarter end, which we believe was still better than the industry average. We continue to work closely with our customers to keep them in their homes. We have invested significant resources into proactively contacting and working with borrowers on casebycase solutions that align with their individual needs and that respect the important role investors play in this process.

The homeowner's willingness to work with us is crucial to our success in keeping people in their homes. We conducted a study of servicing customers who were up to 60 or more days past due on their loans and not in foreclosure or bankruptcy and found that of every 10 of these borrowers, 7 worked with Wells Fargo and reached a solution, 2 declined our help, and the remainder were either unreachable or a solution could not be found.

Let me now shift to credit quality. Overall credit quality deteriorated in the second quarter. Net charge-offs in the second quarter were $1.5 billion or 1.55% of average loans annualized. As previously disclosed, beginning in the second quarter we changed our home equity charge-off policy from 120 days to no more than 180 days, consistent with FFIEC guidelines. The impact of this change deferred approximately $265 million in home equity charge-offs from the second quarter, although the change in policy did not reduce second quarter provision expense, which included the deferred charge-offs.

To illustrate the performance of the different parts of our $399 billion loan portfolio, let me review the segments in detail.

The deterioration in the overall loan portfolio largely occurred in the second lien home equity portfolio, which represented about 19% of the total $399 billion in loans outstanding. At quarter end we had approximately $84 billion in home equity loans managed by our National Home Equity Group, of which about $12 billion were in the first lien position.

Second quarter losses in the total home equity portfolio were $342 million, which, as indicated, was approximately $265 million lower than it would have been because of the change we made in our home equity charge-off policy. Of the $342 million in loss, $97 million was in the liquidating home equity portfolio, loans primarily sourced through third parties. The remaining loss of $245 million was in the core home equity portfolio, about 98% of which was sourced directly through our retail system.

Loans originated through our retail system have performed significantly better than the loans originated through third parties. In terms of financial risk, the principle distinction between the liquidating and the core portfolios is that, due to the continued decline in home prices, 71% of the smaller, liquidating portfolio had a combined loantovalue of greater than 90% at quarter end based predominantly on estimated home values from March 2008, automated valuation models, and May 2008 home price indices, whereas 38% of the core portfolio had updated combined loantovalues above 90%.

Until home prices stabilize we expect higher losses in the home equity portfolio. It is important to remember that most of our home equity borrowers are current with their loans. Only about 2% of the accounts are two or more payments past due at quarter end.

We are working diligently but aggressively with our customers to avoid problems and mitigate loss. The change in home equity charge-off policy this quarter was made to provide additional time to work with those customers who may be experiencing financial stress but have the potential to resolve their difficulty. During the second quarter, that change in policy benefited nearly 900 customers, with approximately $90 million in balances. By working with these customers and finding solutions to their financial difficulties, we believe we will end up keeping more customers in their homes and mitigating loss.

In addition to exiting most indirect home equity origination channels last year, we have been managing accounts to reduce risk while at the same time remaining open for business to our creditworthy retail customers. As a result of our active account management and tightening of credit for new originations, total home equity outstandings were flat this quarter. The liquidating home equity portfolio is down about $800 million or 7% from year end.

The $75 billion first mortgage portfolio experienced slight deterioration, but losses remained relatively low. Second quarter annualized charge-offs were 0.53% with $97 million in total losses, up slightly from $75 million in the first quarter. The relatively low loss rate in our total first mortgage portfolio largely reflected the fact that we never offered option ARMs or negative amortizing products as well as the conservative underwriting in mortgage products we have traditionally held in the portfolio.

Our first mortgage portfolio consisted of $25 billion of real estate secured loans held at Wells Fargo Financial, $12 billion of home equity loans in the first mortgage position, mostly retail originated, and $38 billion of mostly prime, customer relationship-based first mortgages held at Wells Fargo Home Mortgage, regional banking, or our Wealth Management Group.

As we continued to tighten our underwriting standards in the second quarter, the growth in this portfolio slowed, up only 2% from the first quarter. We continued to adjust our maximum LTVs based on local market conditions, enhanced our income documentation standards, and further adjusted our risk-based pricing as we continued to strengthen our new origination requirements and loan quality.

Within the first mortgage portfolio, Wells Fargo Financial had a total of $25 billion of debt consolidation loans originated through Financial's U.S. retail stores at quarter end. Because of the decline in real estate values and active account management, debt consolidation loan growth has continued to slow, with the portfolio up only 2% from the first quarter compared with a 15% increase from second quarter 2007. Ninety-six percent of the $25 billion debt consolidation portfolio was in a first lien position.

Wells Fargo Financial team members who originate these loans underwrite to the customer first and the collateral second. This portfolio does not include interest only, stated income, option ARM or negative amortizing loans. New real estate customers primarily come from outbound calling to customers with a Wells Fargo relationship where we can clearly demonstrate a tangible benefit for our customers by improving their financial situations through debt consolidation.

We conservatively underwrite these loans with full documentation and require income verification. Sixty-two percent of this portfolio had a FICO score above 620. The average LTV was 78%. The average loan size was $132,000. Approximately 53% of the portfolio was fixed-rate loans. The remaining loans were 327 adjustable rate mortgages with a fixed payment for the first three years of the loan. These loans were underwritten to a fully indexed rate and do not contain teaser rates.

Based on the current interest rate environment, starting in the second quarter most of our adjustable rate mortgages that reset throughout the rest of 2008 will reset at the same rate or below their current rate, which will actually reduce customer monthly payments. Like other real estate secured portfolios, delinquencies and charge-offs have increased due to the weak housing market. Second quarter losses were $48 million or a 0.76% annualized loss rate. The credit performance for this portfolio has continued to perform significantly better than published industry rates for nonprime mortgage portfolios.

The size of Wells Fargo Financial's $27 billion auto portfolio declined 14% annualized from last quarter and 12% from last year, reflecting a tightening of account acquisition strategies to reduce loan volume in higher-risk tiers and tiers with unacceptable returns. Credit losses declined $47 million from the first quarter, in part seasonal, and included only $23 million over second quarter 2007. Losses in this portfolio totaled $242 million or about 16% of Wells Fargo's overall quarterly losses.

Total delinquencies increased 16% and 90 days past due and still accruing increased 22% on a linked-quarter basis due to the weakness in the overall economy and seasoning of the portfolio. Delinquencies were flat and 90 days past due were up 11% from the second quarter of 2007. Approximately 50% of the portfolio was for cars or vans, with the other 50% for trucks and SUVS, and just under one-third was for the purchase of new vehicles. Almost 75% of the auto portfolio had a FICO above 620. We are pleased with the improved performance of the auto portfolio under a new management team, new collections and underwriting systems installed a year ago, and tighter underwriting and pricing.

We announced this month that we are exiting the auto leasing business. About 10% of the auto portfolio and about 6% of year-to-date originations were from the lease business.

Our $13 billion Community Banking credit card portfolio is a relationship product primarily offered to our Wells Fargo customers within our banking states. Credit losses have increased from historically low levels as the result of higher bankruptcy rates, seasoning of the portfolio, and continuing economic pressure on consumers, but they remained within our profit model expectations and historical industry norms.

We continue to tighten our underwriting standards, which reduced new account growth but increased the quality of our new customers. We proactively manage our existing accounts, including placing accounts in nonexpansion queues, lowering and in some cases closing credit lines, and for a small percentage of accounts, repricing them consistent with the customer's current risk profile. Since the vast majority of our bank card customers have other relationships with Wells Fargo, we monitor customer behavior using both internal and external measurements.

Wells Fargo Financial has a $7.4 billion credit card portfolio, flat for the first quarter. These cards are primarily sold to Wells Fargo Financial customers and through retailers and manufacturers with large dealer networks, not through mass mailing campaigns. Financial's card portfolio consisted of three different portfolios - $2.7 billion in standard credit cards sold to Wells Fargo customers, $2.8 billion in our retailer portfolio, which is a private label card similar to sales finance, and $1.4 billion in cash on demand, which looks like a credit card but can only be used at an ATM, not at a merchant.

Losses in Wells Fargo Financial's card portfolio increased $18 million from the first quarter; however we have made significant investments in default management, continue to tighten underwriting standards, and appropriately price for risk. The net interest spread on total credit cards is positive, even with the higher loss rates in this portfolio, so growth in this portfolio added to earnings even as dollar losses increased in the second quarter.

Within our $168 billion commercial and commercial real estate loan portfolio, we have an $11.8 billion business direct portfolio consisting primarily of unsecured small loans and lines of credit to small business owners nationwide with an average balance of less than $20,000. Business direct losses, which were up about $30 million linked quarter, showed signs of stabilizing near the end of the second quarter as a result of almost 18 months of tightened underwriting and account management activities targeted at reducing exposure to the highest risk accounts. However, losses in this portfolio, as in all of our loan portfolios, will obviously be impacted by how the overall economy performs.

Our remaining commercial and commercial real estate portfolios continue to produce good credit performance. While losses have increased from historical lows, they were still below historical averages. Losses in commercial lending are lumpy by nature, but we continue to benefit from our focus on deep and long-term relationships.

At the end of the second quarter we had approximately $6 billion in residential one-to-four family construction and land development loans, which was only 1.5% of total loans. While losses in this portfolio increased due to the decline in the residential real estate market, losses remained acceptable because of the quality and experience of our people and customers, and we continue to maintain a high level of discipline in our credit underwriting standards across our commercial and residential real estate businesses.

Total nonperforming assets were $5.2 billion or 1.31% of loans in the second quarter compared with $4.5 billion or 1.16% of loans in the first quarter. The majority of the increase in nonperforming assets was concentrated in portfolios affected by residential real estate. The nonperforming loan increase was affected by our strategies to reduce losses in home mortgage, home equity and Wells Fargo Financial. We work hard at keeping our customers in their homes and have increased the number of loan modifications. Accounting rules require us to classify these restructured loans as nonperforming until the customer demonstrates the ability to make payments under the revised terms. We require six monthly payments before returning the loan to accrual status.

The home equity charge-off policy change also contributed to the increase in nonperforming loans as fewer loans were charged off this quarter. Due to market conditions, we continue to hold more foreclosed properties than we have historically. Loans 90 days or more past due and still accruing, excluding insured and guaranteed Ginnie Mae and similar loan balances, increased by $150 million from the first quarter. The increase this quarter in real estate construction was due to matured loans to a few homebuilders with whom we are working on restructuring.

With the additional $1.5 billion of loan loss provision above charge-offs this quarter, our allowance for credit losses was $7.5 billion, nearly double the $4 billion allowance a year ago. At quarter end, our allowance as a percent of total loans was 1.88%. We believe this allowance is adequate for losses inherent in the portfolio at June 30, 2008.

Let me conclude with a few final comments about our balance sheet. During the last year we've added approximately $20 billion to our available for sale securities portfolio. The $91 billion portfolio at quarter end was largely comprised of agency mortgage-backed securities, private CMOs, which were mostly AAA rated, and smaller amounts of hybrid preferreds and other securities. The securities that have been purchased during the past year were purchased and are being held for their attractive long-term yields.

Stockholders' equity was $48 billion at June 30, up $757 million from a year ago even though we provided $3.4 billion in excess of net charge-offs over the last three quarters. Our leverage Tier 1 capital and total capital ratios were 7.35%, 8.24% and 11.23%, respectively, all up from year end and the first quarter levels even with our very strong loan and securities portfolio growth.

During the second quarter we issued a $2.5 billion tax-deductible hybrid capital security. The security had the lowest coupon for a Fed Tier 1 eligible capital security issued in 2008 and was nearly four times oversubscribed, reflecting the continued strong demand for Wells Fargo securities in the capital markets. Unlike many large bank peers, we have additional capacity to issue non-dilutive capital.

In summary, second quarter results demonstrate the diversity and strength of Wells Fargo's business model and our ability to continue to grow and invest in our franchise. While we continue to tighten our underwriting standards and price for risk, the asset and customer growth we achieved this quarter demonstrates that Wells Fargo continue to be viewed by our existing and new customers as a strong and reliable provider of financial services. While the credit crisis has resulted in higher charge-offs, the impact of these charge-offs has so far largely been offset by the benefit of higher assets at wider spreads, in part created by the credit crisis itself.

Thank you for listening. If you have any questions, please call Bob Strickland, Director of Investor Relations at 4153960523.

Question-and-Answer Session

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