Wells Fargo Bank Analysis, Robert Petts

Examining Risk Management Policies and Practices of Wells Fargo

Robert Petts

Professor Cebenoyan

December 4th, 2014

Introduction

Over 160 years ago in 1852, Henry Wells and William Fargo founded Wells Fargo & Company.

Today one of the “Big Four Banks” of the U.S. (alongside JP Morgan Chase, Citigroup, and

Bank of America), Wells Fargo is one of the largest multinational banking and financial services

holdings company in the world. Indeed, Wells Fargo is the fourth largest U.S. commercial bank

by assets ($1.6T) and the largest bank by market capitalization ($281.02B). Wells Fargo is also

the second largest bank in terms of deposits, home mortgaging servicing, and debit cards. It is

the 8th largest publicly traded company in the world, and the 29th biggest company in the U.S. by

revenue. Headquartered in San Francisco, Wells Fargo provides banking, insurance, investments,

mortgages, and consumer and commercial finance through more than 8,700 locations, over

12,500 ATMs, online, and through mobile devices. Although Wells Fargo used to boast being

the only American bank to be rated AAA, after the financial crisis, Wells Fargo’s ratings had

been dropped to AA-.

This paper will analyze Wells Fargo based on the most recently completed 5-year period (2013-

2009) ending December 31st, 2013. The analysis will be done using financial information

obtained from the FDIC website as well as from Wells Fargo through the website of the

Securities and Exchange Commission. The analysis will span Wells Fargo’s profitability, capital

adequacy, exposure to credit risk, liquidity risk, sovereign risk, off-balance sheet risk, market

risk, interest rate risk, and methods of risk management. Wells Fargo will be compared to the

other members of the “Big Four” when applicable in order to give a relative idea of how Wells

Fargo is doing in these areas. All values are in thousands of dollars ($) unless otherwise stated.

Profitability

Wells Fargo’s profitability will be measured using two ratios: Return on Assets (ROA), and

Return on Equity (ROE). Return on Assets is computed as net income/assets, and measures how

efficiently a company is creating profit with the assets that it owns. Wells Fargo has consistently

held a higher ROA than any of the other Big Four banks in the United States.

Return on Assets

Return on

Equity

Similarly to

Return on

Assets,

Return on

Equity shows

how efficient

a company is

in earning

profit, but

0.00%

0.50%

1.00%

1.50%

2.00%

2009 2010 2011 2012 2013

Wells Fargo's Return on Assets

-0.50%

0.00%

0.50%

1.00%

1.50%

2009 2010 2011 2012 2013

Big Four Return on Assets

Wells Fargo JP Morgan Chase

Bank of America Citibank

Return on Equity measures this against the amount of investors’ funds that it has at its disposal.

ROE for both Wells Fargo and the rest of the Big Four banks shows the same trends as ROA.

Again, Wells Fargo is above the rest of the Big Four in terms of ROA for all 5 years, with the

only exception being JP Morgan Chase in 2010.

Return on Equity

Despite a slight dip from 2009-2010, Wells Fargo’s (as well as the rest of the Big Four’s)

profitability has been steadily increasing. In regards to both of these measures listed above,

Wells Fargo is not at risk of becoming unprofitable.

Capital Adequacy

Capital adequacy is a means of determining whether or not a bank has enough capital to cover

any potential risks or losses they might encounter. After the financial crisis of 2008, capital

adequacy became a very important measure for banks, as it reflects their financial stability. The

Basel Accords require banks to hold a Tier I (Core) Capital Ratio (calculated as Tier I Capital/

Risk Weighted Assets) of at least 4%, and a Capital Adequacy Ratio (calculated as (Tier I + Tier

II Capital)/ Risk Weighted Assets) of at least 8%. Tier 1 Capital is the capital that a bank can use

without having to stop its operations. Tier 1 Capital consists of common stock and disclosed

reserves. Tier 2 capital, on the other hand, is also capital that a bank can use to absorb losses, but

requires a bank to cease operations. Tier 2 is made up of general provisions, undisclosed

reserves, and revaluation reserves. A bank would use Tier II capital in the liquidation of its

assets.

In both measures, Wells Fargo holds a lower level of capital to risk-weighted assets. However,

this isn’t necessarily bad, as Wells Fargo is still well above the Basel requirements. Because of

this, Wells Fargo is more likely to remain solvent in the face of unanticipated loss.

0.00%

5.00%

10.00%

15.00%

20.00%

2009 2010 2011 2012 2013

Wells Fargo's Return on Equity

-5.00%

5.00%

15.00%

2009 2010 2011 2012 2013

Big Four Return on Equity



Credit Risk

Analyzing a bank’s Credit risk is important because it determines the amount of future cash

flows that it will actually receive from its borrowers.

Long Term Assets

In determining Credit risk, it is important to look at the ratio of a bank’s long term assets to its

total assets, as long term assets have a higher potential of defaulting. Wells Fargo has been

steadily increasing its long term assets in the past few years after an initial jump in 2009 from

about $135B to $273B in 2010. In comparison with the rest of the Big Four banks, Wells Fargo

has the 3rd highest LTA/A proportion, second only to Bank of America. While this may insinuate

that Wells Fargo is exposed to more Credit risk because of its high amount of Long Term Assets,

this isn’t necessarily true; not all long term assets have the same amount of default risk, and

some may be quite safe compared to others.

5.000%

7.000%

9.000%

11.000%

13.000%

15.000%

17.000%

2009 2010 2011 2012 2013

Big Four Tier I Capital Ratio


Bank of America Citibank0.000%

2.000%

4.000%

6.000%

8.000%

10.000%

12.000%

2009 2010 2011 2012 2013

Wells Fargo's Tier I Capital Ratio

10.500%

11.000%

11.500%

12.000%

12.500%

13.000%

13.500%

14.000%

2009 2010 2011 2012 2013

Wells Fargo's Capital Adaquecy

10.000%

12.000%

14.000%

16.000%

18.000%

2009 2010 2011 2012 2013

Big Four Capital Adaquecy



Noncurrent

Loans & Net

Charge-Offs

While LTA/A

may give a

rough idea as to

how much

credit risk an

institution

holds, looking

at a bank’s

Noncurrent Loans/ Loans (NCL/L) and Net Charge-Offs/ Loans (NCO/L) can give a more

specific idea as to how risky an institution’s loans really are. Noncurrent loans are loans that are

at least 90 days past due, or are not earning interest income because the borrower isn’t paying;

noncurrent loans are much more likely to default than other loans, and are a good indicator of a

bank’s credit risk exposure. Net charge-offs are the amount of loans that are written off as bad

debt, accounting for any money that was recouped by the written off loan.

Wells Fargo’s NCL’s and NCO’s are fairly typical as far as the Big Four average goes. Both

measures are also slowly diminishing in time, meaning that Wells Fargo is taking measures to

ensure that the loans that it gives our are being repaid in a timely manner.

Loans

Looking at a bank’s loan portfolio can also give insight as to how much credit risk a bank is

exposed to. Loans, regardless of how risky or safe they might seem, always have a certain

probability of default. Because of this, holding a large proportion of loans as a bank’s assets is

risky. Wells Fargo holds a higher percentage of loans in its assets compared to the rest of the Big

0

50000000

100000000

150000000

200000000

250000000

300000000

350000000

400000000

2009 2010 2011 2012 2013

Wells Fargo Long Term Assets

0.00%

10.00%

20.00%

30.00%

40.00%

2009 2010 2011 2012 2013

Big Four Long Term Assets/Total Assets

Wells Fargo Bank of America

JP Morgan Chase Citibank

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

2009 2010 2011 2012 2013

Big Four Net Charge-Offs/Loans


Bank of America Citi

0.00%

5.00%

10.00%

2009 2010 2011 2012 2013

Big Four Noncurrent Loans/ Loans



Four banks. This is because Wells Fargo derives much more of its income from lending than the

other three.

This information alone would imply that Wells

Fargo holds more credit risk than the rest of the

banks within its peer group. However, once

again, it is important to take a look at the

breakdown of the loan portfolio in order to get

an accurate idea as to the riskiness of a bank’s

loans. Wells Fargo’s loan portfolio seems to be

weighted in similar proportions as JP Morgan

Chase’s loan portfolio. Wells Fargo does have a

bit more of its loan portfolio in real estate than

does JP Morgan (over 50% in 2013 as opposed

to just over 40%), which is worrisome, as real

estate has been proven to be quite risky in the

past. If a real estate turmoil such the last

financial crisis were to unfold, Wells Fargo

would be heavily exposed. However, Wells Fargo appears to be cognizant of this, as it has been

steadily decreasing the amount of real estate loans that it holds. Wells Fargo also holds slightly

less than 20% of its loan portfolio in commercial and industrial loans. These loans generally have

a floating rate, so it is important to hold a certain amount of them in a bank’s portfolio as a buffer

and for diversification. Around 10% of Wells Fargo’s loans are individual loans, such as credit

card balances, student loans, and automobile loans. While these loans may be risky, Wells Fargo

manages those risks by determining who qualifies for certain loans and charging risk premiums

in certain cases. Despite their riskiness, individual loans add a much needed level of

diversification to a bank’s portfolio.

0.000%

20.000%

40.000%

60.000%

80.000%

100.000%

JPM Chase Loan Portfolio

2009 2010 2011 2012 2013

0.000%

20.000%

40.000%

60.000%

80.000%

100.000%

Wells Fargo Loan Portfolio

2009 2010 2011 2012 2013

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

2009 2010 2011 2012 2013

Big Four Loans & Leases/ Assets



If these two loan portfolios are an accurate representation of the Big Four as a whole, than it

would imply that Wells Fargo holds a greater amount of risk than the other banks, as it holds the

same (or, as seen previously, possibly more risky) assets in a higher proportion.

Credit Risk Overview

Overall, Wells Fargo holds a reasonable amount of credit risk given the fact that it’s a large

commercial bank and lending in various forms is one of its main sources of income. It is

impossible to be without any amount of credit risk whatsoever, as the risk/return trade-off is the

basis of the financial industry. By holding a quality, well-diversified portfolio of loans (as well

as using some derivatives to hedge), Wells Fargo manages the amount of credit risk that it must

hold well.

Market Risk

Any bank that buys and sells securities in order to earn additional income also exposes itself to

the risk of being involved in the securities market. Market risk is difficult for a bank to manage,

as markets are fairly unpredictable.

Trading Account Assets

The most

accurate way

to measure

Market risk

would be to

look at the

different

durations of

the securities

in a bank’s

security

portfolio, but

this can’t be

done given the information in Wells Fargo’s financial statements. The next best way is to see

what proportion of the bank’s assets are at risk by looking at the amount of trading assets they

hold in comparison to total assets, and how much of their income is derived from these trading

assets. Wells Fargo, being a more traditional commercial bank than the rest of the Big Four, do

not hold many trading assets in their asset portfolio, instead choosing to loan more of their

available funds and derive income in this way. However, from 2012 to 2013, Wells Fargo did

have a slightly sharp increase in the proportion of trading assets to total assets from 1.85% to

8.5%, but this still leaves them below the average of the Big Four banks.

Security Portfolio Breakdown

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

2009 2010 2011 2012 2013

Big Four Trading Account Profits/Net Income



0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2009 2010 2011 2012 2013

Big Four Trading Account Assets/ Total Assets



Although this is still a small

percentage, nominally, 8.5% of Wells

Fargo’s total assets is an enormous

amount of money, so it is important to

analyze the breakdown of Wells

Fargo’s security portfolio to see

whether or not it is seriously exposed

to market risk. Wells Fargo holds

approximately 50% of its securities

portfolio in U.S. government

treasuries, and quite a large

percentage in mortgage-backed and

asset-backed securities. Wells Fargo

also holds a very small percentage of its securities portfolio in equities. This breakdown reveals

that Wells Fargo’s securities portfolio is not only well diversified, but also lacking in any real

major market risk, as the large majority of its securities are either backed by collateral or from

the U.S. government.

Liquidity Risk

At any time, a bank could be exposed to liquidity risk if it doesn’t either have enough cash or the

ability to turn its assets into cash when a depositor wants to reclaim their deposit.

Liquid Assets/ Total Deposits

To analyze Wells Fargo’s liquidity risk, the first metric to look at is the ratio of its cash and

available for sale securities to total deposits. This is a direct measure of a bank’s liquidity, as it

compares a bank’s most liquid assets to the amount of deposits that could be demanded. Until

2013, Wells Fargo held the lowest ratio of cash and

AFS securities to total deposits of all the banks in

the Big Four. However, in 2011 it began acquiring

more cash, and in 2013 it held a ratio of 38.15%.

Holding such a small fraction of deposits in liquid

assets is implicit of liquidity risk on Wells Fargo’s

behalf.

Total Loans/ Total Deposits

The next metric used in analyzing a bank’s exposure

to liquidity risk is the amount of total loans/ total

deposits. Wells Fargo has quite a large amount of

loans compared to the amount of deposits that it

holds. This also insinuates that Wells Fargo is

exposed to quite a bit of liquidity risk; if all of a

sudden a large amount of its deposits were

demanded back, it wouldn’t be able to return them because the funds would be tied up in loans. It

0.000%

10.000%

20.000%

30.000%

40.000%

50.000%

60.000%

2009 2010 2011 2012 2013

Big Four Cash & AFS Securities/Total Deposits



0.0000%10.0000%20.0000%30.0000%40.0000%50.0000%60.0000%

Wells Fargo Security Portfolio

2009 2010 2011 2012 2013

also means that Wells Fargo has to rely heavily on borrowed funds to reach the level of liquidity

that it needs to maintain.

Based upon these two metrics, it is clear that Wells

Fargo holds quite a large amount of liquidity risk. If

something like a bank run were to happen and Wells

Fargo needed to provide its depositors with their funds,

it would be in trouble, and would need to borrow funds

to cover itself.

Sovereign Risk

Banks operating internationally also must ensure that they are not exposed to sovereign risk.

Wells Fargo, although an international bank, does not have many dealings in foreign countries

except for deposits. It’s foreign loans have always been less than 4%, and the amount of interest

income that it receives from abroad is minimal, maxing out at around 1.2% in 2013. However,

both of these measures seem to be increasing, and if they reach a point at which they are

substantial, they will need to be cognizant of the risks involved in being financially involved in

other nations.

0.000%

10.000%

20.000%

30.000%

40.000%

50.000%

60.000%

70.000%

80.000%

90.000%

2009 2010 2011 2012 2013

Big Four Loans/Deposits



0.000%

1.000%

2.000%

3.000%

4.000%

2009 2010 2011 2012 2013

Foreign Loans/Total Loans

0.000%

5.000%

10.000%

15.000%

2009 2010 2011 2012 2013

Foreign Deposits/Total

Deposits

0.000%

0.500%

1.000%

1.500%

2009 2010 2011 2012 2013

Foreign Interest Income/ Interest

Income

Off Balance Sheet Exposures

Wells Fargo engages in many types of

off balance sheet activities, particularly

in purchasing many different types of

derivatives. While Wells Fargo may use

these derivatives to hedge some of the

risk from its other investments, by

holding them they also expose

themselves to the risk that these off

balance sheet items will unexpectedly

cause damage to the balance sheet in the

future. To analyze off balance sheet risk

exposure, it is useful to look at a bank’s

derivatives/ total assets ratio. Although

Wells Fargo holds an enormous amount

of derivatives in comparison with its total assets (353% in 2013), the amount that it holds is

miniscule compared to the rest of the banks in the Big Four. This is to be expected given the fact

that Wells Fargo invests quite a bit less than the other Big Four banks. Although they may be

using these derivatives to hedge the risk of their investments, the fact that these banks are

holding such massive amounts exposes them to a large amount of off balance sheet risk. Wells

Fargo, on the other hand, would be much better off than these banks in an unexpected off

balance sheet event that might negatively affect their balance sheet.

Interest Rate Risk

One of the most dangerous risks facing a bank is interest rate risk; specifically, the risk that a

change in interest rates will diminish a bank’s assets (which are usually longer term) more than

they might diminish a bank’s liabilities (which are usually shorter term), and cause the bank to

drain the difference from its equity.

Interest rate risk is analyzed using the repricing

gap/ assets, which is the difference between the

amount of rate sensitive assets and rate sensitive

liabilities in a certain maturity bucket divided by

the bank’s total assets. Wells Fargo has a positive

repricing gap (meaning that it has more rate

sensitive assets than rate sensitive liabilities) in

every maturity bucket except for the 3-12 month

bucket. The repricing gap for the < 3 month

maturity bracket is extremely high for Wells

Fargo, due to the fact that they hold a large

0.00%

1000.00%

2000.00%

3000.00%

4000.00%

5000.00%

6000.00%

2009 2010 2011 2012 2013

Big Four Derivatives/ Assets



-10.0000%

0.0000%

10.0000%

20.0000%

30.0000%

40.0000%

50.0000%

2009 2010 2011 2012 2013

Wells Fargo Repricing Gap

<3 Months 3-12 Months

1-3 Years >3 Years

amount of current loans (around $400B) compared to current deposits.

This means that Wells Fargo would benefit from an increase in interest rates, as the value added

to the assets would be more than the value added to the liabilities. The fact that Wells Fargo has

a negative repricing gap for the 3-12 Month maturity bucket would offset this gain by a bit, but

the amount of assets and liabilities in that particular bucket is small enough that it wouldn’t have

a large enough impact to completely negate the gain. This can be seen in the table below, where

the change in Wells Fargo’s net income for a 1% increase in interest rates is show. Due to the

fact that the yield curve is predicted to be upward sloping, Wells Fargo would appear to be in a

favorable position in terms of interest rate risk exposure.

Change in Net Income for a 1% Increase in Interest Rates

Maturity

Bucket

2013 2012 2011 2010 2009

<3 Months 0.2746%

0.3114%

0.3396%

0.3682%

0.3889%

3-12 Months

-0.0088%

-0.0020%

0.0035%

-0.0018%

-0.0037%

1-3 Years

0.0335%

0.0325%

0.0269%

0.0259%

0.0498%

3< Years 0.2021%

0.2018% 0.1855%

0.1683%

0.1367%

Risk Management

As a large international institution, Wells Fargo has many different methods of managing the risk

that comes with operating a bank.

The main way that Wells Fargo manages its credit risk is by looking at the customer’s credit

history. This isn’t to say that they won’t offer a loan to someone who possibly has a worse credit

history, but they may not offer them as much, and may charge them a bit of a higher risk

premium than someone with a better credit history. Wells Fargo also tries to work with

customers who are struggling to make payments on their loans through loan restructuring.

Through the monitoring of both current and potential loans, Wells Fargo has been successful in

the past few years in decreasing the amount of loan write-offs, meaning that their risk

management techniques have been working.

Wells Fargo manages market risk in much the same way as most other banks; through hedging

their investments with derivatives. The use of derivatives limits the downside potential of Wells

Fargo’s investments, ensuring that even if a detrimental, unforeseen event were to occur that

diminished the value of their investments, they would be covered. Due to the low amount of

market investments that Wells Fargo takes place in relative to the rest of the Big Four banks, the

low amount of derivatives that it holds also helps manage Wells Fargo’s off balance sheet risk

exposure.

In terms of liquidity risk, Wells Fargo offers liquidity to its customers through the holding of

cash and highly liquid securities, although as seen before in this analysis, they don’t hold enough

cash or highly liquid securities to deposits. Because of this, they must rely heavily on borrowed

funds if a severe event were to occur where they must provide liquidity to many depositors.

However, as seen in the graphs above, Wells Fargo is starting to add to the amount of liquid

assets that it holds, meaning that they are cognizant of the risk and taking steps to decrease their

exposure.

Although sovereign risk does not appear to be much of a concern to Wells Fargo due to its low

amounts of involvement in foreign countries, Wells Fargo still rates each country based on its

default risk and uses that information to ensure that they are only taking on quality foreign

endeavors.

Wells Fargo manages interest rate risk much the same as was done in this analysis. They

breakdown their rate sensitive assets and liabilities and run through a variety of scenarios

involving different changes in interest rates. They look at the overview of these scenarios and

decide which is most likely to occur, and then use this information to try and cover themselves

from future changes in interest rates.

Future Outlook

The biggest problem facing Wells Fargo today is their lack of liquidity. Although an event such

as a bank run of a magnitude that would drain all of Wells Fargo’s liquid assets is highly

unlikely, nothing in the future is certain. Arguably, however, the fact that they choose to use

more borrowed funds if such an event were to occur is a sort of contingency plan to deal with

this, so Wells Fargo isn’t in too bad of a position.

Although this analysis looks at the period after the worst point in the latest financial recession,

from the data shown, Wells Fargo has done a good job bouncing back from the recession. They

remain very profitable, and it seems that they are steadily growing in all the right ways. Wells

Fargo is also diminishing the amount of bad debt that it incurs, as can be seen in the trends

shown in the graphs above.

Overall, Wells Fargo has a bright future ahead of them. They are quite profitable, and very

proficient in their risk management techniques. They are more secure in terms of their income by

offering more loans as opposed to involving themselves in riskier, open market activities, such as

the rest of the Big Four banks seem to be doing. As long as they maintain the level they are at

now and continue to improve in the various areas of risk management, they should also continue

to display success and retain their position as one of the leading banks in the U.S. and the world.

Works Cited

FDIC Website: https://www2.fdic.gov/idasp/main.asp

SEC Website (for 10-K’s and 10-Q’s):

http://www.sec.gov/Archives/edgar/data/72971/000007297114000597/wfc10q_20140930.htm

Wells Fargo’s website (for historical information, investor relations, and annual report):

https://www.wellsfargo.com/about/history

https://www.wellsfargo.com/invest_relations/filings

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/2013-annual-report.pdf

http://www.sec.gov/Archives/edgar/data/72971/000007297114000597/wfc10q_20140930.htm

https://www.wellsfargo.com/about/history

https://www.wellsfargo.com/invest_relations/filings

Wells Fargo Bank Analysis, Robert Petts

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