Q2 2020 Wells Fargo & Co Earnings Call

Okay.

Good morning, My name is Regina and I'll be your conference operator today at this time I would like to welcome everyone to the Wells Fargo second quarter earnings Conference call. All lines have been placed on mute to prevent any background noise.

The speakers remarks.

There will be a question and answer session.

If he would like you asked a question during this time.

Right Star and the number one on your telephone keypad, if he would like to withdraw your question press the pound.

Please note that today's call is being recorded I would now like to turn the call over to John Campbell Director of Investor Relations. Sir you may begin the call Brent.

Thank you Regina good morning, everyone.

Thank you for joining our call today, where our CEO Charlie sharp.

And our CFO, John Shrewsberry, well discuss second quarter results and answer your question.

This call is being recorded.

Before we get started I would like to remind you that our second quarter earnings release in quarterly supplement are available on our web site at Wells Fargo Dot com.

I'd also like to caution you that we may make forward looking statements during today's call that are subject to risks and uncertainties.

Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings, including the form 8-K filed today containing our earnings release and quarterly supplement.

Information about any non-GAAP financial measures referenced including a reconciliation of those measures to GAAP measures can also be found in our Sep filing in the earnings release, and then the quarterly supplement available on our website I.

Well now turn the call over to Charlie.

Good morning, everyone. Thank you John I'm Gonna open the call by reviewing what is clearly a very poor quarter for us I will review the drivers of our results make some comments about the environment.

Discuss the rationale for the intended dividend reduction.

Then turn the call over to John to review second quarter results in more detail.

Our view of the length and severity of the downturn deteriorated considerably from our assumptions at the end of the first quarter and this as well as the knock on impacts from cold and substantially impacted our results. This quarter, we added $8.4 billion to the allowance for credit losses charge offs increased 204.

Million dollars from the prior quarter to $1.1 billion.

Interest income was down 13% in the prior quarter driven primarily by lowering.

The constraints of operating under the asset cap has limited our ability to offset lower rates with balance sheet growth and we actually took actions during the quarter to limit loan and deposit growth, which John will highlight.

Expenses included approximately $400 million related decisions, we made due to cope with most of which would do not expect to be permanent what was the right thing to do for employees and to create the safety of arc facility.

About 350 million of deferred comp with an offset in fee revenue.

Point 2 billion of operating losses, primarily for customer remediation accruals related to our ongoing work to remediate the historical issues community banking as we took another look under new leadership, but upstanding matters.

This accrual will enable us to do the right thing for a customers while resolving these matters as quickly as possible.

Revenues were lower by about $295 million due to cold good related fees and interest waivers for certain products.

In addition, strong quarter of mortgage production revenue was partially offset by $531 billion write down of our mortgage servicing rights asset due to higher projected defaults and faster prepayment assumptions.

While it's a smaller part of the company. We did have record revenues this quarter in our corporate and investment bank.

Even with the loss this quarter, our CE T. One ratio increased to 10.9% from 10.7% last quarter, and it's well above our regulatory minimum of 9% as a reminder, or regulatory minimum reflux, our expected stress capital buffer of 2.5% the minimum possible.

As you know Wells Fargo was predominantly a U.S. bank that takes deposits and mix launch our balance sheet composition is 80% cash loans and our investment portfolio when consumers small businesses middle market companies and corporate suffer.

We do as well as the economic environment brought on by cold that negatively impacts our customers and claims it works it will filter through to our results primarily in the form of outsized credit losses and compressed net interest margins. Additionally, given we operate with the balance sheet cap, we must prioritize balance sheet capacity.

<unk> assets and deposits and there are certainly an opportunity cost Russian environment like this in addition, given the uncertainty and the recovery, we must manage the balance sheet to a level, where we can remain below diasa cap. Even if there was another period of material loan drawdowns upward.

Or upward pressure on our deposit base.

Having said that you are responsible for the position we're in the balance sheet cap exists because leadership sale to both oversee and build the appropriate infrastructure of the company and our financial underperformance is because leadership didn't make the difficult decisions necessary. We are focused on both of these we still look much to do to build.

The right risk and control Foundation, which is what our regulators expect and nothing can or will stand in the way those activities. It is our highest priority, but we also recognize that we've been extremely inefficient for too long and we'll begin to take decisive actions.

None of which will impact our risk and regulatory work to increase our margins. So the first point, we continued to make meaningful changes to improve the foundation of the company.

Second quarter, we announced <unk> corporate risk organization structure to try greater oversight vault risk taking activities in a more comprehensive view of risk across the company. Our new risk model will have five line of business Chief risk officer is to complement the teams and leaders by risk type during the quarter, we hired a new chief operator.

No risk officer, New Chief risk officer, consumer lending and achieve control executive we continue to add additional talent to the senior leadership team since I joined the company nine months ago, I've announced six new members to the operating committee all coming from outside of Wells Fargo with strong and relevant industry experience over two thirds.

Our operating committee have joined Wells Fargo. Since 2018, all of our business line Ceos are now in place, including might wind back who joined Wells Fargo in May as CEO consumer lending and Barry Summers, we joined at the end of June as CEO of wealth and investment management.

Mr owns will be joining us next week in a newly created role as head of operations Luster has more than 30 years of experience and the financial services industry and senior operations roles.

You will be responsible for building more integrated approach two wells fargo's business operations functions.

Proven track record in delivering a better customer experience, while driving substantial efficiencies at the same time.

We also made significant hires and rolls one down from our operating committee, including a new head of government relations corporate communications and corporate responsibility as well as chief administrative officer, and a new head of our home lending businesses.

We continue to have over 200000 employees working from home and we plan to have employees, who were currently working from home continue to do so until at least September. It is too early to determine exactly when we will ultimately return to more traditional work environment, but we will be cautious about bringing people back into the office, while I do believe.

There are meaningful benefits people working physically together, we will move forward when you're comfortable that the health risks are manageable.

Where there was a specific need we will do so with the appropriate safety precautions and place we will make these decisions by geography by facility.

We've done the since the beginning of the crisis, we will continue to do so and serve our customers and communities.

We've made significant accommodations for customers through the ended June we have helped more than 2.7 billion consumer and small business customers by deferring payments and waiving fees. This includes over 2.5 million payment deferrals, representing more than $5 billion and principal and interest including 3.2 billion.

In dollars and mortgage loans serviced for others.

We provided approximately 6 million fee waivers for consumer and small business customers exceeding $200 million for commercial clients. We processed approximately 246000 deferrals, representing more than $1.5 billion, a principal and interest payments.

In addition for commercial distribution and auto finance customers we provided.

Surety date extensions, representing approximately $6.6 billion of outstanding principal and interest.

Through the end of June we have funded 179000, PPP loans totaling $10.1 billion with an average loan size.

$6000, 60% of those were for loan amounts of less than $25000, 84% of those were for companies that had fewer than 10 employees, 90% have less than 2 million annual revenues and 41% where to companies in low and moderate income areas for at least 50% but.

I'd sensors trucks, and we announced last week, our open for business fund, we have committed to donating approximately $400 million gross processing fees earned from the payroll protection plan just to help support businesses impacted by the Cobot 19 pandemic and we will work with nonprofit organizations.

Hi, capital technical support and long term resiliency programs to small businesses with an emphasis on serving minority owned businesses.

Customer deposits have continued to increase reflecting unprecedented government stimulus programs lower spending and customers converting investments into cash while commercial deposits declined reflecting actions, we took to manage under the Africa, which John will describe in more detail in March our commercial costs.

Summers utilized over $80 billion that their loan commitments during the market turbulence at the onset of the pandemic and almost all of those loans will pay down in the second quarter.

Debit card spend started to increase in April and returned to pre coated levels in may and in the last fall. We can June were up approximately 10% from the same week a year ago.

Super credit card spend improved steadily starting in mid April but was still down approximately 10% from year ago as of the end of June.

Virtual card spend remained significantly lowered throughout the second quarter and was still down over 30% in the last full week in June compared to the same week, a year ago with declines across industry segments continue to monitor our consumer and commercial customer spending trends as a nation goes through the various stages of reopening.

Trenchant this digital usage are strong.

Mobile deposit dollar volume was up over 100% in the second quarter compared with a year ago. The second quarter digital Loggins were up 21% from a year ago.

Let me turn to the dividend now.

Today, we announced that our board expects to reduce our dividend for the third quarter, just 10 cents per share.

Reserve has authorized banks to pay common stock dividends that do not exceed an amount equal to the average of the bank's net income for the four proceeding calendar quarters based on the instructions. We previously announced that this limitation would cause us to reduce for dividends from the current level of 51 cents a share.

In addition, while this requirement currently applies to the third quarter Federal Reserve stated it reserves the right to extend the limitations.

Earns more about the evolution of the cobot event separately from this our board has been reviewing the level of the dividend and I've discussed way in which we would approach evaluating right go forward level first we'd look at our capital position as I said, our capital position remains quite strong. So our current capital level is not the driving factor.

Decision.

Having said that as we look forward, we do not pretend to have a deeper understanding of the path or the recovery than others, using our economic assumptions our capital levels remain above the minimum required and our see CCAR results confirmed the strength of our capital position, but we believe it's prudent to note that our assumptions are just fashion. So we felt it.

Year to factored this uncertainty into our thinking around the appropriate dividend level in this environment.

After evaluating our capital position, we considered our current and expected earnings level, we expect the impact of cobot to continue to negatively impact to earnings until we see a clear trend meaningful improvements in unemployment and GDP. This will result in continued lower levels of Eni and certain economically sensitive.

The revenues as well as potentially unforeseen expenses to operate in this environment. In addition, while our Hcl is intended to cover expected losses based on our current economic assumptions, we're mindful of the uncertainty and the need to reevaluate these assumptions continually and I will discuss this more but while we.

I would have actively begun to address the fact that our expenses are significantly to buy it will take some time to see the impact of our actions in our results putting this all together it is critical and these uncertain times that our common stock dividend reflects current earnings capacity, assuming a continued difficult operating environment evolving regulatory guidance.

And protect our capital position economic conditions, where to further deteriorate. Given this we believe it's prudent to be extremely cautious until we see a clear path to broad economic improvement. We're confident that this eventual economic improvement combined with our actions to increase or margins will allow our wonderful franchise to say.

Port a higher dividends in the future we're extremely disappointed to take the section and do understand that many rely on this stream of income. However, we must be prudent in this environment.

I have acknowledged in the past that our expenses are too high and that we're building roadmaps to improve our efficiency ratio to repeat there's nothing structurally different about wells Fargo prevent us from being as efficient as our large peers, but we're far from it for us to bring our level of efficiency close to our peers. The math would tell you we.

To eliminate over $10 billion of expenses, while our work is not yet complete to commit to specific numbers and time frames, we expect to take a series of actions beginning in the second half of the year to begin to reduce our expense base and bring our expenses in line with the size and composition of our businesses this will be.

Multiyear effort for sure.

But would like to see a reduction in expenses next year.

And now we now have a centralized team driving the effort across the enterprise and are lines of business and functional areas have dedicated resources stacked against US. This work did not start in the last few months, but extremely challenging operating environment and uncertain outlook has accelerated our sense of urgency isn't.

I want to note that I deeply believe that the sex or size is about making us a better and more efficient company not just about reducing expenses, we have too many management layers spends of controls for managers are too narrow and we have resources dedicated to activities that are not a priority. Today. This cannot continue we also have the opportunity.

To play lessons, we've learned since the onset of the pandemic to drive efficiency across the company over the medium term, we have the opportunity to materially reduce our expense, including increasing digital adoption for retail and commercial clients, reducing third party spend consolidating locations, including branches field offices.

At sites and applying technology differently. In addition, the opportunity to consolidate our operational platforms is still meaningful as a financial company and specifically a GCIB, we must be strong financially to serve our customers and support our communities, but also to provide growing opportunities for our employees, while our balance sheet a strong.

Our margins are too narrow to ensure that source of strength, we need to begin to take action to improve our results.

As I've said and I'll say it again.

We will not do anything impact the work, we have underway to build out our risk control environment the opportunity to become more efficient exist elsewhere in the organization and we will protect this work at all costs.

I will continue to share more specifics about our plans as they develop and we will be talk more about this next quarter.

While there remains much economic uncertainty many market liquidity trends were strong as fed programs continue to effectively support the sneak functioning of the capital markets.

Still like to pre crisis levels market spreads have continued to improve since the peak the dislocation and of retraced, 70% to 90% of their mid March widening liquidity in treasury and interest rate swap markets returned to pre crisis levels and defense open market purchase program has stabilized mortgage mortgage basis valuations and improve liquidity.

HQ really bid ask a measure of the cost to transfer risk has retrace to pre crisis levels, while measures of volatility are now below pre crisis levels.

However, the economic recovery will not be smooth.

Such that the economy is still essentially closed we're just beginning to open and additional restrictions are being implemented as the spread of the virus continues to increase in many areas.

World, what consumer spending has increased from levels at the ended the first quarter. It is still down from a year ago with significant declines in areas like travel entertainment and restaurants, and while government stimulus programs provided the safety net for many they are scheduled to run off raising the possibility of more economic hardship ahead, having said.

All this cities communities people in businesses all are all learning what it takes to reopen safely and there is progress on vaccines and therapeutics, we will do what we can to support the fastest recovery possible, but we will be cautious outlook until we see the facts I want to conclude my comments today by discussing an important.

Topic racial and justice and my conversations with different groups over the past months, the pain and frustration with the lack of progress within both our country and wells Fargo's clear the quality and discrimination has been clearly exposed and must not continue wells Fargo has not been effective and creating enough diversity working.

Assistant late inclusive environment I've outlined a number of actions we are taking around race to change the outcomes.

Including creating a new role.

The which will have a broad mandate of driving diversity and inclusion in both workplace, but also our business.

We'll be evaluating operated members operating committee members based upon their progress improving diverse representation inclusion in their area responsibility and it will have a direct impact on your end compensation decisions.

And we've announced a donation of these gross processing.

These for PPP estimated to be approximately $400 million.

This is just the beginning of the work needed to address this crisis, that's a meaningful contribute to the change that is necessary, but I believe that this is a watershed moment and we will be part of making sure. This time is different finally I want to thank all of the employees at Wells Fargo continue to work tirelessly to serve our customers and successfully.

Execute on our priorities I will now turn the call over to John.

Thanks, Charlie good morning, everyone.

Charlie's comments covered most of the information on page two of the supplement including the largest driver of our reported loss, which was the 8.4 billion dollar increase in the allowance for credit losses in the second quarter. So let me highlight just a couple of things here first our income taxes in the second quarter reflected the impact of annual incomes.

It's primarily tax credits.

Driven by our reported pre tax loss as a result, we currently expect our effective income tax rate for the remainder of the year.

The approximately 26% excluding the impact of any discrete items.

Also deferred compensation plan investment results increased net gains from equity securities by $346 million and increased personnel expense by $349 billion as we've highlighted many times while these hedges are largely.

So they can result in large swings in our reported revenue and expense trends.

In late May.

Entered into arrangements to transition these economic hedges from equity Securities.

Derivatives in the form of total return swaps as a result of this change starting in the third quarter reporting for this item will be less volatile since most of the accounting impacts from deferred comp hedges will be reported in personnel expense.

Turning to page three.

Charlie cover the support for providing to our customers and communities during the pandemic, but let me just highlights of the approximately $400 million donation for small business recovery efforts, we announced last week through the new open for business FID will be delegated when the gross fees are recognized in revenue.

Turning to page four well earnings in the second quarter were significantly impacted by the economic environment or capital and liquidity continued to be strong with both our CPT, one ratio and LCR increasing from the first quarter.

Our CE tier one ratio increased to 10.9% 190 basis points above our current regulatory minimum of 9%, we expect our stress capital buffer to be 2.5%, which is the lowest possible under the new framework.

That would result in the regulatory minimum for RCT, one ratio remaining at 9% even with a large increases in our allowance over the past few quarters. Our she T. One level was $23.7 billion above the regulatory minimum.

Our LCR increase to 129% 29 percentage points above our regulatory minimum, but our primary unencumbered sources of liquidity for approximately $511 billion.

Turning to loans on page five similar to industry trends period, and consumer and commercial loans outstanding declined in the second quarter, but average balances grew reflecting increases in outstanding balances late in the first quarter.

I'll explain the drivers of consumer and commercial period end loan balances in more details starting with consumer on page six.

Consumer loans were down $20.1 billion, 5% from the first quarter. This decline includes the reclassification of $10.4 billion of conforming first mortgage loans.

Held for sale status to provide flexibility to manage our balance sheet under the asset cap.

Economic slowdown from closed at 19 reduced consumer spending and was reflected in lower credit card balances lower auto originations and other evolving at installment loan balances. In addition, we took actions during the second quarter to tighten credit standards, given the current economic environment and to manage to the constraints of the asset cap.

These actions included no longer purchasing jumbo mortgage loans through our correspondent mortgage business and not accepting home equity and personal line of credit applications.

The auto business, we've taken actions to mitigate future loss exposure in our spreads on new originations improves to their highest levels since 2016.

That said states began to reopen later in the quarter, we saw increased slow demand, including higher credit card spending and higher auto loan originations.

Turning to commercial loans on page seven season, I loans declined $54.9 billion or 14% from the first quarter driven by Paydowns of revolving loans following increase loan draws in the first quarter during the market turbulence at the onset of the pandemic.

As Charlie highlighted almost all of $80 billion of loan draws in March.

We paid down during the second quarter. These paydowns were partially driven by strength in capital markets and helped drive record revenues in the second quarter, and our corporate and investment bank.

Commercial real estate loans increased $2.1 billion from the first quarter with growth in both commercial real estate mortgage and construction loans.

Turning to deposits on page eight.

Industry as experienced very strong growth, but due to our asset cap constraint, we work to manage growth of certain lower liquidity value or deposit categories.

However, even after these actions average deposits grew 9% from a year ago and 4% from the first quarter.

Linked quarter growth was driven by non interest bearing deposits, which were up 18% 12 interest bearing deposits declined 1%.

Sure good end consumer and small business banking deposits grew $78.6 billion from the first quarter. This strong growth reflected covert 19 related impacts including customers preference for liquidity.

Load and tax payment deferrals, which otherwise would have reduced deposits.

Neal is checks and lower consumer spending.

Phil banking deposits declined $32.1 billion, reflecting actions, we took to manage under the asset GAAP, including an emphasis on reducing certain non operational deposits.

Average deposit cost declined to 17 basis points down 35 basis points from the first quarter.

With declines across all of our lines of business.

While wholesale banking deposit cost declined the most reflecting higher deposit betas, both web and retail banking deposit costs also declined.

We currently have no active retail banking promotions and we expect deposit cost will continue to decline in the second half of this year and reach the single digit lows realized.

In 2015 in 2016.

Net interest income declined $1.4 billion or 13% from the first quarter due to balance sheet repricing driven by the impact of the lower interest rate environment.

$275 million less favorable hedge ineffectiveness accounting results driven by large interest rate changes.

$187 million higher MBS premium amortization during <unk> due to higher prepayment rates and these declines were partially offset by a shift to a lower cost mix funding.

Net interest income was down 13% for the first half of the year and that as I discussed in June. We currently expect net interest income to be in the 41 to 42 billion dollar range for the full year 2020.

Which would be down 11% to 13% from the full year 2019.

This decline reflects the lower interest rate environment and the constraints the asset Cat places on our ability to grow the size of our balance sheet.

As well as higher MBS premium amortization, which we expect to persist for the remainder of the year.

Turning to page 10, non interest income increased $1.6 billion or 24% from the first quarter driven by a $1.9 billion increase in net gains from equity securities, reflecting lower securities impairment and higher deferred compensation plan investment results will explain.

But in some of these drivers in more detail.

Posit service charges were down $279 million from the first quarter, driven by close to 19 related impacts, including lower overdrafts as customers have reduced debit card transactions and increased deposit balances as well as higher fee waivers.

Trust and investment fees declined $223 million from the first quarter.

Investment banking had a strong corridor with revenue increasing $156 million or 40% is driven by strength in debt and equity capital markets. This growth was more than offset by both lower retail brokerage advisory fees, which were priced at the beginning of the second quarter when market levels for advisory.

Assets were pricing were lower decline in brokerage transactional revenue.

Yes banking revenue was relatively stable linked quarter with strong growth in mortgage loan originations more than offset.

Offset by declines and servicing income total residential held for sale originations increased 30% from the first quarter to $43 billion.

Primarily driven by lower mortgage interest rates lower interest rates drove strong industry volume the second quarter estimated to be the largest origination market since the third quarter of 2003, as we managed our application pipeline to handle the strong demand our margins increased.

In the second quarter, our production margin on residential held for sale mortgage loans was 204 basis points up from 108 basis points in the first quarter. We've continued to add capacity and expect originations to increase in the third quarter if rates remain low.

We would expect margins to be relatively stable.

Second quarter levels.

Servicing revenue declined to $960 million from the first quarter. The decline was driven by a lower valuation of our MSR asset as a result of updated assumptions, including higher prepayment assumptions and higher expected servicing costs due to an increase in projected defaults.

Servicing fees were also lower due to payment deferrals and fee waivers provided to our customers in response to the pandemic.

Finally, net gains from trading activities increased $743 billion from higher trading volumes across many products increased volatility leading to wider bid offer spreads in substantial spread and price improvement in certain capital markets.

Turning to expenses expenses on page 11, as Charlie highlighted our expenses are too high.

And we're beginning to take further action to improve our efficiency.

The 1.5 billion dollar increase in our expenses from the first quarter was driven by higher operating losses as well as higher personnel expense, reflecting a 947 billion dollar increase in deferred comp expense.

Charlie described the $1.2 billion of operating losses, which included $765 million of customer remediation accruals for a variety of matters as well as higher litigation accruals.

The 597 million dollar increase in personnel expense included the increase in deferred compensation, which is PNM neutral and $231 billion at Cobiz 19 related employee expenses, including premium pay for those who had to come into the office and payments for backup child care most of the club at 19 really.

Good employee expenses have now expired.

We also had $133 billion of higher cobot 19 related occupancy expense to make our properties safer for our employees and customers, including enhanced cleaning.

Additional supplies and workstation modifications these costs will likely remain elevated until the pandemic ends.

The impact of Cobot 19, also reduce some of our expenses, including travel and entertainment and advertising and promotion expense.

Turning to our business segments, starting on page 12, as Charlie highlighted we now have the leadership for our five business segments in place.

We will transition to reporting our segments in accordance with the structure starting in the third quarter.

Community banking reported a net loss of $331 million driven by an increase in provision expense on page 13, we provide our community banking metrics, we had 31.1 million digital active customers up 4% from a year ago, while the number of digital customers remained stable from the first quarter. These customers.

Our doing more digitally with loggins up 10% from the first quarter.

And the number of checks deposited using a mobile device, reaching a record high in the second quarter up 32% from the first quarter.

Approximately 20% of our branches are temporarily closed due to covert 19 as a result fewer branches being opened and increased digital usage teller and ATM transactions were down 19% from the first quarter.

28% from a year ago. However, we still have approximately 1 million teller transactions occurring at our branches every business day.

Our customers demand for cash has decreased by approximately 20% compared to a year ago. This decrease was reflected in lower demand for cash in our branches.

While ATM transaction volume was down the amount of cash with drawn at our ATM says increased reflecting higher levels of cash per withdrawal in part driven by the higher ATM withdraw limits, we implemented in the first quarter.

Charlie highlighted the improving traffic trends, we experienced during the second quarter for debit and credit card spend higher debit card spend later in the quarter resulted in total second quarter spend being flat compared with a year ago. However transaction volume was down 13% from a year ago with customer spending more per transaction.

As a reminder, debit card fees are based on transaction volume not dollar volume.

Turning to page 14, wholesale banking reported a net loss of $2.1 billion as revenue growth was more than offset by an increase in provision for credit losses.

I've already discussed the drivers of loans and deposits. So let me highlight a few other business drivers.

Corporate and investment banking capital markets had record revenue in the second quarter driven by the trading revenue increases I described earlier and record investment grade debt issuance.

Wells Fargo Capital Finance was the number one book runner of asset based loans with year to date market share increasing to 20%. We maintained our leadership position in this market by providing an important source of liquidity to our customers during a very challenging time.

Wealth and investment management earned $180 million in the second quarter down 61% from the first quarter.

Primarily driven by an increase in the allowance for credit losses, the lower interest rate environment and lower market valuations at the beginning of the quarter.

We continue to experience strong demand from clients for liquidity products with growth in deposits and money market funds in or asset management business Wells Fargo asset management achieved a record high $578 billion and assets under management in the second quarter up 12% from the first quarter driven by continued momentum in the money market.

Yes.

Higher market valuations and fixed income net inflows.

While advisory assets in our brokerage business increased 14% during the quarter, we had lower retail brokerage advisory fees since they're priced at the beginning of the quarter when market valuations were lower these fees will benefit from the stronger markets at the beginning of the third quarter.

Turning to credit results for the company on page 16, our net charge off rate was up eight basis points from the first quarter to 46 basis points, which is still at historically low level, particularly during an extremely challenging economic environment.

Keep in mind that significant amount of customer accommodations, we provided for our consumer and commercial customers. Since it started the pandemic will delay the recognition of net charge offs delinquencies and non accrual status for those customers, who would have otherwise moved into past two or non accrual status. However, I will point out that this dynamic was considered in our allow.

While it's for credit losses.

Commercial criticized assets increased $13.3 billion or 53% from the first quarter with Cnine up $7.2 billion and CRB up $6.1 billion.

Non accrual loans increased $1.4 billion from the first quarter driven by growth in commercial non accruals I would note that 75% of our commercial non accrual loans were current tonnage principle as of the ended the second quarter.

We provide more detail on Cnine nonaccrual loans on page 17.

Well see an eye loans outstanding and total commitments declined from the first quarter non accrual loans increased 59% driven by oil and gas and real estate and construction Cnine loans, which includes credit facilities to reach and other non depository financial institutions last quarter, we provided more details on industries with.

Slated monitoring and those industries largely drove the increase in criticized assets in the second quarter, including retail entertainment and recreation.

Turning to our commercial real estate portfolio in slide 18, we are the nations largest commercial real estate lender in our portfolio is well diversified both by property type and geography.

Commercial real estate loans are subjected to rigorous underwriting standards.

And are well structured before coded 19. This portfolio was performing late performing at historically strong credit levels with a good mix of assets and geography, well capitalized customer base and overall low levels of leverage.

We had proactively reduced our exposure to retail wouldn't have minimal exposure to land or condos, where losses were highest in the last cycle.

Since the pandemic began we've worked to assist customers on a case by case basis. We've continued our strict routine monitoring process with the goal of identifying problems. Early RCR you team has an experienced bench with workout backgrounds and perspective in times of distressed which has enabled us to ramp up quickly. However, these are unprecedented times.

The non accruals were up $286 million or 30% from the first quarter.

Given what's been what's been going on in the economy is not surprising the shopping centers retail and hotels motels accounted for 59% of non accrual loans in the second quarter and accounted for 90% of the increase from the first quarter.

Criticized assets were up $6.1 billion or 140% from the first quarter driven by the same sectors that drove the increase in non accruals with the addition of office buildings.

Turning to our oil and gas portfolio on page 19 oil and gas loans accounted for one percentage of our total loans outstanding with $12.6 billion outstanding at the end of the quarter down 12% from the first quarter.

Total commitments were down $1.7 billion from the first quarter, reflecting the impact of spring redetermination changes on borrowing bases.

Active portfolio management.

As well as the weaker credit environment.

Net charge offs increased $111 million from the first quarter with 87% of second quarter net charge offs from the GNP sector.

Non accrual loans increased $865 million from the first quarter with approximately 93% of non accruals still current on payments.

Criticized loans increased 26% from the first quarter, reflecting downward credit migration, resulting from commodity price volatility and included numerous credit downgrades of publicly rated companies.

On page 20, we provide detail on our allowance for credit losses.

Point $4 billion increase included $6.4 billion for incur a commercial loans in $2 billion for consumer loans.

Our allowance coverage for total loans was 2.19% of 100 basis points from the end of the first quarter with the largest increases across commercial loans junior lien mortgage loans and credit card loans.

We highlight the key drivers of the increase in our allowance for credit losses on page 21.

We considered current economic conditions, which worsen significantly compared to prior expectations as unemployment levels reached 14.7% in the second quarter. In addition to over 2.4 trillion dollars in fiscal stimulus programs as well as customer accommodations provided near term support for borrowers.

On this page we provide details on the economic forecast in our base case scenario for the second quarter allowance.

Which assumes near term economic stress recovering into late 2021, including unemployment levels declining to approximately 6% by the fourth quarter of 2021.

Hi housing prices are forecasted to remain relatively stable commercial real estate prices are forecasted to decline by low to mid teens with hotel restaurant and retail sector is expected to decline much further.

In addition, collateral prices remain highly uncertain given limited property sales.

While the large majority of weight is placed on the base case scenario, we apply some waiting to a downside scenario to reflect the uncertainty in the economic forecast.

And as I previously mentioned.

Customer forbearance and other deferral activities provided in response to covert 19 were considered in our loan portfolio performance expectations and loss forecast.

However, please keep in mind that our allowance for credit losses is influenced by a variety of factors, including changes in loan volumes portfolio credit quality as well as general economic conditions.

While the timing of the end of the pandemic in the eventual path to economic recovery remain unclear, we believe that our allowance captures the expected loss content in our portfolio.

As of the under the second quarter.

Turning to capital on page 22, as I highlighted earlier RCT, one ratio increased to 10.9% in the second quarter, we elected to apply the modified Cecil transition provision in our to our regulatory capital. The impacted this selection was an increase in capital of $1.9 billion at a 14 basis point increase.

Ladies and RCT one ratio.

Additionally, as the result of senior debt issuance during the second quarter and a decline in our R.W.A.R.T. lack ratio increased to 25.3%, which provides a significant buffer to our required minimum of 22%.

In summary, our results in the second quarter were disappointing and economic conditions remain uncertain, but we're focused on doing the work necessary to improve the earnings capacity of the company, including reducing our expenses, while meeting our regulatory commitments and Charlie and I will now take your questions.

At this time, maybe if I could ask a question. Please press star followed by the number one on your telephone keypad first question will come from the line of Erika Najarian with Bank of America. Please go ahead.

Yes, good morning.

My first question is a clarification question for Charlie Charlie during your prepared remarks, you noted that your expenses were about $10 billion greater than your peers or where you need to be to be equivalent appears on efficiency.

Are you, saying that lopping off $10 billion and expenses is an eventual long term goal for this company to be inline with our larger peers.

Well I mean, what I said was that the mess if you do the math.

What it says is that when you look at their efficiency ratios versus ours, our expenses or at least $10 billion higher than they should be and there's no reason why that should occur.

And so we are doing the work to create a roadmap for a company, which is significantly more efficient.

Exactly what the timeframe is and where we ultimately get too I think we'll provide more information on the future will play itself out, but we can do the same out that you can do and there's no reason why as a management team.

We don't have the ability to be as efficient as the rest.

Got it Thats clear and my follow up question has to do with he has the potential for the fed to extend that.

The income test beyond the third quarter I dividend.

I'm wondering so you know as we think about you mentioned that expenses should start coming down in 2021, you know as I think about how consensus is formulating future earnings power I think.

Intensity is expecting that you're premier majority of you were your reserve build should be behind you, but I don't think that restructuring cost for example that would relate to future efficiency initiatives are in with consensus and against the question that I'm really asking here is that you know if.

The fed extends the income test beyond the third quarter.

Do you feel confident that according to how they're looking at dividend capacity that 10 cents is it supportable going forward.

Sure. This is Sean the.

They certainly have the ability to to extend the current framework and it frankly, even seems likely just given the way the calendar lines up in the and re submission process is going to work for the next few car.

I think Charlie's point is we're going to do what's necessary to get as efficient as we can be and to the extent that that kicks off.

Onetime charges, which you might expect and if that has an influence on our dividend capacity as a result at the fed keeping that the current regime. In place then they will have to tolerate that I don't think we're not going to do what's right economically.

Because of accounting consequences, we're going to do we're going to follow gap, we're going to get as efficient as we can be outcomes going to be the outcome. We in part we set to be the current dividend or proposed to set the current dividend where it is.

It would buy us plenty of room to operate while we wall, we'd get through the next few quarters and and chart the eventual path to greater profitability.

But accounting consequences will be what they are it wasn't the primary consideration and setting the number where we did.

I would add as I think.

Is that when we think of it.

The work that we did.

We didnt.

Our board Didnt.

This.

Conversation around the dividend with that idea of at at each quarter and making it the termination.

And so our hope is that this does become a level, which is sustainable as we go through this period of uncertainty and as the fed.

Decides how they want to treat capital return over the next series of quarters.

We do have some items that impact our capital our ability to return capital with this rule that doesn't reflect our earnings power going forward right. We had a $3 billion settlement with the department of Justice.

Which is in our historical numbers that $3 billion. When you look at it is something like round numbers 18 cents a share.

The negative.

That ultimately will rollout and is already actually in our capital number so.

We have these dynamics that.

The board thought about when we set.

The dividend level for the quarter that don't relate to the future earnings capacity of the company, even as we look out into 2021.

Got it thank you for the clear answer.

Your next question comes from the line of John Mcdonald with Autonomous research.

Hi, Good morning, Good morning, John could you remind us.

Just where are you on the asset cap flexibility what needs to be done each quarter now you know with deposits coming in and some loan demand and what kind of flexibility how to operate onto that and where you are today on the you know that the way gets measured thanks sure sure. So we were in compliance with it if he ended the second quarter.

And the items that we did during the late first and early second quarter to maintain compliance we're really focused on our wholesale funding.

Footprint by shrinking or the amount of external repo and other financing that we do and taking trading assets to everything we had a focus on certain categories of non operational deposits the ones that have very low liquidity value.

And it's really this is from this point forward.

This is more of a liability management exercise to make sure that.

That we don't.

Retain too much in the way of low liquidity value deposits that we thoughtful about other other liabilities on the asset side, there's so much cash on the balance sheet right now.

I didn't get plenty of flexibility having to do what we need to do with loans.

You saw that are.

LCR print was 129% for the quarter and deposits have grown nicely. So.

We're very thoughtful and cautious about how we price deposits about those that have low liquidity evaluating we're thoughtful about.

Maturities as they come up in non deposit funding because with the inflow of deposits. We can rely more on that and less on on a notes and an institutional Cds and other things. That's the work that we've been doing and Thats. The path that we have over the next quarter too.

Okay and he reiterated the net interest income outlook for the year, how should we think about kind of the jumping off point for the net interest margin in net interest income as we go into next quarter or what are some of the puts and takes that we should factor in the model.

Yes, I think it's going to be relatively flat from where it is today, we're sort of were in that zone.

And as I said 41 to 42 billion for the year still feels like the right number. So I think it'll be you know, we're not really carefully managing the new admits were looking for the dollars and net interest income.

But it shouldn't deviate too much from where we are right now.

Okay got it and is there anything in terms of asset cap progress Charlie can comment I know you can see too much but in terms of the work being done and and progress in doing what you need to do to satisfy the fed.

John I appreciate.

Everyone.

Being interested given the limitations of it and asking the question is can be the same response.

Every single quarter, which is we're focused on it it is.

Along with the other enforcement actions the biggest priority that we have we're doing our work.

And the fed will determine when the work is done to their satisfaction.

Understood. Thanks.

Thanks, Jeff. Your next question comes from the line of Scott Siefers with Piper Sandler.

Hi, Scott I wanted to get Hey, thanks for taking.

John just was hoping it might be able to sort of update or refresh your thoughts on.

How and sort of when losses might might evolve I guess embedded in that is sort of how are you treating re ups deferral requests thing things like that night I guess.

Additionally, the updated reserve build kind of.

Mm implied super sort of what you're thinking about cumulative losses through the period, but just any any update updated thoughts you can share. Please.

Yes.

It relates to deferrals, which generally speaking is that consumer side of the house.

The the fact that we are deferring definitely pushes out rolls through delinquency buckets into charge off and so so the actual charge offs themselves will probably come later than they otherwise would we believed that we fully provided are captured that in the allowance.

So we've taken the credit charge today that we think is the right one at the ended the quarter.

Even if the charge offs come somewhat later.

We're also seeing we saw tickup in charge offs in.

In in commercial but there also.

Things do take a little bit before before they roll.

I think I guess I would expect a charge off rates and there will be different by asset category, just sort of move up slowly through the end of year, even into the first couple of quarters and next year and then start to flatten out after that just based on our the way things progress through through loss recognition.

Okay, perfect and then.

Maybe just to switch gears, a little the additional customer remediation accruals.

Charlie John can you go through sort of the I know you alluded to sort of taking a fresh look at things under under new management, but again, just curious given the charges we've already seen over the past couple of years sort of what what drove those those additional accruals in the new thinking.

Got it so as soon as Charlie said it was just new leadership at the at the top of the organization in consumer lending and in the.

In the center capability that we have running customer remediation are they pick on they've got an item by item and thought about how to be a little bit more expansive a little bit more.

Consumer friendly.

Many of these things aren't crystal clear and you're always making a judgment as to who it applies to how much it but how much should apply and over what timeframe and really in that effort as Charlie said to speeded up and move it through.

There were a little bit more expansive in order to end to accomplish that but it's it's by and large it's the same items that we've been talking about for the last couple of years, they're always new things that come into that bucket, but the but the bigger dollars relate to the same topics that we've been covering for awhile.

Once again emphasize as John said as most of the dollars do relate to those items and.

There is theres theres valid theres theres, a lot of value and get these things behind us.

It's the work it's the overhang is what our customers entity to think about us.

And so we're obviously going to do what's right for the financial position of the company.

But we want to treat people properly and we want to move on and moved to the future.

And so we made decisions around what we were willing to do certainly with that but that balance lands.

Okay perfect. Thank you very much.

Yes.

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

Hi, good morning.

Hey, a couple of questions. So first off.

Charlie just want to get a sense as to.

Where we should be thinking about where the expense improvements come from and the reason Im asking is I know you're in the middle It business unit reviews, you've got new business unit heads in several places it typically folks like that are going to want to make investments you're not going to touched the regulatory side.

So you know where where should we anticipate you have room to start bringing down expenses ahead of regulatory.

Framework changes.

Yes.

I think your point is actually very important one which is part of the reason why we've been we're trying to be very careful about making it clear that we are going forward and actively going to start.

To take actions to reduce expenses.

But we don't want to back ourselves into a corner until all of our work is done because of those two things that you mentioned, which which are very important.

Having said that.

The reality is that the work that we have to do the foundational work to build.

The risk Saul infrastructure and ultimately satisfy the work that the regulators would like us to satisfy it's clear it's distant.

It is fairly broad across the company, but we know exactly what it is resources or protect against that.

When we look elsewhere in the company.

I think I used the words in.

In the prepared remarks. It is we just we have.

Spans and layers.

At the company, which are well beyond what.

I've seen at other places and makes us very very inefficient company.

We just look at the work that's being generated the things that are being done.

We as a management team believe that we can change the priorities.

So that we're being really clear on what has to get done and stop a bunch of work that has to get done.

We have duplicative platforms duplicative processes.

Across the company so as we think about.

A series of these things.

They are extremely significant because these things exist just about every part of the company. In addition, I just also want to point out that.

We have stopped any reductions.

That we're going to take place just given the environment.

And so there is a.

A series of actions.

That we are ready to take.

In fact, we have a series of employees who've been told that their jobs will ultimately go away.

But we were going to let some time passes we got through the initial stages the coakley crisis. So.

We do see a clear path to start making an impact on the expense base.

And it's like an and the more we do the more clear the next round.

That's the thing that you could start in second half I know you mentioned that you know we see the benefits here in 2021 with expenses below 20.

But should we anticipate that some of this will start in second half 20.

We are clearly going to take the actions.

In the second half of this year and obviously depending on.

With the economics of all that is in the accounting of it not quite sure whether youre.

And next year.

Got it.

Okay. That's that's understandable and then just switch gears to a question on mortgage.

So it's a question here Oh, yes, that's because I just wanted one thing, which I just think is important which is.

Because I didn't say this in the prepared remarks, but it's certainly talked about this inside the company.

Which is which is we.

Don't look at a quarter like this and just say okay that is what it is losses are higher our margins or narrow we know we've got some work going on so we will eventually get around to it.

While we knew these things had to get done and the work was getting done it's not lost on us.

Our underperformance relative to where we should be earnings.

And so while I think there was a.

Sense of urgency towards both getting the regulatory worked on and improving our performance.

I never sense of urgency existed before.

Is that the small relative to what it is going forward.

Yes, sorry, yeah, I get that.

No I get that and I also I'm hearing in your commentary that.

The cost around the regulatory and the risk in the.

Those costs.

Is it fair to say are more known today than they were maybe a year ago.

I think absolutely as time goes on and we become we can get.

And what happened.

It's it's clearly easier for us to push.

Oh are brought understanding of what that takes.

And again I, just just to be clear.

When we go in part of the reason why it takes US a period of time to do this properly is we're going to have.

Very formal processes in place to ensure what ever reductions in our expense base.

We take.

That they do not impact any of that work and so that will be informal and it will be very very formal.

Because that would be just a terrible terrible mistake.

For everyone.

Not to do that properly so.

Beyond hiking consciousness on that issue.

Okay.

All right just switching to mortgage refi speeds have been incredibly high.

And three second quarter and John just wanted to get your sense as to what's in your base case assumptions for three Q4, Q I mean part of the reason for asking is it impacts.

The servicing.

Prepayments speeds it impacts year Eni outlook with a.

Refinancing on the agency and then I was just wanted to have a quick follow up question here on the Ginnie buyouts that you did that you know the American banker highlighted this morning, just understand is that the first of many.

Or not thanks, yes. Good question so on on mortgage speeds and it shows up in the MSR shows up in our investment portfolio and it shows up in the run off of booked loans that are in our held for investment portfolio and loan for him.

Really the speed assumptions vary depending on the vintage the coupon the debt to income the.

LTV et cetera, and to be refinance ability of borrower by borrower, but I think whereas aware as anyone of how fast things have gotten.

And we're seeing 30 handle CPR on.

Various pools of loans and so while we think we've captured that in our updated estimates on the MSR in particular, it does feed into this level of.

I call it $500 million to $700 million per quarter of premium amortization for mortgage securities, which we as I said is likely to remain for the rest of year.

On.

On a ginnie buy outs, you know as what's happening there is that their loans that have gone delinquent in part because of coated.

And.

As of the service or.

We essentially have the accounting consequence of owning the whether we buy them out or not they are deemed because the option to purchase so deeply in the money were deemed to have bought them and so our calculus was either to have a giant pile of cash and that that consolidated asset or to go ahead and.

By them out and not have that asset essentially that asset twice, but use the cash to buy the asset and these are guaranteed loans from our perspective, not a huge credit consequences just carrying the asset for a period of time before to other goods redelivered are sold or worked out in some way so.

That's that's why we were a big buyer in the in the actually that was that after the ended the quarter.

And then with respect to whether it continues on its worlds facts and circumstances that same tension. We'll have we'll apply if were deemed to have them on our books because we have the option to buy them. Then we may and if cash levels remain where they are then we may go ahead and do it just so that we don't really double up the size of our balance sheet and that is that asset cap.

Consideration.

Yeah, I know what makes a ton of sense, but so it's a function of in more forbearance from here is that the driver.

More slash ongoing vets right and whether we are the service or not but that's yeah thats great worse.

Okay. Thank you.

Yep.

Your next question comes from the line of can you can with Jefferies.

Okay, Hi, good morning, good afternoon, now at East Coast.

Just a follow up question on the Eni outlook outtake seems like in the second half some pluses or minuses to get to the mid zone of your 41 42, but just can you help us understand just how much more roll through their needs to be.

From here on both asset yields and securities yields to your early points of how you're reinvesting and then what from here can also happened on the deposit cost side as a partial offset.

Yes, so I think of deposit cost side, the our anticipation is that between the.

The reduction in pricing for interest bearing deposits and the growth or continuity of non interest bearing deposits that our average deposit cost.

As back in the single digit basis points.

By the by the third or fourth quarter. That's the trajectory that were on Thats, where we were in 2015 2016.

On the asset side here, depending on what happens to LIBOR probably in particular.

Spreads are holding from where we are lending and there will be some.

It could there could be some lower spread loan product that that was replaced with higher you've heard about that in autos is true in some categories of see an eye but.

That's a piece of it on the Securities front, we've been trying to stay invested but the level of prepayments that Betsy just referred to I think at our our securities portfolio down by almost $30 billion in the quarter and so.

How much more duration, we want to add at these low yields. This is a separate issue, we havent, but adding much and credit related securities product, but as I mentioned I think to John D.

The the outlook for for NIM is relatively range bound to the rest of year, who were sort of bumping along what we think the bottom could be I mean, obviously things could change.

But but at a zero in the front end and 60 70 basis points in the long end. This feels about like where we're likely to be lift the things that I mentioned.

Right and then so I guess then it really just Eni growth next year or just you starting from a high point. This year. So we'll probably be in the whole still next year, but.

Really does it depend on the asset cap, then or does depend on the mix of of earning assets in order to get that cut off this $10 billion ish type of Eni number yes. It's good question. It's both so it's going to what choices, we make on the asset side and and what the market is offering what where loan demand comes from I think will matter a lot.

The slope of the curve if things get a little steeper that obviously could be helpful. Because we're so exposed at the long end.

And then if there's an opportunity that have a bigger balance sheet, we're certainly not budgeting that we're counting on it but.

That would be a difference maker.

Okay. One just quick follow up John on the servicing side of mortgage great production and then the tougher servicing results. There's both core fees that are debtor contracting because of the Prepays and then there's all the hedging what's the best where you can help us understand.

How that mortgage banking line item just trajectory from here, given especially the uncertainty and how your model out.

The the servicing side.

Yeah, it's tricky, but so I think what we've said as we expect volumes on the production side to be a little bit higher and margins to be relatively constant. So if those two things hold true the third quarter should be a great relatively great production environment for mortgage and on the servicing side, we think we've captured the higher servicing costs for.

Our default servicing modification servicing et cetera.

We now have faster speed expectations in the model, although we said that a quarter ago too. We were we were surprised on the downside.

But if we if both of those things are captured than we will we will produce.

Lower servicing fees because the book itself is getting smaller.

But with the all take smaller servicing revenue.

As long as we're not.

Taking big right does on the asset that are offsetting the benefit that we're generating on the origination side and hopefully the third quarter.

Reflects that.

Okay got it thanks John.

Yep.

Your next question comes from the line of Saul Martinez PBS.

Okay. So hey, guys Hello, Thanks for taking my questions.

First of all really really specific question related to the fourth quarter dividend cap can you just.

There are five John that's based on net income before preferred stock dividends and because I think that guidance from the fed is public that it's based on what I see nothing configure and for you guys. Obviously that does that does matter given that give you cited for stock dividend. So just wanted to.

Make sure that.

With that points clarify.

Yes, the way, we're calculating it's not yet after tax but before preferred stock dividends, which gets you Tonight.

Available to common.

Okay got it okay.

Okay. So it's been so you're calculating before before for preferred stock dividends is to just to be correct. Yes.

Okay got it.

A much much much broader question and.

Kudos on on the donation to the Cdfive and a lot of and do a lot of very good work and.

I guess on that point, though I do think that it's pretty clear, though not wells does have to maybe more than others really focus on multiple stakeholders and different pools and you know the IPO strictly shareholder driven capital.

So obviously already under attacking it's make your regulators meet their demand employees I think it changing the are concerned about the wealthy but.

The communities you working.

And then you have guys like me who.

Talk like you're off season.

Super high efficiency ratio, you're going to right size or cost structures and and I guess, how do you think about that the balancing act in the is competing demands I think in the past. This management team took argued that they can do.

Do all of those things simultaneously and I think to certain degree maybe it's true but there are currently Archie tradeoffs and as you know end and.

So some element of the zero sum dynamic going on so I guess Charlie.

Curious, maybe just more philosophically, how you think about that.

I guess ultimately how do you think about shareholder.

Shareholder value in that natural and pull of goals.

Yeah, I guess I don't think about it as a trade off and I don't think about it as something which is.

Different for us versus other.

Significant companies, whether your financial institution or not I think.

It is very very clear that our ability to be successful as a company for our shareholders.

The fact that we are broadly considering a much broader set of stakeholders. If we don't do that.

Customers, whether their consumers or companies ultimately won't want to be supportive about of us.

We'll have issues in our local communities it will filter through too.

Ladies and likely the regulatory agenda, so I think.

Very much thing that they are very much related.

Theres No reason why the things that we should be doing to be more thoughtful of the broader set of stakeholders.

They arent a set of.

It is.

Ultimately it should be something beyond that.

You know the PPP fees were certainly something that was very unique.

We are in the middle of this.

Really horrific time for small businesses at especially a minority owned small businesses.

The right thing for us as a significant company in this country is to be as helpful. As we can with that community.

It's also ultimately helpful for us if we can make a difference in the communities.

That we operate.

And then we also looked at that relative to just the what we thought was fair for us in order to participate in the PPP program and so I think you put all those things together and there is alignment.

And those that don't think about it that way will likely suffer over the long term.

Yes.

Alright, thats thanks for the top last appreciate it.

Your next question comes from the line and Steven Chubak with Wolfe Research.

Hi, good afternoon.

So I wanted to start off Charlie without just a theoretical question on the asset cap can you talk about the proactive steps that we're taking to manage the balance sheet to stay below and how that negatively impacted and I think most investors are focusing at this juncture on normalized eni and through the cycle revenue growth expectation.

If the fed were to lift the asset Cat Tomorrow I was hoping you can give us some idea or context around the amount of pent up growth potential in the balance sheet. Today I just I think it would be helpful. If you could frame the impact to the asset cap on NII or lease volume growth based on where things stand to that.

So this is John if just as a data point is using rough math, if if our balance sheet. This expanded by call it $200 billion or about 10%.

During this coded timeframe and then.

It's a question about whether there was ample opportunity to do that around several asset classes, but in certain areas are certainly was.

With something like our average NIM.

The impact that that would have had on us would have been indices are approximations, but to reduce the drawdown.

Hi by 50% so half of how things have worsened would have been covered by that expansion of the balance sheet.

That's one way to think about it. It if there were there were more immediate opportunities to put loads on in particular I would say in March as capital markets for close I think everybody knows that we top custom redrawing available facilities in or other request for new facilities.

The the bigger probably more constant piece of it increased balance sheet at least in the businesses that we serve today would probably be to have a bigger.

Securities and securities financing portfolio.

In support of our corporate and investment Bank, where.

We have drawn down.

As part of managing under the asset cap and Theres, a because a handful of benefits to that including being able to do more business with the companies that were and the institutions that we're financing in that realm.

But you also end up with the Big LIBOR funded.

Book that is a little bit less.

Hey, symmetric in a down rate scenario and we certainly have suffered from that.

There's a real benefit to being substantially deposit funded in that it's very low cost to begin lift but.

But in a down rate environment, it's a little bit more violent in terms of the outcome that it generates and to have a bigger component piece of LIBOR funded assets.

Slide were funded liabilities, it's a little bit less.

Hi, producing in the best of times, but it maintains its margin in the in Indonesia environment. So that would have been a benefit also.

Charlie you may have other thoughts.

I think thats.

Okay.

Okay. No. That's helpful color John So thanks for that just had one more question. This morning, I guess I've asked over the last couple of quarters, but wanted to get some context around the four core fee income level or the jumping off point, we should think about for the back half. When you cited some the tailwinds from mortgage production.

I trust fees should benefit from higher markets, but you also have some normalization of trading activity and just given all the different moving pieces I was hoping you can give us some sense as to what the right jumping off point might be for Threeq if.

Yeah, we though we don't put a number on it and call it core, but rather talk about the.

Component pieces of it and.

So service charges on deposits, which is a big one for US My assumption is that it's going to its going to feel at least for a while like it does today people are spending differently. There there are maintaining cash balances at a higher level and so there are whether its waivers because of high balances or the absence of overdraft.

After that puts pressure on that line item as our customers do what's right for them. In this environment, you mentioned brokerage advisory et cetera that should be stronger going into the second half of the year.

Investment banking, but we had we had a record high grade market in the first quarter. So while other activity may pick up a little bit my sense is that that probably normalizes somewhat.

Card fees have reflected what I mentioned in my in my prepared remarks, which is at least in the debit card space. We've got balances are flows in dollar terms about equal to last year, but the number of transactions lower which has.

Hey, a negative impacting card fees and credit card fees have been improving that haven't haven't caught up so that.

I don't think is going to pop back up anytime.

Really quickly mortgage I mentioned on the production side should be very strong there should be strong.

And and hopefully we we've.

Weve accounted for faster speeds and higher costs in servicing trading as you said probably gets a little bit softer.

And other items.

Or less material and there's nothing really noteworthy so that's how I would take about the categories.

Hey covered again it takes so much that John.

Sure.

Your next question comes from the line of Matt O'connor with Deutsche Bank.

Hi, Matt Hi, I.

I wanted to circle back on kind of longer term view of of getting your efficiency closer to peers and I guess the first question is why do you necessarily think it's an expense issue versus the revenue issue or is it a combination of both.

It's definitely a combination of both revenue, particularly interest income, which doesn't carry a lot of expense load would be very helpful. I think what we're trying to do is.

As assess where the company is today and what we can do about it and.

We can do more about expense than we can about revenue.

In.

In the balance sheet constrained environment in a in a recession and in a low rate environment. So it's it's actionable by by the management team, but without a doubt.

Some of them out of normalization of certain categories that revenue would be.

Would contribute to it but having said that I think we've sort of factored in for a variety of different ways on the idea that all things being equal and I'm sure they won't be but at least we think about it today that $10 billion is a reasonable.

Amounts.

Two.

To go after to put wells Fargo on a level playing field with large cap peers.

And the only thing I would it what John said as.

So this isn't the the calculation of the 10 billion that as a that's a mathematical exercise when the management team. The operating committee gets in a room.

There is absolutely no disagreement in the room not about the math, but about the inefficiencies that exist inside the company away from all of these risk related activities.

And the work that we've been doing is to build the plans from the bottom up.

Identify where that is and so.

You know, whether that's the full 10 billion or or not we'll see what we get too.

But there is.

Certainly have.

We believe that we can make a significant debt.

Based upon what we know.

And just to be clear, what you think kind of the longer term cost base can be when.

You use a $10 billion has come a reference point should we just annualize. This quarter's costs that gets you down 58, you take out 10, that's around 48, I mean is that the thought process.

I think of 54 ish is more of the normalized starting point without the the excess expenses that are loaded into this quarter for the items that we mentioned.

Well take 10 off to 54.

Yeah.

Okay, and I guess, just relate to that like whenever I think about kind of cost saves like there are areas that you don't want to invest and there is just natural inflation creep.

So I mean, you guys kind of opened up a little bit the can of worms on the 10, Diane I know these are things that are tough to predict looking out a few years, but what we didn't know how can of worms, because I don't I don't look at it like we have a can of worms. I think we look at we looked like work knowledge and what the facts are which is the facts are as we compete with other companies.

Is that are investing tremendously and with that those set of investments.

The math says the following and so what we know we purposely haven't said, we're going to reduce our expenses by certain point in time, because we're doing the work to figure out what the timing looks like with.

<unk> reductions versus our investments.

But I think what's important is not just that we acknowledge that that gap exists, but we are proactively working get to a place.

Which makes sense both from an efficiency standpoint, knowing that we should be investing in the business.

Okay, Alright sounds like we'll get some more details in the third quarter or so I think we all look forward to that.

Thanks.

Your next question comes from the line of John Pancari with Evercore ISI.

Hi, good morning joined.

On the on the credit side.

Just wanted to see if I get your updated thoughts around your.

Through cycle loss estimates that you would expect I know, you're 2020 company run D. Fas is about 27.7 billion on the debt a fair way to think about it and then also want to get your thoughts around the reserve you took a pretty good addition.

This quarter and now your reserve is about 74% of that 2020 de fast.

Because.

Likelihood for additional substantial reserve additions from here. Thanks.

Thanks.

Thanks for the question, so where we do the math to compare our own estimations to the de fast outcomes, but we don't.

We don't think of them is necessarily better informed about our loans that are portfolios and our risk profile and our collection activity et cetera. So that's it's a it's a useful data point and it's an external one that people can judge against but.

But we're where we think more about our own experience and the.

And the scenarios that we believe are likely ones in the in the world that religion and so so that's that's how we focus that went to build that we made in the allowance I think were.

At the almost 2.2% coverage.

Of the outstanding loan portfolio and of course, it's very different by by loan category like it is for every other bank I.

I think we believe that if the world unfolds in the way that we've got it model than assumed in our and our and our both modeled loss estimations and in our.

And in our bottoms up portfolio by portfolio work that we will have captured the loss content in the portfolio as of the ended the quarter.

And as a result, or less things really Blake in a worst direction that.

That that this would be.

This would have accounted for those losses.

Got it thanks, John and then related to that Tom a commercial real estate side.

Just want to see if you could discuss the credit trends that you're seeing in commercial real estate I know that delinquencies in CMBS structure is really spiked for the industry beyond even financial crisis levels and.

But clearly that is being staved off somewhat at the banks by forbearance efforts are you could you just give us a little bit of that granularity around what you're seeing and the level of forbearance on in commercial real estate and is it if you're seeing a greater pressure in the portfolio to forebear to given the pressure that your borrowers are seeing thanks Yep Yep the first.

Distinguishing point I would make is that.

I know you notice, but but for everybody's benefit CMBS structures are non recourse loans and.

So there is no there's no.

Alternative other than than than realizing on the collateral there's no mechanism for extra cash flow to enter into a structure unless somebody does something that they're not contractually obligated to do to try to ensure things up and I think as I've.

Seen most recently the June numbers in CMBS or about 13% of loans are not current.

Conversely on the bank's balance sheet most of the loads that we have have real sponsorship and recourse and and and generally speaking our lower LTV.

And then CMBS to begin with so our actual performance is quite different.

And then I think we talked about this last quarter too, but the variation in how how deep will go from an LTV perspective is as you'd hope you know with a more stable property types, we might have higher leverage and with the lease stable property types, we'd have lower leverage, which which which helps a lot in a in a downdraft.

So we have you know in round numbers, roughly a 150 billion dollars' worth of commit commercial real estate loans outstanding at the end of the quarter.

The biggest piece is a quarter of that his office or 20% of that is apartments, 12% is industrial 10% as retail excluding shopping centers in the 9% two shopping centers and everything else is below 9% actually hotels is about 8%, which is a volatile property.

He type.

And then among non accrual loans the.

Shopping centers.

Our 32% hotels, 14% and retail excluding shopping centers is another 14% and everything else is below it was below 14% there's about a billion three of non accruals overall.

That's what it feels like you know we're working through these things borrower by borrower, sometimes the concessions that we're making are just a covenant related sometimes they are.

Real forbearance and and we allow people to take a little bit more time to pay our borrowers have been generally calm and constructive it's not a not a lot of panic at this point in the cycle the problem loans of skewed towards retail projects, many of which were already struggling and and then also the the hotel owners with lower.

Well recapitalization, so I hope that's what that's helpful.

Got it now that it's helpful. So really you your reserving within commercial real estate or you would say that that represents the similar stance for your overall portfolio. In other words, you are pretty much finished building reserves there as well.

[noise] for for how we understand the world at the end of the second quarter, Yes, and and we think Thats relatively we think it's very realistic. We I should also add that in commercial real estate and elsewhere. There. Our teams have gone loan by loan borrower by borrower and made an assessment of where we think we are and where are we thinking things are go.

Going so it's not just to modeled set of expectations, but real.

A real careful review.

Every borrower every property and their circumstances.

Got it alright, thanks John.

Yep.

Your next question comes from the line it Brian Kleinhanzl with KBW.

Great. Thanks, Hey.

One quick question that's more of a clarification you did mentioned that on slide 16 at save a percent of Nonaccruals were current on interest and principal was that referring to the 1.4 billion increase or was that referring to the total and I guess why non accrual or for their current on interest and principal.

Total.

Total on the.

Okay.

And then separately when you think about the de faster results.

Anything that you may perform better than those results I guess, where do you take exception with kind of how the feds modeling your stress losses versus how you see him coming through the cycle yeah.

Forgive me, if I don't and if I don't started quite or response by saying, we take exception with the feds results in the following way because that's not really that will be helpful. But.

You know they draw from different models and have different approaches and we draw from our own as I said bottoms up Aro modeled outcomes are on historical outcomes change in the composition of the portfolio change in underwriting standards since whatever we're comparing it to and and we end up with the numbers that we end up with I'm happy to note that I think in.

General the fed.

Applies a in general a lower loss rate for a variety of loan categories took two wells fargo than they have for some other.

Lenders not not universally true based on the composition of portfolios, but.

Where we like our numbers were a lot of of work with a lot of very close inside knowledge of borrowers properties et cetera goes into it and it's being compared with something that's more statistically driven from a model that we don't have access to.

Thanks.

Yes.

Your next question comes from the line, it's Chris Kotowski with Oppenheimer and company.

Yeah. Good morning tourists things one just the hi to follow up on Matts question. I mean, just you know from 2017 to today I mean your revenue runway went from 88 billion to roughly 70 ish billion.

And your core operating expenses of kind of stayed flattish at 54 ish, let's say it so I mean sitting here on the outside it looks like it's primarily a revenue probably not an expense problem.

And and I mean are.

When you put out a number like $10 billion or are you worried that that is going to like forgo the optionality on capturing backup 18 billion, then lost revenues or should we assume that thats kind of gone.

I think you should go back and listen to the words.

That who used to describe what the 10 billion isn't how we're thinking about this.

So theres no question in our minds that we should have the ability to generate higher revenues in the future. No question that will help when it comes to an efficiency ratio. What we're talking about is if you go back and look at where we were as a company versus the others the others.

The the big companies that we compete with had been working on this for five to 10 years and there is and again interesting we're being very factual about which you should which you should.

Which you should go back and check yourself, which is there is this meaningful difference.

Between was our expense base looks like.

And there's and then I recognize you're on the outside but what we're telling you is from one on the inside that we use a management team continue to believe that the opportunities are substantial to improve the efficiency of the organization because we see it Dana.

And we're going through a process to identify exactly what it is where it is.

It's not just people is it's the third party spend here is extraordinary things that we rely on outside people to do is beyond anything that I've ever seen our ability to.

Reduce facilities is substantial.

So there is this long list of things that we will actively be working on.

Whether that gets to 10 billion, whether it gets to more whether its guess left we'll see we're going to share more as we develop the plans, but I think it's just important for us as a management team to be very objective at what things looked like for this company before we wound up in today's environment.

And those efficiencies clearly exist in the company.

Okay, and then just a small thing I thought I heard Jones say that you're no longer accepting home equity and personal line of credit applications and I mean, I realized that those have been declining categories and that they are not.

Another kind of product lines that today that they were.

Before the great financial crisis, all that but still I phones kind of.

Sort of key products in a big consumer bank.

You know Arsenal and doesn't attend the wrong message to not not even take the applications.

Well I guess, let me.

Oh I'm talking about these junk and talking with is I guess when thinking about it is.

First of all we do offer personal lines in the company because we have a credit card business and so for US. It's a question of making sure that we've got.

Right products.

Of the customer and so we think we have the ability to do that the home equity product as you rightly mentioned has certainly declined in terms of the amount of production that was taking place.

But we do have to make a determination in the uncertain environment as to what is a smart thing for us to.

To participate in along with consumers as they add risks to their balance sheet.

As time goes on if we feel differently about the environment and about real estate values those decisions could change as well.

Okay fair enough. Thank you.

Your next question comes from the line of the vaccination with JP Morgan.

Hi, Charlie Hi, John a couple of questions. Thanks.

Taking them personally.

Charlie I use still on track to be giving us some kind of strategic reveal a strategic plan towards the end of the you.

Uh huh.

Should we expect that with the costs details I didn't want to give us a third quarter Ho how you're thinking in terms of timing of the too. Thanks.

I think in as we.

Between the third and fourth quarter, we're looking at getting both done to share the complete or complete sort of thoughts with you.

Okay. So you do them she'll give it to simultaneously so that we can see how the to fit together.

Again, I think that's what we're targeting.

But we'll have to see how it plays out in our our progress.

Okay.

In that same then tally as you're thinking about all of the.

You could talk about not having too much of an expense dollars relative to the.

Yes pairs.

How much of this legal finance businesses.

It's because we just don't have enough scale on the revenue side.

Are you thinking you're going to exit some of those businesses what are you thinking there.

Are you thinking about mall business exits any any thoughts on that.

Yeah, that's a good questions as I think and I think we've talked about this a little bit over last couple of quarters are there. Other absolutely are some things that we do which either we don't have scale in.

For just might not be.

Big enough to have an impact on the company going forward and it's not clear that is integral to us being able to fulfill the primary.

Banking relationships that we have from the consumer to small businesses middle market up to the corporate so I think is it was we think about what the company should look like.

We absolutely are looking at those things and so we certainly expect that we would continue to I think John is used the word prune. Some of these are some of these things that exist inside the company.

As we've been doing I don't think about them in terms of.

Is it differently the five lines of business that we've determined we do believe are key to the future of the company, but when you go below that there's certainly some activities, which might not meet our criteria for continuing to be here.

And then when you give us these combined videos when you give us some sense of you know we've been we've heard about you'll need to spend more on technology areas that you're behind them and they give us some sense also where that stands business by business and what you need to do and how that sort of.

Dovetails with the numbers too.

Listen multiple well see when we get closer level of detail that we go through with you, but certainly the work that we're doing.

To place the fact that we.

Don't want to stand still and our businesses.

Thank you.

Your next question comes from the line, that's Charles Peabody with mortality.

Good afternoon. Thank you.

Two questions, one and I apologize if you've already covered this right transitioned over late from Citigroup call.

What would the the variables that went into your thinking on the level of the dividend I mean was it.

This was a level that you didnt have to worry about it again what is it a function of.

What you think your core earnings power is going forward or is it is a desirable capital more quit what were the variables that.

Got you to that level.

Handful of things of course, and and with the expectation that it's likely that the great constraints on the calculation of allowable dividend hang around for awhile.

Even though they may not but they but they certainly may we've we found a level that we believe is.

There's something that gives us more of upside ability as is the covered environment clears up as the.

Medium term earnings power of the company becomes more more known both in terms of sources of revenue and what's happening with expense et cetera. So that we don't we would end up or have a low likelihood of ending up in an environment, where you are making.

The repeated changes to the dividend.

So im not so much about our capital levels are fine we have 23 ish billion dollars of excess on top of our regulatory capital requirements and we feel it's gone up as you may have observed and that's even after building a $20 billion allowance. So so not so much capital sufficiency although.

In the future could turn out differently than wouldn't than we and others are planning right now, but it really more about thinking about the core earnings power and and ER and and resulting upward trajectory when the time is right.

So I'll just add I know, we certainly appreciate the multiple calls that are going on today to say a busy day for you. All I would encourage you to go back and look at the prepared remarks, because we did walk through the thinking.

Thank you.

As a follow up question there's the.

June 22nd letter from 40, or 50 60 Congressman on both sides of the bi partisan and address diminution in Powell and in this letter. They you know warn of a looming crisis in the CRT and C M, particularly the CMBS market and they asked for hit help from the Treasury.

And the <unk> said.

I was curious what actions you think they might be thinking about taking to support the CMBS market or what actions would you like to see them take.

[noise] I ER.

I don't know notes that we have an opinion on what actions, we'd like to see them take.

I do think that as between the the risk owners in CMBS transactions, and the and Servicers and borrowers single people should be looking to maximize recovery value.

But the contracts are pretty are pretty.

Pretty thoughtful this isn't the first.

Downturn that those those market participants have done through and my expectation is that that a lot of auto decision, making power is going to end up in the hands of special Servicers and and I don't know how to Oh I don't know why it would be a good idea to to impose some other regime on top of that that.

That does that change those contracts, but but I don't have a kind of a careful thoughtful review of what's being proposed.

Thank you.

Our final question will come from the line of Gerard Cassidy with RBC.

Hello, Gerard Thank you.

I apologize if you touched on this are ready, but when you guys gave us in slide team I'm, sorry, 23 in the number of customers you have helped with differing payments in waiving fees can you give some color on the trend in terms of the applications for these deferrals I assume they were very heavy early on.

Yes, they do downwards, and then second how many of the customers that have come up for renewal have actually asked for a second extension of the from the deferrals.

Well, it's different by loan category and and yes, it's true that the that the people initially asking sort of a high point, we peaked our peak.

Was the second week in April I think on average we had about 60 or 70000 accounts per day, who were who were asking we've dropped.

Well almost entirely I think we're at four 4000, a day for the week of fleet June.

So if that's if that's helpful.

And then of course the extension question is related to how long was the initial deferral to begin with and in general I would say that a bit more people are getting comfortable with.

With.

What's coming out the other side, but but yet we still have a a good base of folks who are in deferral.

And then second John and you guys can any color from the fed how long they are going to be supportive of the industry yourselves included in granting these deferrals without having to reclassify when loans and put more capital again.

There I don't think we've got a specific conclusion on that although we do assume that there's going to be some point in time, after which whether it's the regulators not only the fed and or accounting convention is going to cause us to have to consider these if something other than to performing loan.

Might be different by category it might be different by regulator.

But the longer we go on the greater the risk of that.

Great and lastly, thank you again to the great detail that you gains given new commercial industrial loan portfolio.

I noticed as you mentioned the increase in non accruals on page 17, given categories can you give us some color on the real estate in construction and non accruals went in to 90.

Moving on from I guess, what's going on in the prior quarter, but how much was construction versus loans to the non depository financial.

[noise] you know I don't think I have the breakout.

In front of people that can have the IR team follow up with you.

Okay, Great no I appreciate it thank you.

You bet.

All right guys resin. Thank you very much for the time, we appreciate it and we will talk to you soon take care.

Ladies and gentlemen, this does conclude today's call. Thank you all for joining and you may now disconnect.

[noise] [noise] [noise].

[music].