Wells Fargo (WFC) Presents at 2018 RBC Capital Markets Financial Institutions Conference (Transcript)

Wells Fargo & Co. (NYSE:WFC) 2018 RBC Capital Markets Financial Institutions Conference Call March 7, 2018 2:00 PM ET

Executives

Neal Blinde - Treasurer

Analysts

Gerard Cassidy - RBC

Gerard Cassidy

With us is Neal Blinde. Neal has been the Treasurer at Wells now since November 2015 and he’s had over 14 years with the Company in a variety of roles. So, again, thank you so much for coming, Neal. We appreciate it.

Neal Blinde

I’m about 16 years with the Company now and on the management team. So, logically that makes me one of the new people. We’ve got a really good mix of new management that’s coming up from the outside and then we’ve also got a great mix of people that are very long-tenured with the Company.

Gerard Cassidy

And when you look at the long-tenured, just sticking with management for a moment. With the blend years ago of the Norwest and Wells Fargo, but now I would assume, it’s primarily -- it’s just the Wells Fargo, I mean not legacy Wells Fargo. But, it’s the combination of the two companies.

Neal Blinde

It’s really Wells Fargo and Wachovia. And we’re seeing a real diversification in the geographies as well. We’ve obviously got our headquarters in San Francisco. That’s the primary geography for the management team. But we’ve got a very significant presence on the East Coast as well. The head of our Wealth and Investment Management division is here in New York. We have a big presence through Wells Fargo Securities in this market. And then, in Charlotte, North Carolina, which was the headquarters of Wachovia, we also have obviously very large presence.

Question-and-Answer Session

Q - Gerard Cassidy

Sure. Maybe we could start, obviously, the big news recently is the consent order, of course. And Tim has been very explicit on you guys are open for business. Can you just tell us, and I know it’s relatively new, but how it’s going from a business standpoint through your customers, how you’re managing that situation with them?

Neal Blinde

Well, it’s actually matched really quite seamless, because of the timing of the consent order was somewhat fortuitous in that. At the end the fourth quarter of every year, we tend to have a fairly large build and the balance sheet. And that’s from the likes of retail customers have big inflows from the holiday season, our municipal banking customers have tax receipts that represent inflows for their business. That goes into bank deposit accounts and creates a build in assets in the bank. What we typically then see in the early part of the first quarter is an outflow as those inflows go to pay vendors and in the case of businesses that need to fund their vendors, in the case of municipalities and other customers, they go into investment.

So, that natural outflow creates some reduction in the first part of the first quarter. So, as we sit today, we experience that natural reduction in the balance sheet of the first part of the quarter. So, we’re complaint with the asset cap today with a cushion. So, that puts us in a good position to be very purposeful in the way that we approach the cap.

Now, as we get to the later part of the first quarter, we’re going to start to see some seasonal build in the balance sheet. And really, the driver for that is not related to the seasonal trends in loan production. In fact, in the first quarter, we tend to be a little bit slower seasonally in mortgage products and credit card products. But what we do see is related to taxes, people and businesses that are going to get refunds, tend to filed early. And those refunds start to come at the later part of February and into March. So, that creates build in deposits, which in turn creates a build in cash and balance sheet size at the end of the first quarter.

So, as I mentioned, we sit today with a nice cushion versus a cap. We’ve outlined some actions that we can take to manage the cap. So, as we start to see that build in deposits, there are some actions that we would likely take in the deposit category, and I can talk about some of the specifics if that’s interesting. But, we would start to take some of those actions to maintain the level of headroom and compliance with the cap that we would want to see.

Now that said, in the second quarter, we also tend to see seasonal outflows because individuals and businesses we’re going to owe taxes, tend to file on April 15th; this year, April 17th is tax due. So, we would expect to see meaningful deposit outflows at that time as people pay their taxes.

Gerard Cassidy

And similar to prior meetings, if there is questions from the audience, please feel free to ask them. Maybe talking about the deposits and managing it, I believe Tim and John talked about on the call that I think you have identified maybe a couple of hundred billion of non-operational commercial deposits as the potential is maybe being able to move some of them. Can you share with us some of the thoughts of how you guys will be able to manage that?

Neal Blinde

That’s right. So, we have approximately $200 billion of non-operational deposits. We have a $149 billion of financial institution deposits we have identified as the category we could adjust, if we needed to create some headroom for natural growth in the major lending and deposit taking categories. Those are not additives, I would note. There is some overlaps. So, you can’t just add those two numbers together. Within financial institutions, there is some operational and some non-operational.

So, the first swap in terms of creating headroom if and when we need to, and we would expect over the course of the year modest loan growth and therefore we would expect to need to take some of these actions. And in the materials that we provided when we described the consent order, we described that impact as an income impact of $300 million to $400 million. And that was really based on some of these balance sheet adjustments that on average over the course of 2018 would average in the $55 billion to $75 billion range.

So, as I mentioned, the first stop [ph] is financial institutions deposits. That customer base is a very sophisticated customer base. They tend to be large financial counterparties, so think of international and central banks. The deposit taking in that category tends to have very little to know liquidity value and they tend to be very, very short-term in nature, sometimes not even 24 hours, just overnight deposits, and they are very price sensitive. They are highest beta deposit category and are highest cost deposit category. So, that’s a customer base where we’ve seen one of our large peers in fact a couple of years ago push out in the area of a $100 billion in deposits in very short period of time to manage leverage ratio constraint.

So, this is not new territory for the sector. There are many alternatives that that universe of depositors can go to. My expectation is that the impact is very modest, and it’s a very resilient customer base. They understand the nature of the consent or they understand what this means. Notwithstanding that, even though they are financial institutions and many we think of those more as counterparties, they are truly relationships for us as well. We do other things besides deposit taking. So, we will be very purposeful in all cases where we are making decisions about specific loans and deposit. And it won’t all be financially driven. So, if there are things in the nature of relationship that would cause us to keep particular deposit, even though it may have low liquidity value or it may be particularly more costly, that all -- that relationship factors into the equation.

Gerard Cassidy

From a technical standpoint, can you just share with us or go over just the timeline between where you are now through the September time date and then the end of the year and so on?

Neal Blinde

Sure. So, there was a requirement that we file plan with the Federal Reserve within 60 days of the consent order, which we received on February 2nd. This goes without saying, but we take the consent order very seriously at the Company. We are stacking up all of the needed resources and management is devoting significant time to satisfy the requirement of the consent order within the timeline that Federal Reserve has laid out for the Company. So that timeline begins with this 60-day plan submission. The Federal Reserve will make a determination as to whether or not our plan is adequate in the areas of operational risk, compliance and the Board’s oversight of those activities. We will then implement, once we satisfy that they are there adequate and satisfy the Federal Reserve, we’ll implement those plans immediately. And in the period from the submission of those plans through the implementation to September 30th, we will engage a third-party to come in and in effect validate that we have adequately implemented those plans. The Federal Reserve will then have the benefit, both of its supervision and evaluation of what we’ve done and what has been provided by the third-party. They will evaluate that information, they will make a determination. And if that satisfies the requirements in their view, they then could lift the cash at that time.

Gerard Cassidy

Now, as part of the consent, does the Fed have to get back to you before the third party finishes their review or there is no restriction on when they get back to you?

Neal Blinde

There is not a hard timeline in terms of the Federal Reserve’s review of the materials that we provide. I do believe that the Federal Reserve very much wants to see us satisfy the requirements that they’ve provided, and that they will work with us along the way. I would also note that this isn’t a process that’s a black box where we go and do some work up until September 30th and submit that to the Federal Reserve, not knowing if it’s consistent with the objectives that they intended to lay out for us. The Federal Reserve has engaged with our Company. They are active in their supervision of the Company. And it’s our intent along the way to preview the steps that we are taking, to preview the milestones that we are achieving along each step in the process. So, if there is any point between now and September 30th that we need to adjust course to ensure that we are satisfying the requirements that we do that in a timely way.

Gerard Cassidy

Just circling back to your comments on the deposits and have you identified the nonoperational and the financial deposits, physically how do you get them to leave, [ph] do you just lower the rate or do you physically talk to them and explain the situation and the customers move their deposits? But, how does that actually happen to...

Neal Blinde

So, that market is a highly liquid and fluid market; it’s ebbing and flowing every day. Like I said, in many of these cases, the deposits will come in late in the day and they’ll leave early the following day. So, there is a price discussion. It is a very price-driven market. There is relationship associated with that. And so, as that market ebbs and flows, pricing can be part of that discussion. Obviously the decisions that we’re making first and foremost are centered around minimizing the impact to our customers and ensuring that financial risk management stays at the level that we think is required for our Company. So, we won’t be doing anything that we think is detriment to financial risk management. The next sort of priority is we will be looking at strategic impacts, financial impacts, meaning specifically what does it mean to the margins and returns for our business. So, it would be natural by extension that some of the highest costs, lease strategic deposits would be the first that we would reduce in that process. But, it is, I should be very clear, a very bespoke processes. These are not just transactions, they are relationships behind the transaction. So, we will be very thoughtful of each adjustments that we make.

Gerard Cassidy

When shifting over and talking about interest rates, what’s your guys’ expectations on interest rates? And do they differ much from the forward curve in terms of what the forward curve is calling for and Fed fund rate increases?

Neal Blinde

So, our perspective on rates we do love our securities division, we publish economic forecast. For the corporation, we don’t give a public rate view. But, what I would say is that what’s been produced by Wells Fargo Securities, which is fairly consistent with what you see from other third-party economists in my mind is fairly noncontroversial. So, that would suggest that we do have room for additional rate hikes over the course of the year. I would note that we’ve taken some actions to change our asset sensitivity on the balance sheet, as a result of that view.

The group will probably recall that for a very long period of time, we were quite outspoken in our perspective that rates were going to remain low for an extended period of time. And as a result of that, between 2014 and 2016, we’ve put on $86 billion at peak of swaps to extend the duration in our portfolio and reduce our asset sensitivity. That produced tremendous financial benefits to the Company because during that period we did realize low -- a consistent low rate environment. The result of that was that we added about $3.1 billion of carry during that period. Since that time period -- and it was really around September of 2017, we started to take the view that economic factors including inflation, expectations, policy within the U.S., we also very closely evaluate both economic equation and policy internationally because that becomes constraining at the long end of the curve. When I woke up this morning, Germany’s 10-year level was about 70 basis points. So, a significant delta. That makes levels in the U.S. look quite attractive. And over the longer term, that could still be constraining. That’s something that we’ll continue to monitor, once we get -- once we get further out.

But notwithstanding that, the view was, we now really saw a path for the Fed to start increasing rates. So, in September, we started swap unwind. We accelerated that into the fourth quarter. At the beginning of the first quarter, the first couple of weeks of January, we unwound substantially more swaps and described that on the earnings call. And then shortly after the earnings call, we unwound the remainder of our swap. So, all $86 billion have now been unwound.

The economic cost of that is a little under a $1 billion that will be amortized over the average remaining life of the swaps, which is roughly three years on average. So that had the end result of boosting our asset sensitivity at the Company from the low end of our target range, which is 5 to 15 basis points of increase as a result of a 100 basis points increase parallel shift. So, we have now moved from the low end to the midpoint of the curve -- or the midpoint of that target range for the reasons that I described, we think it’s an appropriate risk management activity because we view that the bias of risk in interest rates has moved to the upside rather to the downside. So, I think that’s all very consistent.

Now, the two other points that I’d make is first, philosophically, our Company will always probably remain a little bit closer to neutral than the peer group on average. And the reason for that is we think it’s beneficial from a risk management perspective to have less volatility in earnings and ROA, we also think that it’s very difficult on a consistent basis to outperform the fixed income market by speculating on rates. So, we’d like to take that risk off of the table, and for that reason, you’d expect us to operate closer to neutral and have a little bit of resulting stability.

The second point, I’d make, which is really tangential to this is because we’ve observed some fairly significant moves in rates recently and I’d note that we unwound -- we completed our unwind of the swaps before they were at the level that we’re at today, so we have some real economic benefit by average of our timing. We’ve seen not only upward movement in rates but we’ve also seen some change in basis. So, for instance, the relationship between LIBOR and OIS, those factors in combination with the upward movement in rates would tend to produce some negative hedge in effectiveness to the Company. So, I would expect some of that this quarter, if those changes that we see through today, remain durable through the end of the quarter. That said, I wouldn’t expect the kind of magnitude that we’ve seen historically because we adopted accounting change, which really leaves those impacts to a large degree.

Gerard Cassidy

On the swap amortization of $300 million, that goes to the net interest revenue line then, or is that just a expense in the P&L?

Neal Blinde

Net interest income. And it’s actually, -- it’s now upto $1 billion that will be amortized over three years. So, you may be doing the math of a third of that roughly. Yes. That’s the geography.

Gerard Cassidy

A tiny headwind relative to the size of your net interest revenue?

Neal Blinde

Right. This is probably obvious but I will say it. The real benefit of the swap unwinds increases as rates increase. So, it becomes more beneficial with each successive rate increase.

Gerard Cassidy

We’ve been talking a lot at the conference about the right side of the balance sheet. This industry has been very fortunate to have taken in a lot of deposits over the last seven, eight years, partly due I think to the Fed quantitative easing now we are going into shrinkage. Aside from the operational part that you -- non-operational part on the deposits, how about the core deposits? What are you seeing in the consumer area, your core deposits? Are the betas holding tight or they’re turning to move up, what are you seeing in that part of it?

Neal Blinde

Yes. I would really describe, all three of the major deposit franchises, as core for our Company. So that’s commercial deposit taking franchise, the wealth deposit taking franchise, which is obviously heavily concentrated in sweep deposits, and then the community banking franchise, which is where we’re the largest retail deposit franchise, in the U.S. So, I’ll talk about each of those.

Starting with commercial. What we are seeing in the market today is very consistent with what we’ve been seeing in the market for some time, really for over a year and that betas in that are behaving the way we model them to, not better than model, not worse than model, very consistent with the way we model them. They’re more responsive than the other categories.

The wealth and investment management deposits were behaving better than model until the end of the second quarter 2017. That’s when we started to see a couple of things happen. The first is, we started to see customers migrating a little bit more rapidly out of deposits and into other risk assets, so into bonds and into equity. So that created some reduction and there needs to be some pricing response related to that. The second is, we started to see some of the peers increase rates on their sweep deposits. We increased rates in our sweep deposits in response to those market levels. So, we’ve really seen that across the group. And now, they’re behaving more like model today. So, it’s fairly consistent with how we model, not better.

So, that leads to community banking deposits, which to-date really haven’t seen any movements in the betas. The betas have been effectively zero in that component of deposit taking. I would suggest however that that is likely in front of us. It’s likely a little bit more significant this cycle than we’ve seen in prior cycles. And if you go back to our Investor Day in 2015, in my presentation, I shared a slide that broke down the component pieces of that 5 to 15 basis-point assets sensitivity. And one of those was the response rate overall on our deposit book. And what I described at that time was a response rate of 45 to 55. The last time, we had described betas to the market and the Investor Day two years prior, it was 40 to 50. So, we have increased, based on expert judgment, there is nothing in the data that tells us that they’re going to be more responsive this time. But, we recognize that there have been some demographic changes and also the ability to move deposits is more fluid than it’s been in the past. So, we’ve made some of these adjustments. So, we’d expect that to play out as we get further into the rate hiking cycle. And incidentally for net interest margins, that’s going to be the single largest determining factor, what happens with ours and what I think happens with industry net interest margins.

Now, the last point that I would make in this category is even though we haven’t seen in the interest income line those betas start to move up, I would argue that we have seen it in total costs. We haven’t seen it in this way at our company. But in the market, there has been very significant deposit, acquisition activity by virtue of our front offers. Everyone in the room probably regularly receives an offer of $500 to $1,000 to open a new primary checking account from any number of banks, set a bill pay and start transacting for a period of time. That’s been fairly prevalent for over a year. It’s a very good deposit acquisition strategy. We haven’t had a need to deploy it, because we’ve been roughly 68% deposit funded and we’ve had relatively modest loan growth. So, we haven’t had a whole lot of pressure. It’s certainly something that we would do when -- if and when we get into a period where we need to drive more deposit growth. That comes as a cost. That cost comes through as a marketing expense. So, it does not show up in betas. But it is a very real cost that the industry is experiencing.

Gerard Cassidy

When we look at deposit betas, particularly in the community bank, have you guys done any work, or do you have any history that says that when the Fed funds rate gets to X, you’re really going to see these betas take off? Because going from zero to 25 basis points to a 125 basis points in Fed funds is maybe not enough…

Neal Blinde

It doesn’t mean a whole lot. They have $25,000 in the bank that 25 basis points…

Gerard Cassidy

Correct. Is there any number that you guys look at and say, if Fed funds gets to 3%, these guys are going to start moving the money or whatever the number may be?

Neal Blinde

I get asked that question a lot because conventional wisdom suggests that the first 100 basis points of the cycle are zero beta and then you have some catch-up and you get into a more normal trend. We don’t hold out specific level that people are going to see that catch-up. The way that our modeling works is our modeling at this point in the cycle suggests every quarter that the next quarter is the quarter. Now, our expert judgment tells us based on what we see in the market that that model is conservative at the moment. And the primary reason for that is that these models are driven predominantly on historical experience versus rate. So, you are correlating relationships between deposit rate and an index rate. What it doesn’t -- what they don’t take into the equation as well is what’s happening with loan production and other earning assets, because it’s increases in loan production and other earnings assets that create the demand dynamic for the deposits and it’s the competition that follows that demand to drive beta. And because we’ve had moderating loan growth in this environment, we haven’t had as much pressure on the need to generate deposits in that competition.

And then, the last point that I would make is that the nature of competition is quite different. And I understand that you’ve heard some of this at the conference that now we’ve got a dynamic that there are segments of the market that have outsized capabilities, particularly in the mobile area, and that adds tremendous value to the customer that’s not in the form of rate paid. So, there are I think market share dynamics going on where institutions that have those mobile capabilities, in particular mobile and online capabilities are able to attract deposits in a non-rate related way.

Gerard Cassidy

Speaking of which, obviously you guys are one of the leaders on digitalization, on technology spending, what do you see in terms of how the smaller banks? Are they going to be able to keep up and be as effective with some of the better products that you guys have and some of your peers have?

Neal Blinde

I think, the nature of the customer relationship at the smaller banks will be different. I think, there is absolutely a place in this market for banks of all sizes, banks can produce good returns at all sizes and banks can serve their customers at all sizes. But, I do think, they will serve them in different ways and in different geographies. So, the demographics of customers that are particularly in more urban centers, we see are very attracted to most advanced mobile technologies.

Conversely, in more rural markets where a lot of the lending activity and overall customer relationship orients around in input prints, smaller ticket C&I and commercial real estate lending a deposit -- a more traditional deposit relationship can be tied into that. And it will be part of the overall customer value proposition. That will still have benefit and value as we move forward in time. But, I think what we will see is some of those marginal customers that didn’t have the knowledge of or the access to, or perhaps the offerings weren’t quite as appealing that now are getting that access, developing more knowledge and the offerings are becoming better, it’s those marginal customers that you see move to that base of institutions that have the capability to offer it. So, I think, we will continue to see some of that migration. And it’s certainly not over, and I think it’s very healthy because it produces a better overall customer experience and customer value. Hard to say when that ebb and flow shifts. But, I don’t think that means that community and regional banks aren’t competitive anymore. They are just competitive in more targeted areas, product classes and regions.

Gerard Cassidy

We are almost out of time, but maybe one or two last questions. CCAR is coming up of course. Your guys view on -- obviously, it was little more stressful for everybody in terms of the severe scenarios or very-severe. Any color on how you guys are thinking about it and the approach you’re taking to CCAR this year?

Neal Blinde

Sure, well, first and foremost, it was more-severe. I would note that the tax impact you probably talked about, there isn’t the same tax shield that we had. So, while the tax act is very beneficial overall to the base case, in particular one of the effects is you don’t have the tax shield for the losses. People don’t focus this closely on the fact that OCI is also a part of the equation. Tax shield also is impactful to OCI. So, you not only have the heightened severity in terms of the assumption set, but the impact of that is greater because of the change in taxes. And I think the very appropriate decision by the Federal Reserve for us to reflect that. That’s reality. We need to reflect it in the stress test.

Now, in terms of our firm’s positioning. We really have been in an environment where loan growth has been fairly modest. And as a result of that, our RWAs are lower than we forecast in the last CCAR process. And therefore, our capital level is a lot higher than we forecast in the last CCAR process. So, from a quantitative perspective, we feel very good about the level that we are coming in with. And we also feel very good about the approach that the Federal Reserve is taking procedurally, this time around. We think that transparency is improving. We think that we have got a better understanding of how the models work at the Federal Reserve. Every year, we get a little bit better understanding of the qualitative process.

So, I feel good about the process and our entry point based on capital levels, notwithstanding the fact that it is a more challenging test this year. That will create deeper troughs than last year’s test.

Gerard Cassidy

I guess, lastly, if you put yourselves in the shoes of the folks in the audience, what types of questions should they be asking management teams today to help them make a decision whether to invest in the bank stock? What would you be asking management teams?

Neal Blinde

So, I think, there are a handful of characteristics that I look for. And I used to run the banks practice within the investment bank at our firm. And I’ll walk through those very quickly. So, first and foremost, I always look to the quality of the management team and the loan and deposit production franchises. And there’s a lot that under pins that more than we have time for today. But, you do want to look for durability, you don’t want to see revolving doors. And that’s not just the management commentary; that’s in particular on the commercial side of the equation because commercial lending is still very much a relationship business in this country and internationally. So, you want to look for very strong relationship-driven franchises that are able to produce consistent results over time.

Secondarily, you want to look for in the product offerings. On the consumer side, I do think it’s very differentiating today that the technological capabilities in particular that I described. And then, across both consumer and commercial side, deposit taking and lending, the breath of the service offerings. Because offering more products to a customer adds more value to the customer. Relationships with customers also tend to be more stable when they are deeper relationships, not just in size but in type of relationship. And that’s really beneficial, if you’re fixed income investor as well because those types of relationships are much stickier. Then you obviously want to look at what’s happening from an expense perspective. And the balance there is it’s very natural to just look for how much leverage can I get out of expenses within my modeling forecast horizon. What you need to be really mindful of is understanding when do those expense reductions start to erode future value or impact risk management. That’s the way we think about it at our Company as we draw the line on expenses at the point where you could put either of those to a risk, because we simply won’t sacrifice in either of those two areas.

Gerard Cassidy

Sure. We’ve run over. But, I want to thank you very much for joining us Neal. Please join me in a round of applause.

And I want to thank everybody for joining us for this year’s financials conference and companies like Wells made it a real big success. So, thank you again. And good luck to everybody trying to get home with the weather the way it is. Thank you, again.

Neal Blinde

Thanks.