Wells Fargo & Co. (WFC) Management Presents at Morgan Stanley Financials Conference (Transcript)

| About: Wells Fargo (WFC)

Wells Fargo & Co. (NYSE:WFC) Morgan Stanley Financials Conference Call June 13, 2018 10:00 AM ET

Executives

John R. Shrewsberry - Senior EVP and CFO

Analysts

Betsy Graseck - Morgan Stanley

Betsy Graseck

All right, great. Thanks everybody for joining us. Pleased to have John Shrewsberry, CFO of Wells Fargo. John has been CFO for four years now.

John R. Shrewsberry

Four years.

Betsy Graseck

At Wells for 20. And before CFO you were running the securities business?

John R. Shrewsberry

That's right.

Betsy Graseck

Yes. So, we've got a lot to talk about today, but before we kick off, I want to warm up the room on Wells Fargo, and let's get a couple of polling questions through. What do you think will be the biggest driver for Wells Fargo shares over the next two years, resolution of the consent order, accelerating capital return, stronger loan growth, stronger fee growth, or expense management, what is top of your list for biggest driver for Wells?

John R. Shrewsberry

You can only pick one, is that right?

Betsy Graseck

You could pick two, if you want, yes. We'll give you two clickers. All right, we've got resolution as number one. Let's go to the next question. What expense ratio do you think Wells is going to achieve by 2020? You can see the numbers here; 59 or higher, 58, 57, 56, 55, or lower, you can read the numbers as well as I see them. And okay, so that's a bit of a consensus but it skew to the more optimistic side I guess I would say.

So, let's kick off with a question here, John, on just the strategic repositioning of the business, because you have done a lot in auto and in just the shape of the business, having exited insurance brokerage. Maybe you could speak a little bit to how far along you are with this strategic repositioning and is there any more to do?

John R. Shrewsberry

Sure. So, three things to say. First one is, in terms of the overall strategy of what's most important and what to do now, and I'm sure this will come up in this discussion in another context, but satisfying the terms of the consent order that we are operating under strategically is at the front of the line. It has less to do with the things I'll talk about next, but I wouldn't want to overlook how important that is to just changing some things about the way the business runs to be as well-controlled in operational risk and compliance as we are and as we are known for in credit. That would be job one.

More traditionally in terms of strategy, you heard at Investor Day that for the first time ever we are running all of our consumer businesses under a single, unified consumer strategy where historically we've been much more product and channel focused, and to the extent that they were strategically aligned, it was through treaties between products or treaties between channels. And now, the leaders of those businesses set strategy together, think about customers from the customers' segment perspective or the customers' attributes perspective, and then bring the products, services, delivery around that. So that's a huge strategic pivot and it's more efficient. It's a better experience for the customer and it really changes the whole retail side of how the company works.

As it relates to some of the tactical things that we have done strategically really to sell off bits and pieces of things where we just have not been getting the return that we like, there's a few more of those things to do. None of them are game-changers. It's all pruning, where there is a business that's maybe very high functioning, but it's just worth more to somebody else other than Wells Fargo, and we have done a few of those, you will see us do at least a couple more.

We announced some sale of branches a week or so ago. That has more to do just with the general repositioning of the branch footprint. There are some that actually are worth more to somebody else than they are to us. Those are great branches but the geographies just didn't fit with the rest of our footprint.

Betsy Graseck

Those branch sales, the 52 you announced, that was embedded within the 300 you were planning on doing this year or that's over and above?

John R. Shrewsberry

Over and above. I'm going to go with over and above.

Betsy Graseck

Okay, all right. Okay, got it. And then on the consumer strategy that you highlighted, is that moving from treaty to fully integrated, is that all done at this stage?

John R. Shrewsberry

It's not – it will never be all done because it's a roadmap for how we are going to operate forever forward, but I'd say we are fully operationalized in terms of how we are prioritizing decisions, how we are thinking about product, how we are putting the capabilities and products around specific customer segments, we are operating that way. It needs to mature and it will start to show more and more results over time, but it's halfway along in terms of that maturity.

Betsy Graseck

Have you started to see it show up in revenue growth, [indiscernible] revenue growth?

John R. Shrewsberry

The first place it will show up I think is in rationalizing product sets and customizing the delivery of capability really for a higher rate of consideration and acceptance by particular customers, students, small business, mass market, emerging affluent, affluent, et cetera. It's too early to say, aha, look at that uptick, that uptick in revenue or that takeout of costs because of things that we have done with this strategy. My guess is, through this year, into next year, we'll be pointing to this strategy for all the good things that come out of each of those businesses that we get more intentional about operating in more of a segment way.

Betsy Graseck

Okay. So, let's touch base on the consent order first and then move into the operating leverage. On the consent order, you indicated that you expect to operate under the asset cap through the first part of 2019? I think I got those words right?

John R. Shrewsberry

Yes. I think that's right.

Betsy Graseck

Okay. And then Tim said a few weeks ago that you have the ability to shrink more non-core deposits to make room for more core loan growth. Maybe you could give us a sense as to how much room you have and how much core loan growth you can be generating even with this asset cap that you've got?

John R. Shrewsberry

So, because of the ambient state of deposit growth and loan growth in the markets that we are serving and because of the ability to sort of dial down FI or other institutional deposits with low liquidity value and shrink the balance sheet, the asset cap in and of itself is really not much of a constraint in terms of how we run our business. It's not a constraint on organic loan growth. We are not having to tell our folks to compete in a different way. That really isn't our issue.

So, item one, two, and three, as it relates to the consent order is satisfactorily addressing the concerns and delivering the goods under the consent order, which if it takes us a short amount of time, which is what we reasonably expect, a medium amount of time and a long amount of time, it's still getting it done right, getting it done to the satisfaction of our regulators and other observers matters the most, and we're not in a hurry because of the asset cap. I just distinctly didn't operate with the asset cap, but it's not slowing us down from running our business.

If we were in a high loan growth environment or a high deposit growth environment and with rates ticking up the way they are, you will see I think this quarter from banks reporting that especially maybe in the high net worth category there are more deposits that are moving into cash equivalents et cetera which takes even a little bit more pressure off of this calculus.

So, the asset cap is one thing and I expect it will be gone in the timeframes that we have talked about, but more importantly, it's making sure that we are focused, all our energy is focused on getting the work done right so that we are not having a debate six months from now or nine months from now about whether it should be lifted or shouldn't be lifted. The work should stand on its own.

Betsy Graseck

And at this stage, maybe you could give us some color on what's left to do for the consent order? Just the kind of questions that we have are, what part of the process are you in now, is it people, systems, are you already executing on the specific requests, and is it already embedded in business as usual, just give us a sense as to the trajectory.

John R. Shrewsberry

Yes, I mean it's different pieces. If you think about operational risk, there are either 8, 10, 12, 16 different types of operational risk. Each one of them has a different level of business as usual, maturity, or thankfully just real definition in terms of how that risk gets controlled, how that control environment gets overseen, how all of that rolls up together into aggregated risk reporting for management and for the Board. And so there is different stages of maturity.

It's the last mile of knitting all of this together so that from the Fed's perspective and from our Board's perspective that they can get delivered a real contemporaneous, risk-sensitized understanding of all of the potential risks that exist in the businesses at Wells Fargo, and so it won't be done until that is done. But some of it is business as usual, some of it is still – there is still some drawing board activity.

There isn't another firm that we are aware of from our relationships with other firms, with the regulators, with the consulting community, who has this exactly right. This is an opportunity for Wells Fargo to get it exactly right and we are getting plenty of feedback along the way. And so, my sense is, it will take all of the amount of time that we have described before we have finished the last piece of it or set ourselves on the course to maturity for the last piece of it, because you are never actually done. But some parts are further along than others.

Betsy Graseck

Got it. And you've got a few new Board members that have come in recently. Maybe you can speak to if they have same kind of expectations or have they brought with them some different expectations?

John R. Shrewsberry

Yes, so we have six new board members in the last year or so, all of whom have joined Wells Fargo's Board at a time when it's crystal clear that the bank is undergoing great transformation, that the expectations are very high, and that frankly the focus is on getting a well-controlled and well-governed firm, again specifically from an operational risk and compliance perspective. I think people feel great about credit, great about market risk. Now, everything needs to meet at the top and be governed similarly, but eyes wide open in terms of what expectations are.

So, real engagement, lot of enthusiasm for it, we are very fortunate to have as the Chair of our Board a woman who is a former governor of the Board of Governors for the Federal Reserve, which is very valuable, a senior leader from another U.S. GSIB, also very valuable. We got more technology expertise. That's a topic I'm sure we'll talk about. It's just a bigger topic in general in large banks these days either with respect to the secular changes in how we deliver to customers or cyber security, or efficiency for that matter. So, just substantially more specific expertise for what's required to succeed in a bank of our size today.

Betsy Graseck

Okay, great. So, let's move on to the operating leverage question and you saw a wide range of expectations on the expense ratio going out to 2020. You put your guidance out, you have been very clear about how you expect to execute on the expense side with branch consolidation, spans and layers, automation, et cetera, centralization. Can you speak a little bit on the revenue side and what are the main drivers of the revenue side of that operating leverage that can maybe get you towards the midpoint or the low-end of your expense guidance range?

John R. Shrewsberry

Sure. Nothing has more operating leverage than interest income. And so, to the extent that either through where rates go, both rates on the asset side and then separately on the liability side, my sense is that that will be a real contributor over the next couple of years.

On the noninterest income side, there is leverage there as well. Some of those categories tend to bear more expense. And if you tick through the line items of noninterest expense and think about what's going to be most meaningful, my sense is that we'll begin comping favorably on deposit service charges later this year, into next year. We took some specific moves that took those numbers down over the last year, so to be more customer friendly on overdraft in particular.

We have got market-sensitive revenues that will probably reflect the S&P, to pick a benchmark, but reflect where markets are going. They benefited meaningfully from an upmarket over the last couple of years. Flows are positive but harder to come by. More of the marginal return to come from performance.

Mortgage is a big topic. If rates keep ticking up or begin ticking up again I guess, it's a long end, that probably will begin to shrink the purchase market, certainly shrinks the refinancing market. And so, unless there is a big breakout in – unless employment remains as strong as it has been and a preference for ownership increases from where it is and available supply ticks up also, my guess is higher rates mean a smaller mortgage market and today the competitive forces have got people competing for margins that result in a gain that is marginally profitable for most participants in mortgage origination. So, that probably changes a little bit. We're in it forever.

So, we will be as efficient as we can be but it wouldn't surprise me if some capacity comes out over the next year or so. I don't think people, especially smaller people will be able to stay-in in quite the same way if they have an analogous cost structure. On the one hand we have more scale, on the other hand there's a lot more regulated entity, and my sense is that some of the smaller players probably compete favorably on cost with us because what they lack in scale, they benefit from in a different regulatory touch.

But in terms of its contribution to our revenue, I think we'll be fighting for retail share, we'll be aggressive with our cost structure that allows us to compete even while pricing is generally unfavorable for the industry. But I'm not looking for it to be an outsized contributor if we have burned through the refinancing wave that's existed for the last several years and if we are moving into a higher long-term rate environment, which I believe that we are unless we're going to have a really flat yield curve here in the next year or so, then that will be a headwind for the size of the market as well.

Betsy Graseck

And you have a sizable revenue pool coming from your investment line. That's something else to drive a little bit of opportunity.

John R. Shrewsberry

Yes, sure. So, we have pools of money that we invest in merchant banking types of investments through Norwest Equity and Norwest Venture Partners, and in this environment, those games keep coming through. It's a lot of technology oriented investments that pay off quarter to quarter. It's cyclical and it's hard to forecast, but it has been a benefit. We have sold some assets that where we thought that market was willing to pay prices that were too good to pass up versus hanging on to interest carry over time. We have seen that recently in some pools of pick-a-pay loans where it's just a really, really strong bid. So, produced gains on the one hand, but at least in the case of loans, there is the missing interest income on the other hand. We are making a trade-off today versus over time.

So, there is always a combination of things. There could be gains on sales of businesses that we sold, et cetera. Those are harder to forecast and they are meaningful contributors at the margin to whether noninterest income has an upward sloping trajectory or not.

Betsy Graseck

Right, okay. What about client acquisition? So, can we talk a little bit about customer loyalty? I know you have been working hard to kind of reposition the brand and maybe you could speak to how that's resonating in the field as well as whether or not you've seen any uptick in customer acquisition?

John R. Shrewsberry

So, customer loyalty, meaning people who already are customers, I think we have talked about the retail numbers each quarter, that's actually been quite strong and I think loyalty and satisfaction are back up to the levels that they were before the fall of 2016 on the retail side. Our bigger challenge and where we have been spending time and money is making sure that we are telling the story of our fixing Wells Fargo to people who aren't our customers because we'd like them to consider being our customers. That's more of a consumer topic frankly. On the commercial side, it tends to show up in politically exposed types of, muni types of activities, but not as broadly across corporate.

On the retail side, our marketing, our brand re-jiggering has been aimed at helping people understand what's going on at Wells Fargo, understand the acceptance of blame and the need to fix and the necessary work we've undergone to fix things, so the people will continue to consider us when they have a banking need changing, moving from one place to another, changing accounts, being attracted to a credit card product, mortgage origination, et cetera, to make sure that we are not limited to the pool of customer who we already have, who we care a lot about, but we want to broaden the pool.

And that has been the emphasis of it, that's what's driven the ads that you have seen on TV over the last several weeks, and the early returns of it that has had an impact and it could be effective, it could be sustained, but it appears to be effective.

Betsy Graseck

Another lever that you could lean on for revenue growth is like putting some of the technology investments you have made. Maybe you could speak a little bit to, [indiscernible] Investor Day very robust tech symposium I guess you could call it…

John R. Shrewsberry

Much like yours in the other room [indiscernible]

Betsy Graseck

Oh, did you see that? Oh yes, okay, something like that, yes exactly. Could you give us a sense as to where you are in leveraging those tools? I mean I know some of them were beta, some of them have already been launched. And give us a sense as to what you are looking for with regards to the client acquisition or growth from the tools that you have invested in?

John R. Shrewsberry

Sure. So, it starts with creating a great, an improved and a great customer experience that is much better than the history of banking which is more people and paper intensive, allows for self-service, and a real ease of use of becoming a customer, or if you are a customer, of initiating a new product or account opening, or if you have all of that satisfied, just in terms of the way you deal with Wells Fargo, you get information, you transact, et cetera. So, at the very front end is, what is the customer experience and will it be pleasing over time.

The benefits of it, as we have gone down each of the paths, you mentioned a couple of the products, are that it enables digital account acquisition, [indiscernible] from the phone in a way that takes, that also takes cost out, promotes a lot more accuracy and makes us better managers of risk. Theirs is [re-keying] [ph] of things, there's less human error, there's less paper intervention, et cetera. So, our sources of data become much more rich and much more accurate, and all of that sort of feeds what I'll mention in the moment which is this ongoing virtuous river of data that can then be redeployed for the benefit of the customer in a variety of ways.

So, some of the things that we talked about at Investor Day were the digital mortgage application. We're approaching 30% now in terms of the applications that we received digitally on the retail side. There is an opportunity there for a much better customer experience and then to take a lot of cost out, because if people are approaching this digitally, then we don't have the same compensation relationship for a human being who is responsible for the origination of the mortgage. So, the modernization of that is going to be – there's a lot of benefit that comes from it.

On the investing side, we have launched our so-called robo advisory capability. Our product is called Intuitive Investor. Right now we have it more targeted at people who are new to investing, but very easy onboarding experience, very low maintenance, but – I'm a customer – satisfying relationship with the technology, at least as satisfying as talking to a person about the portfolio rebalancing, asset allocation discussions, et cetera. And so, there is a lot of opportunity for that to broaden out in terms of what the capabilities are we deliver through it and what the customer experience is and for which customers over time. That's a big one.

Greenhouse, just talked about, which is basically our digital bank for people who are new to banking. So, there is really no people involved, it's an entirely digital experience. That will launch. It's in pilot now with team members. It will launch in 2018. And there, it's purely customer acquisition, very early in people's lives when their needs are a little bit different, and it's designed to help people become satisfied, attached customers of Wells Fargo for their lives.

The Control Tower is in pilot now and will be launched in the next quarter or two. This is the ability with your phone to really understand who among all the people that you are paying is regularly either receiving or withdrawing money from your account and information from your account. So, we have customers who give up their username and password credentials to other apps so that their information can be scraped into some sort of a data service that gives them a pleasing dashboard. And we are quick to point out to our customers that there is risk in giving your banking credentials to a stranger, and yet they do it anyway. And so, this tool allows them to turn that on and off and to control it much more seamlessly so that they can provide information but without providing people access to their money, which is what people do every day.

We've got a limited version of that today where you can turn things on and off in the app, but this idea that if you've got 50 recurring payments and you want to turn them off without having to go through a lot of phone calling of people on the other end or investigation, as quickly as hitting a button it allows you to keep track of that, because people lose track of that over time.

Betsy Graseck

And obviously, so enhancing the mobile digital experience for the consumer while rationalizing your branch structure, are you able to do a national digital consumer bank type of [indiscernible] product?

John R. Shrewsberry

Yes, it's interesting. I think we probably – so there are major metropolitan areas in the country where we don't have a presence, and it isn't currently at the top of the list in terms of things to test. As these capabilities mature, it's certainly possible. And the way to test it would be to go into one of these markets and advertise meaningfully and to really test the thesis.

Incidentally, most of those markets you would describe today as over-banked already, so it's not as though they are missing out on having a Wells Fargo or any other bank there. But if there was something, if we felt like the offering was really compelling, that would be a way to test whether that would work.

And it's not just about getting more digital to rationalize the branch footprint by the way, it's really account acquisition and customer acquisition through a variety of channels that may or may not have happened through a branch. It also takes a lot of pressure off of call centers. So, today or historically people who spend a lot of time on the phone, if they lost their wallet or if something bad happened or if there was fraud on their account, et cetera, the more digital we become, the more those things can take care of themselves or a self-serve can be provided through the mobile device, and the better the experience because call volumes are down.

People, they don't need to get somebody to solve the problem for them. That's also meaningfully efficiency-enhancing. We have more than 100 call centers and we have already begun driving down call volumes as a result of the digital activity that we have explored over the last year or two and the next couple of years will drive it down even further.

Betsy Graseck

Okay, great. So, on the path towards improving operating leverage, maybe we could shift to the numbers. Let's talk about 2Q. I don't know if we are about two weeks away from being finished with second quarter, I don't know if there's any…

John R. Shrewsberry

The second quarter ends on June 30.

Betsy Graseck

Yes, good. So, coming soon. Between now and then, we have [indiscernible] and CCAR, right.

John R. Shrewsberry

That's right.

Betsy Graseck

So, it feels like a mile away, but pretty close. Just any updates on the quarter that you can [indiscernible]?

John R. Shrewsberry

So, I wouldn't file this under guidance or I don't feel terribly differently than the last time we talked about the environment that we are operating in. I would say that I'm reading some other banks talking about upticks in loan growth and our own bankers talked about upticks in pipeline, but I'm not really seeing robust loan growth come through even if people are busy competing or planning for deals or other things that might result in loan growth tomorrow or a month from now. So, I'll be interested to see how the industry reports that.

On the deposit front, I mentioned that I think we are starting to see certain categories of high net worth deposits, excess liquidity gravitate toward money market equivalents for higher yield than bank deposits pay. You probably see that in the numbers at the margin. Not the most valuable deposits from a liquidity value point of view, but people as expected beginning to appreciate how far we are from zero and what a one-year or two-year yield might be and moving excess liquidity in that direction. That would be in the numbers I think.

Markets related revenue reflecting where we are. This, I think there is an expectation suddenly for more M&A [indiscernible]. I don't think we'll see it into second quarter numbers, but this AT&T-Time Warner outcome really probably does begin to allow some discussion that's already been happening behind the scenes for larger dollar investment grade M&A to occur. That could be really interesting for our business and for others because those tend to get backed up by funded or unfunded bank commitments and DCM takeouts when they happen. So, I think that will probably be better than maybe you might have thought a month ago or a week ago or even before yesterday. Not a Q2 item, but just in terms of what's in the offing.

Betsy Graseck

Got it. Maybe we could end just talking a little bit about capital. You have got what looks to me at least like a lot of excess capital. I don't know if you agree or not.

John R. Shrewsberry

We have 12% CET-1 and our target is 10%. So, I would agree.

Betsy Graseck

Okay. Did CECL do anything there? I mean I know we have CECL coming-in in 1Q 2020.

John R. Shrewsberry

Not yet. We mentioned at Investor Day that there are a couple of things that might shape the 10%, our own 10% target a little bit higher once they become better understood. One of them is CECL and what CECL looks like in stress because that will matter the most with respect to what our capital levels would be. And then the other one is the imposition of the stress capital buffer and whether that means as an industry and as a bank our target needs to be a little bit higher. But today, 10% is the number with sort of a bias to maybe slightly above that.

Betsy Graseck

And on CECL, is there any color you can share about how you are thinking about it?

John R. Shrewsberry

So, I think every bank has done its original or some early versions of modelling out their current portfolios and comparing what the calculated allowance looks like compared to today's and the expectation of course because we are moving to a life of loan construct that allowances will be higher. And I know that at least one bank is out there with their preliminary estimate.

We are sort of working through ours with our accountants, working through ours with our regulators, helping everybody understand that it has had a tendency to increase the allocable allowance to consumer loans and it has had at least based on our loan mix the tendency to even reduce the academically calculated allowance for commercial loan portfolios, mostly because the CECL construct has you calculating an allowance to the contractual endpoint and we have a lot of short-dated corporate and commercial loans for which we have been carrying allowance with an expectation of a certain amount of renewal in that portfolio. If you take that off the table, it actually shrinks I think a little bit. So, the net of those two will be different for every bank, but for us means a bigger allowance but not as big as if we were just the consumer side of Wells Fargo.

So, still a little bit of work to do on that. As I said, we are working through with our auditors, working through with our regulators to help everybody understand that, and everybody I think will be perfecting all of the new models and creating challenger models, et cetera because a lot of this modeling is very new, but more but maybe not as much as people would have feared when they heard life of loan.

Betsy Graseck

And unlikely be a material impact on the capital ratio I expect?

John R. Shrewsberry

I think that's right. There will be that day one impact and then the ongoing impact that what does it mean to recalculate life of loan loss given a supervisory severely adverse scenario at some point in the future. That is an unknown. The life of loan calculation is different every time you calculate it depending on what you from that point forward feel like the environment is going to deliver. So, if you – like today's life of loan calculation is relatively benign, it's worse than the one or three year outlook, which is the basis for today's gap, but you end up with the worst number, a bigger number when you do it in stress. So, how that works through CCAR has to be understood.

Betsy Graseck

Maybe the regulators will give us credit for that.

John R. Shrewsberry

Maybe, yes, for carrying a big allowance, yes, that's right.

Betsy Graseck

All right, thank you very much. We appreciate it.

John R. Shrewsberry

I appreciate it too.

Question-and-Answer Session

[No Q&A session]

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