A joint statement by Richard M.Kovacevich, Chairman and John G.Stumpf, President and Chief Executive Officer of Wells Fargo is given below. This statement has been taken from the company’s 2007 annual report.
To Our Owners
Our 2007 results were disappointing. They were not what you, our owners, expect from Wells Fargo. They were not what we expect of ourselves. Our diluted earnings per share of $2.38 declined nine cents from 2006. Two items, in particular, caused this.
First, in the fourth quarter Visa Inc., the world’s largest credit and debit card provider, completed its global restructuring and announced it would be going public, contemplating an initial public offering early in 2008. Wells Fargo owns approximately 2.8 percent of Visa. With the concurrence of the U.S. Securities and Exchange Commission, Wells Fargo recorded a pretax charge of $203 million, or 4 cents per share, during the year (third and fourth quarters) for its share of Visa’s anticipated litigation expenses. These charges were not expected, but we anticipate they will be more than offset as a result of our ownership in the valuable Visa franchise. Second, in the fourth quarter Wells Fargo recorded a special credit provision of $1.4 billion pretax, or 27 cents per share, largely for higher loan losses we expect in our home equity portfolio from indirect channels through which we’re no longer accepting new business. These two items reduced our 2007 diluted earnings per share by 31 cents. So, what happened and why did it happen? What did we do right? What did we do wrong? For the last several years in our annual reports and other investor communications, we’ve been saying to you, our owners, that the financial credit markets were acting as if there’s little or no risk to lending money.* “Liquidity” —the amount of money readily available for investing—had reached unprecedented high levels for individuals, corporations and central banks worldwide. This led, in part, to careless, undisciplined lending, borrowing, investing and overall risk management across many segments of the economy. Many categories of debt became significantly overvalued. Lenders were not being paid enough for credit risk. Credit spreads were at record lows across all asset classes. Aggressive subprime mortgage lenders, many of them unregulated brokers, used “teaser” rates and “negative amortization” loans (which add to the unpaid balance) to put many people in homes they could not afford. Easy access to cheap money encouraged excessive risk taking, highly leveraged transactions and complex pools of mortgage-backed debt obligations (many of which were underestimated for risk by some rating agencies). This foolishness could not go on forever. Something had to give. Housing prices—inflated by speculation and aggressive lending—plunged in many parts of the country. Trust and confidence in the mortgage securities market collapsed. Large global and domestic financial services companies took losses exceeding $163 billion, writing down mortgage loans, leveraged loan commitments and other assets. A long-overdue upward repricing of risk continues into 2008. Despite the pain it has caused many individuals and organizations, long term it is healthy for our industry and our economy. Credibility, trust and confidence in pricing for risk are being restored in the credit markets. This swift retribution is one of the strengths of capitalism.
“In financial services, if you want to be the best in the industry, you first have to be the best in risk management and credit quality. It’s the foundation for every other measure of success… Our company maintained its credit risk discipline reasonably well during the years of excessive risk taking in our industry.”
Credit Quality: What We Did Right
In financial services, if you want to be the best in the industry, you first have to be the best in risk management and credit quality. It’s the foundation for every other measure of success. There’s almost no room for error. For instance, to meet our profit goals for lending to commercial businesses, we can be wrong on credit throughout an economic cycle only about one-third of one percent of the time. That’s a very small margin of error. Our company maintained its credit risk discipline reasonably well during the years of excessive risk taking in our industry.Unlike many of our competitors, we did not make option adjustable-rate mortgages (ARMs)—consistent with our responsible lending principles www.wellsfargo.com/jump/truthinlending). We did not make negative amortization ARMs. We offered in only a very few instances, below certain credit scores, stated-income mortgages and low- and no-documentation mortgages. Because of our prudent lending to customers with less than prime credit and our decision not to make negative amortization loans, we estimate we lost between two and four percent in mortgage origination market share from 2004 to 2006. That translates into losing between $60 billion and $120 billion in mortgage originations in 2006 alone. We’re glad we did. Such lending would have been economically unsound and not right for many borrowers.
Unlike many of our competitors, we did not participate to any significant degree in collateralized debt obligations (CDOs), structured investment vehicles (SIVs) to hold assets off our balance sheet, hedge fund financing, off-balance sheet conduits, the underwriting of low-covenant or no-covenant, large, highly leveraged loans and commitments to companies acquired by private equity firms through leveraged buyouts (LBOs).
Our balance sheet strength enables us to take the long view. We have minimal ARM interest rate “reset” risk in the loan portfolios we own because we underwrote those loans to account for higher interest rate resets. We sell the vast majority of our mortgage loans to capital market investors. We believe our commercial lending portfolio is among the highest quality of any large bank in the nation. We’re disappointed with the $1.4 billion in special credit provision, but it is less than two percent of common equity after tax, and it’s relatively small compared to the $163 billion in write-downs taken by our competitors.
Only Way to Lend: Responsibly
We’ve built a reputation as an industry leader in responsible lending. Our goal is not just to help customers achieve the dream of home ownership, but to do what’s right for them so they can keep their homes. Our Responsible Mortgage Lending Principles (first published in 2004) commit us to:
- Price loans fairly and consistent with the risk,
- Give customers the information they need to fully understand the terms of the loan,
- Make a loan only if it provides a demonstrable benefit to the customer,
- Not lend to customers unless we believe they can make the loan payments, and
- Work diligently to help customers having trouble making their payments so they can stay in their homes.
Because of our Responsible Mortgage Lending Principles and our Responsible Mortgage Servicing Principles, our foreclosure rate in our home mortgage servicing portfolio in 2007 was more than 20 percent better than the industry average. Less than one in every 100 loans in our servicing portfolio was in foreclosure.
We contact customers with impending ARM resets, offer a toll-free number they can call to discuss solutions with a Wells Fargo expert, and provide credit management education programs. In 2007 across the mortgage industry, almost one of every two foreclosures involving a customer with an ARM occurred before the loan was reset at a higher rate, mostly due to too much debt, lower income or a decline in the home’s market value. For those borrowers in financial trouble, about half never contacted their servicer. So, our message to any of our customers struggling to make payments is loud and clear: Call us! If they do, we can work with them to try to find options to help them stay in their home or find other alternatives to avoid foreclosure.
We also must protect the interests of investors who own the mortgage-backed securities and who depend on a flow of payments from those securities. Of the 10 million home mortgages we service, about three percent are adjustable-rate mortgages for customers with less than prime credit whose rates are expected to increase sometime before the end of 2008.
At this time, it appears eight to nine of every 10 of these customers are expected to pay in full, refinance, manage the payment or benefit from a solution. To help keep more of our customers in their homes, we launched in 2006 a free program called Steps to SuccessSM for all our new mortgage customers who have less than prime credit. It provides credit reports and credit scores, access to advice from credit education specialists, financial education and access to automatic mortgage payment programs to help consumers better manage their credit. We’ve signed up 20,000 customers for this program, and they appear to have a lower likelihood of delinquency than our customers not enrolled in this program. We’re a leader in Hope Now, a new national alliance of mortgage counselors, mortgage servicers, capital markets investors and the government to help at-risk homeowners facing foreclosure or higher ARM resets. The industry campaign includes direct mail to millions of at-risk borrowers, encouraging them to contact servicers or counselors for help and a toll-free customer hotline.
In late 2007—partnering with other large mortgage servicers, the U.S. Treasury Department and the American Securitization Forum—we announced our support for a “fast-track” solution for many subprime ARMs scheduled to reset to higher rates in 2008 and 2009. In February 2008, as part of an alliance with our large peers and the U.S. Treasury, we sent letters to both our nonprime and prime customers 90 days or more late in their mortgage payments, offering them, if they qualify, a 30-day pause in the foreclosure process so we can consider a possible solution to help them to stay in their homes.
We’re a strong, well-capitalized, well-funded mortgage lender and servicer and can maintain our liquidity for the long term. With our extensive distribution network and our strong relationships with Realtors, builders and joint venture partners, we have the opportunity to grow mortgage market share responsibly at a time when some of our competitors have gone out of business or are struggling—and we’re hiring highly successful salespeople from our competitors. We’ve been the nation’s #1 retail mortgage originator for 15 consecutive years.
Credit Quality: What We Did Wrong
Our risk management performance in 2007 was not perfect. We made some mistakes. We took on too much risk—and did not price sufficiently for it—in the home equity loans we purchased through indirect channels such as mortgage brokers, bankers and other mortgage companies. Too many of our home equity loans had “loan-to-value” ratios that were too high — the ratio of loans to the fair market value of the property. Sometimes we did not require full documentation for these home equity loans we purchased from brokers because these were prime borrowers who had high credit scores with lower expected risk of default.
When home prices in parts of California and other areas of the country fell dramatically, the severity of the losses was much higher than we or anyone else expected. We should not have offered such lenient loan terms through indirect channels, and we made the mistake of taking on too much risk. We should have known better.
In third quarter 2007, we stopped purchasing home equity loans from third-party correspondents. In fourth quarter, we stopped purchasing loans through wholesalers when the borrowers were not Wells Fargo mortgage customers. We’ve also exited the nonprime wholesale and correspondent channels for first mortgages. In fourth quarter 2007, we placed $11.9 billion of such loans—about three percent of our total loans outstanding —into a liquidating portfolio, and added $1.4 billion to our credit loss reserves primarily for losses incurred in this portfolio. We continue to accept loan applications in the home equity wholesale channel, but only for loans behind a Wells Fargo first mortgage and that have a combined loan-to-value ratio below 90 percent. Balance Sheet and Capital Strength
In addition to credit quality, another important attribute of an outstanding financial services company is capital, or what’s left for shareholders after subtracting a company’s liabilities from its assets. At Wells Fargo, our #1 financial goal is to have a conservative financial structure as measured by asset quality, capital levels, diversity of revenue sources and dispersing risk by geography, loan size and industry. We want to maintain such a strong balance sheet that our customers would put their money in our banks even if there was no FDIC insurance. Capital measurements show how much a bank depends on borrowing and how much “cushion” it has to absorb losses.
Wells Fargo’s capital ratios are among the strongest in our peer group. You can see one of the most important measures of capital strength on the opposite page. Our capital levels as a percent of our tangible assets outpace our peers. This is one reason we have the only bank in the U.S. rated Triple A by both Moody’s Investors Service and Standard & Poor’s Ratings Service.
Our 2007 Performance
Despite the disappointing earnings-per-share results in 2007, our businesses’ core performance in 2007 was strong. Wells Fargo achieved double-digit revenue growth, up 10.4 percent, something very few financial institutions were able to accomplish. Our revenue also grew faster than our expenses (up 9.5 percent), which we consider the best long-term measure of a company’s efficiency. Our return on equity (after-tax profit for every shareholder dollar) was a very respectable 17.1 percent. Most of our businesses achieved very solid financial results. Among their achievements: • Wholesale Banking – Record net income of $2.3 billion, up 13 percent, and revenue up 15 percent, its ninth consecutive year of double-digit growth. Average loans rose 20 percent. Cross-sell reached a record 6.1 products per Wholesale customer relationship (4.9 five years ago) and 7.6 products per middle-market commercial banking relationship. Almost a third of our regional commercial banking offices had more than eight products per relationship. Some averaged more than 10! • Asset Management Group – Double-digit growth in revenue, earnings and assets under management. Wells Fargo Advantage Funds—with assets up 24 percent—is the nation’s thirdlargest fund manager among banks. • Community Banking – Revenue up 11 percent, average loans up nine percent, average retail core deposits up six percent, record retail bank household cross-sell of 5.5 products per household (5.2 a year ago, about three, nine years ago), and we opened 87 new banking stores. One of every five of our retail banking customers has more than eight products with us, and in our top region almost one of every three customers does. Core product solutions (checking, savings, credit cards and referrals of mortgage, insurance and brokerage) rose 11 percent, 16 percent in California. Wells Fargo Packages sales (checking account and at least three other products) rose 21 percent—purchased by almost three of every four of our new checking customers. Consumer checking accounts rose a net 4.7 percent. • Team member engagement – An important leading indicator of satisfied customers who give us more of their business— rose again. Our ratio of engaged to actively disengaged team members in Community Banking now stands at 8.5 to 1 (7.1 to 1 last year, 2.5 to 1 five years ago)—the fifth consecutive year of improvement. The national average for all surveyed companies is only 2 to 1 Wells Fargo Home Mortgage had a relatively good year and was the nation’s #1 retail mortgage originator for the 15th consecutive year despite the sharp housing downturn and turbulent secondary markets. Mortgage originations declined seven percent to $272 billion, but our owned home mortgage servicing (processing the monthly payments of your home loan) portfolio reached $1.53 trillion, up 12 percent from 2006.
As we’ve said for years, our greatest opportunities for growth are right in front of us: satisfying all our customers’ financial needs and helping them succeed financially. Here’s a progress report on three of our biggest growth opportunities: wealth management, insurance and business banking.
Wealth Management Group Our #1 strategic initiative is to grow our investments and insurance businesses to 25 percent of our company’s total earnings. We continue to make good progress. The total assets we managed in our Wealth Management Group —Investment Management, Insurance, Brokerage, Trust and Estate, and Private Banking—grew 10 percent in 2007. We want to give our highest-value customers the most personalized service possible. To that end, we introduced Wells Fargo Private Bank across the country, including several markets outside our 23 Community Banking states. The Private Bank provides personalized wealth management solutions for clients with $1 million or more in Wells Fargo relationship balances, excluding mortgages. Our dedicated relationship teams help clients manage their daily financial needs, preserve and build wealth, achieve philanthropic goals and build a legacy for future generations.
Our Wealth Management Group grew core deposits 28 percent and loans 15 percent—and our offer of 100 commission-free trades through WellsTrade� online brokerage for our Wells Fargo� PMA� Package customers helped us grow self-directed brokerage assets under administration by 35 percent. We also launched The Private Bank online, which generated significant new balances. Insurance We’re the world’s fifth-largest insurance brokerage, third-largest U.S. commercial insurance brokerage, and the largest bank-owned U.S. insurance brokerage, but we’re a long way from being #1 for all our customers’ insurance needs. The last four years, almost half our new insurance business came from Wells Fargo customers—yet only five of every 100 of our 28 million customers have bought at least one insurance product from us. Our goal: one of every five.
We believe this is achievable because insurance (with checking, mortgage and investments) is one of four core products: one that consumers value so much that they’re more likely to buy more products from that same company than from competitors. We want to provide the full line of insurance products that both our commercial businesses and retail household customers need to help them succeed financially.
As part of a broader relationship conversation with our customers (not just “transactional selling” of insurance from a third party), we now help our banking customers via the phone and the internet plan their insurance needs, recommend the best product choices, and update them as their needs change. This is an “inbound” service model—triggered by events in our customers’ lives and channeled to our insurance sales centers through referrals from our banking stores and our Wells Fargo Phone BankSM centers (1+ million such referrals in 2007, up 50 percent). Our acquisition this year of Greater Bay Bancorp in northern California also brought us ABD Insurance and Financial Services, the nation’s 15th-largest insurance broker. This expands our insurance presence on the West Coast and adds insurance products to our menu that especially benefit the technology, real estate and construction industries. Also in 2007, we acquired six insurance brokerages and nine insurance portfolios in California, Georgia, Illinois, Michigan, Minnesota, New Hampshire, North Carolina, Ohio, Texas, Utah and Washington. Business Banking We’re making good progress in broadening and deepening our relationships with businesses that have annual revenues up to $20 million. Our sales of product “solutions” to businesses through our banking stores rose 16 percent this year, up 40 percent from two years ago. Small business loans, usually less than $100,000, rose 19 percent, up 40 percent from two years ago. We’re the #1 U.S. small business lender in dollars for the fifth consecutive year.
We’re also #1 by this same measure for loans to small businesses in low- and moderate-income neighborhoods. Since 1995, we’ve loaned $35 billion to businesses owned by women, African-Americans, Latinos and Asian-Americans. There’s still tremendous opportunity to do better. We want our business banking results to be as good as our consumer results, especially in cross-sell. More than four in 10 of the small businesses that opened checking accounts with us bought a package of four or more products from us at the same time. That’s up from 2.5 of every 10, two years ago, but it’s still lower than the 7 of every 10 of our consumer customers who bought a package of products when they opened checking accounts with us. Our average business relationship now has 3.5 products with us (3.0 two years ago), but that’s still far fewer than the 5.5 products our average retail bank household has with us.
The key to the bottom line for us has always been the top line—revenue growth—but we can’t be complacent about the expense line. We’re known across our industry as number one, second to none, for cross-sell and revenue growth, and now we also want to be known for smart, efficient expense management. We’ve always paid close attention to expenses in our businesses, but in 2008 we’re formalizing a process to coordinate expense management consistently and quickly across our company. Obviously, this is a time of slower economic growth, potentially higher credit losses and slowing deposit growth, causing pressure on earnings across our industry, but this is a process we need regardless of good times or tough times. It’s just good business. We’re examining all aspects of how we spend money, from buying goods and services to the structural expenses of each of our businesses. We want to take full advantage of our company-wide buying power and expense management best-practices. Making expense management a competitive advantage across our company should enable us to grow market share when many of our competitors are struggling.
One Wells Fargo: Our Progress
For the past two years, hundreds of our team members have examined processes inside our company that are most important to making it easier for our customers to do business with us. Their work is part of a way of thinking and acting we call “One Wells Fargo”—a culture of collaboration that instinctively and naturally puts what’s best for the customer first—and then delivering it. Our “One Wells Fargo” teams are working on six major initiatives: • Deliver a consistent “you know me” experience for our customers. Example: We streamlined the process for opening checking and savings accounts by compressing the online process from 15 screens with 18 fields to fill in down to five screens and four fields. Completions for the new, shorter application have tripled. • Speak the language of our customers with clear and simple messages. Example: We now have company-wide guidelines, tools and examples of correspondence to help us communicate with customers in ways that are easy to read, understand and act on. We use their language, not “bank-speak.” For instance: Bank-speak Customer-speak Credited Deposited Debited Withdrawn Insufficient funds Not enough money in your account Unauthorized transactions Charges made without your permission Delinquent Past due Delayed availability Your money will be available on (date) • Communicate more effectively with customers electronically rather than with paper. Example: Two-thirds of all our servicing communication with customers now is available electronically —saving 15,000 trees a year. We deliver one of every five of our checking or savings account statements online only, an increase of 50 percent in 2007 alone. • Simplify products. Example: We reduced our “menu board” of checking products from more than 20 down to six checking and savings account packages. This makes it easier for our customers to do business with us and easier for our team members to serve them. We rolled out an automated tool across all our Community Banking states and the Wells Fargo Phone Bank for those situations when we reverse fees. • Fix customers’ problems the first time they contact us. Example: We now track in 14 of our 80 businesses and 15 of our 39 call centers how often we fix problems for customers the first time they contact us. This covers 95 percent of the calls ur customer service team members handle. This year, we fixed problems for three million more customers after they contacted us the first time. By measuring and tracking this and finding ways to improve the process, we expect the number of first-time fixes to improve significantly over time. • Address recurring complaints affecting customer loyalty. Example: Making it easier for our customers to reconstruct where they paid for goods and services. When they review their debit card, ATM and online bill pay transactions, they now see the name and location of the merchant where they made the purchase or payment rather than just the generic “Check card activity.”
Wells Fargo has been at the forefront of every major innovation in financial services, including being the first to offer internet banking (1994). How does this happen? It does not, we can assure you, start with technology in search of a need. Nor does it start with outside consultants. It starts with our customers and the team members who serve them. Everything we do at Wells Fargo starts with what our customers need. Developing products and services to satisfy their financial needs requires an environment in which our team members at every level (most often those closest to the customer) are free to use their “what if” imaginations. They then should be assured that they’ll find open, receptive minds across our company willing to listen to their idea’s potential. Then come the most important steps— developing the new idea, designing the system, processes and technology, testing with customers and making changes based on their feedback, and then rolling out the well-tested new product to the marketplace.
In our annual report this year, beginning on page 12, we show you how our customers benefit from our latest and best products and services—created by our talented teams—and how every new idea we have for better serving our customers starts by “Working Together” with them.
We thank all our 159,800 talented team members for their outstanding accomplishments during what has been one of the more challenging years we’ve ever experienced in financial services. We thank our customers for entrusting us with more of their business and for returning to us for their next financial services product. We thank our communities—thousands of them across North America—that we partner with to make them better places to live and work. And we thank you, our owners, for your confidence in Wells Fargo as we begin our 157th year. And now we’re going for great in ’08!