Doo-Doo Bank Drill Down: Part 1 - Wells Fargo

By: Reggie Middleton | Sun, Jun 1, 2008
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This is the first of several drill downs into the list of 32 banks in deep doo-doo. Before I go on, let's outline the articles in this series thus far...

The Asset Securitization Crisis Analysis roadmap to date:

  1. Intro: The great housing bull run - creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble - A comparison with the same during the S&L crisis
  2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
  3. Counterparty risk analyses - counterparty failure will open up another Pandora's box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis - part I
  6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  8. More on the banking backdrop, we've never had so many loans!
  9. As I see it, these 32 banks and thrfts are in deep doo-doo!
  10. A little more on HELOCs, 2nd lien loans and rose colored glasses
  11. Will Countywdiw cause the next shoe to drop?
  12. Capital, Leverage and Loss in the Banking System

Well, the first bank on the drill down list will also be 2nd of the banks that I will deliver a forensic analysis on (the first was PNC Bank). That bank is,,, (drum roll in the backgroud, crescendo.... I know some of you hate it when I do this........) Wells Fargo! I can hear a few of you naysayers cackling behind your computer screens as I type this. Wells Fargo is a big name brand bank (cackle, cackle)! Wells Fargo has Warren Buffet as its largest investor (cackle, cackle)! Wells Fargo this and that and blah, blah and (cackle, cackle).... All I can say is, beware of name brands (I actually felt compelled to address this in earlier posts). I have made more than a couple of dollars benefiting from name brand hubris and smaller investors who would rather be told what to do than read a balance sheet! Time will tell if I am right or not on Wells Fargo, just be forewarned - several of the banks on teh Doo-Doo 32 list have already taken a trip to the confessional! The score card for the credit crisis to date, Reggie Middleton - 10, big name brand investors - 0 (not to toot my own horn, I'm sort of a modest guy and I know I have a big mistake/loss coming soon, it just isn't going to be this one). I actually have a lot of respect for Buffet, though. Hell of a fundamental investor and cash flow king, and charming public persona as well as being modest (at least he's got me beat). My appreciation differs from that of many, though. His investment track record is quite impressive for it stands the test of time as consistent. As a smaller, unknown investor, he was the most impressive, but now he is an icon and his very words and even a scent of investment from him actually moves markets. Even though he has a much larger capital base to work from (which makes it harder to generate large proportionate returns), his influence can be confused for investment acumen. All in all, he is one to be admired, but the investment results stemming from alpha have to be seperated from the ability to manipulate and move the market (unless that actual ability can be defined as alpha - topic for another day). We all make mistakes though, and Wells Fargo is a mistake waiting to happen. Let's walk through this company as I see it. Of course, since Wells Fargo failed to cooperate with me in releasing their numbers, I used statistical data to back into their probable delinquincies where they weren't directly available from their public filings.

Wells Fargo Observations

Loan portfolio:

Large exposure in Construction and Development (C&D) loans: Of its total loans of $386 bn, Wells Fargo (WFC) had $19 bn exposure in construction and development loans in 1Q2008. WFC's exposure was the fourth largest among all US banks in absolute amount after Bank of America, Wachovia and BB&T, comprising nearly 36% of its shareholder's equity (this is unadjusted for bullsh1t).In 1Q2008, C&D loans witnessed the highest stress with NPA to loan ratio of 2.32%, followed by real estate 1-4 family first mortgage with NPAs to loan ratio of 1.91%. C&D NPAs (Non-performing or dead assets) witnessed a 114% increase over 1Q2007 and 38% increase over 4Q2007. In Wells Fargo loan portfolio, as of December 31, 2007 California represented nearly 32% of total C&D loans, Florida represents 5%. These areas are experiencing extreme stress due to thier high (the highest in the country) residential delinquency, foreclosure and REO rates.

This stress is real, and is already causing losses in the condo construction and sales markets, retail malls and now office buildings. Please see my primer and series on the Commercial Real Estate Crash and ongoing series of financial shenanigans and excessive debt issues of General Growth Properties for additional information.

Sizeable Real Estate loans exposure in troubled markets: Wells Fargo had $148 bn loan in 1-4 Family Mortgages (WFC has a high correlation to industry-wide losses) which represented nearly 38% of the banks' total loan. Out of these loans nearly 51% comprised junior lien mortgage loans (much higher probability of total loss and no recovery). After C&D loans, real estate loans have highest NPAs as proportion of total loans. In 4Q2007, real estate 1-4 family first mortgage NPAs to total loans stood at nearly 1.91% of total loans with total NPAs of $1.4 bn. In terms of geographic exposure, real estate loans from California and Florida comprised 33% and 4% of total real estate loans (i.e 13% and 2% of WFC's total loan portfolio).

WELLS FARGO 1Q-2008 4Q-2007 3Q-2007 2Q-2007
Loan Composition
Commercial 92,589 90,468 82,598 77,560
Other real estate mortgage 38,415 36,747 33,227 32,336
Real estate construction 18,885 18,854 17,301 16,552
Lease financing 6,885 6,772 6,089 5,979
Total commercial and commercial real estate 156,774 152,841 139,215 132,427
Real estate 1-4 family first mortgage 73,321 71,415 66,877 61,177
Real estate 1-4 family junior lien mortgage 74,840 75,565 74,632 72,398
Credit card 18,677 18,762 17,129 15,567
Other revolving credit and installment 55,505 56,171 57,180 53,701
Total consumer 222,343 221,913 215,818 202,843
Foreign 7,216 7,441 7,889 7,530
Total Loans 386,333 382,195 362,922 342,800

Wells Fargo haa increased their loan assets every quarter for the past 4 quarters. Those past 4 quarters are just past the peak of the largest equity real asset and credit bubble of the century? Question: Why is Wells Fargo increasing the amount of these quickly depreciating assets on its books while the underlying properties are rapidly decreasing in price?

Large Second Lien Home Equity exposure with rising NPAs: As of 3Q2007, Wells Fargo had second highest home equity loans exposure among all US banks in absolute amount. In 1Q2008, Wells Fargo had $83 bn loans in home equity comprising nearly 19% of total loans and a staggering 174% of its shareholder's equity.

A more granular view of Wells Fargo's loan portfolio shows us the following (I've highlighted areas to take notice of)...

WELLS FARGO 1Q-2008 4Q-2007 3Q-2007 2Q-2007
% Change
Commercial 2.3% 9.5% 6.5% 7.3%
Other real estate mortgage 4.5% 10.6% 2.8% 2.5%
Real estate construction 0.2% 9.0% 4.5% 4.3%
Lease financing 1.7% 11.2% 1.8% 8.8%
Total commercial and commercial real estate 2.6% 9.8% 5.1% 5.8%
Real estate 1-4 family first mortgage 2.7% 6.8% 9.3% 9.3%
Real estate 1-4 family junior lien mortgage -1.0% 1.3% 3.1% 4.2%
Credit card -0.5% 9.5% 10.0% 6.7%
Other revolving credit and installment -1.2% -1.8% 6.5% 0.5%
Total consumer 0.2% 2.8% 6.4% 4.8%
Foreign -3.0% -5.7% 4.8% 10.7%
Total Loans 1.1% 5.3% 5.9% 5.3%
 
Loans 90 Days or More Past Due and Still Accruing
Commercial 29 32  
Other real estate mortgage 24 10 140% increase??
Real estate construction 15 24  
Lease financing 68 66  
Total commercial and commercial real estate 314 286  
Real estate 1-4 family first mortgage 228 201  
Real estate 1-4 family junior lien mortgage 449 402  
Other revolving credit and installment 532 552  
Total consumer 1,523 1,441  
Foreign 40 52  
Total Non Accural Loans 1,631 1,559  

Increasing provisions and chare-offs

WELLS FARGO 1Q-2008 4Q-2007
 
Delinquincie as a % of Loans
Commercial 0.03% 0.04%
Other real estate mortgage 0.06% 0.03%
Real estate construction 0.08% 0.13%
Lease financing 0.99% 0.97%
Total commercial and commercial real estate 0.20% 0.19%
Real estate 1-4 family first mortgage 0.31% 0.28%
Real estate 1-4 family junior lien mortgage 0.60% 0.53%
Other revolving credit and installment 0.96% 0.98%
Total consumer 0.68% 0.65%
Foreign 0.55% 0.70%
Total Non Accural Loans 0.42% 0.41%
 
NPA's
Commercial 588 432
Other real estate mortgage 152 128
Real estate construction 438 293
Lease financing 57 45
Total commercial and commercial real estate 1,235 898
Real estate 1-4 family first mortgage 1,398 1,272
Real estate 1-4 family junior lien mortgage 381 280
Other revolving credit and installment 196 184
Total consumer 1,975 1,736
Foreign 49 45
Total Non Accural Loans 3,259 2,679
 
GNMA loans 578 535
Other 637 649
Real estate and other nonaccrual investments 21 5
Foreclosed assets: 1,236 1,189
 
Total NPA's 4,495 3,868

 

I'd like to repeat this so it is not wasted on anybody: From April 1, 2008 onwards, Wells Fargo has changed its home equity charge-off policy to 180 days from 120 days previously. Amid current deteriorating credit markets with residential sector showing no signs of recovery, it is quite understandable that the bank has changed the policy in a bid to defer recognition of provision and charge-offs.

So, have the implemented this policy in other areas after the last filing, or previously without disclosing it. Did I miss it in the footnotes somewhere? Now, all of their delinquincies and NPA numbers are suspect! See chart below...

WELLS FARGO 1Q-2008 4Q-2007
 
Delinquincie as a % of Loans % increase
Commercial 0.03% 0.04% -11% <----- Questionable!
Other real estate mortgage 0.06% 0.03% 130%  
Real estate construction 0.08% 0.13% -38% <----- Questionable!
Lease financing 0.99% 0.97% 1%  
Total commercial and commercial real estate 0.20% 0.19% 7%  
Real estate 1-4 family first mortgage 0.31% 0.28% 10%  
Real estate 1-4 family junior lien mortgage 0.60% 0.53% 13%  
Other revolving credit and installment 0.96% 0.98% -2% <----- Questionable!
Total consumer 0.68% 0.65% 5%  
Foreign 0.55% 0.70% -21% <----- Questionable!
Total Non Accural Loans 0.42% 0.41%    

WELLS FARGO 1Q-2008 4Q-2007 3Q-2007 2Q-2007 1Q-2007  
  Latest Quarter Growth
Provision as % of Loans 0.52% 0.68% 0.25% 0.21% 0.22% -23% Loss cushions decreasing
Provision as % of NPA's 45% 68% 28% 27% 27% -33% Loss cushions decreasing
Gross Charge off to Loans 0.46% 0.37% 0.30% 0.28% 0.29% 22% Losses increasing
Gross Charge off to NPA's 39% 37% 35% 35% 36% 6% Losses increasing
Allowances as % of Loans 1.56% 1.44% 1.11% 1.17% 1.22% 8% Allowances for loans increase
Allowances as % of NPA's 134% 143% 126% 148% 149% -6% But allowances as % of what's needed >
NPA's to Loans 1.16% 1.01% 0.88% 0.79% 0.82% 15% NPAs increasing substantially, this number is also in doubt
Shareholder's equity 48,159 47,628 47,566 47,239 46,073 1%  
Goodwill 13,148 13,106 12,018 11,983 11,275 0% Goodwill is increasing along with Charge-offs/NPAs, HMMM!!!
Adjusted Equity 35,011 34,522 35,548 35,256 34,798 1%  

I expect recoveries in the red font below to drop precipitously. The yellow highlight shows where there is already weaknes in recoveries in earier quarters.

WELLS FARGO 1Q
2008
4Q
2007
3Q
2007
2Q
2007
1Q
2007
 
Recoveries % increase % of total
Commercial 31 35 35 25 24 -11% 13%
Other real estate mortgage 1 1 2 3 2 0% 0%
Real estate construction 1 0 1 0 1 100% 0%
Lease financing 3 5 3 4 5 -40% 1%
Total commercial and commercial real estate 36 41 41 32 32 -12% 15%
Real estate 1-4 family first mortgage 6 4 6 6 6 50% 3%
Real estate 1-4 family junior lien mortgage 17 14 14 16 9 21% 7%
Credit Card 38 30 29 30 31 27% 16%
Other revolving credit and installment 125 111 105 139 149 13% 53%
Total consumer 186 159 154 191 195 17% 79%
Foreign 14 15 15 17 18 -7% 6%
Total Recoveries 236 215 210 240 245 10% 100%

Extraordinary gains offsetting loan write-downs in 1Q2008

• Out of net income of $ 1,999 mn in 1Q2008, Wells Fargo recorded an extraordinary gain of $323 mn and $94 mn on gain on sale of mortgage-backed securities and increase in mortgage servicing income, respectively. These gains were partially offset by $263 mn write-down of mortgage loans and $63 mn write-down on commercial mortgages held for sale. Additionally the bank also recorded unrealized loss on securities available for sale of $598 mn in 1Q2008 compared with unrealized gain of $680 mn in 4Q2007. Be aware of the margin for abuse in valuing MSRs (mortgage servicing rights, etc.). If the mortgage is likely to go into default and be foreclosed upon, it is unlikely the servicer will be able to monetize future revenue streams from servicing the mortgage. Also, be aware on non-descript mark ups and gains. The entire world had to eat sh1t due to plummeting MBS values for almost a year with literally no market for these securities. How did those genius at WFC manage to sell their MBS securities with little or no market, and sell them at a gain of $323 million on top of it. The guys at Countrywide, Lehman, Bear Stearns, Morgan Stanley, Merriill Lynch, UBS, HBOS, and a whole hell of a lotta other folk (including me) are dying to know!

The Investment Bank Shell Game Trick - Adopted by the Commercial Banks? Reclassification of Level 2 and Level 3 assets to record gains

• As of December 31, 2007 Wells Fargo's level 2 and level 3 assets comprise of 49% and 18% of total assets (on fair value basis) representing $61 bn and $23 bn of level 2 and level 3 assets, respectively in 1Q2007. It also reclassified its assets from level 3 to level 2 to recognize gain to offset losses arising from higher provision. Come on now fellas! Since you can't observe marketable prices for these assets, and no one wants to buy them, and no one is aware of a market for them - you just make up whatever the hell you want. It may as well be a profitable number to record a gain, right? What the hell is the use of making up a value if you can't do it to your benefit?

A likely example of this parlour trick classification could be the CDO's onWells Fargos books (which we know nobody really wants right now). Look carefully:

Investments in Collateralized Debt Obligations AAA AA-BBB Other Total  
Corporate credit 13 292 217 522 Junk CDO's as %
of Total 25.23%
Bank or insurance trust preferred 257 37 0 294
Commercial mortgage 24 20 0 44 AA-BBB CDOS as %
of Total40.58%
Residential mortgage 0 0 0 0
Total 294 349 217 860  

FAS 157 Overview - Like Morgan Stanley and Lehman Brothers, Wells Fargo seems to somehow think we should believe those assets that can't be sold and can't be priced are worth more after they can't be sold and can't be priced than.

  Level 1 Level 2 Level 3 Total
Trading assets 1,041 6,268 418 7,727
Securities available for sale 38,178 29,392 5,381 72,951
Mortgages held for sale 0 24,852 146 24,998
Mortgage servicing rights (residential) 0 0 16,763 16,763
Other assets 1,145 207 41 1,393
Total 40,364 60,719 22,749 123,832
% of total 33% 49% 18%  

Portfolio overview

Loan Portfolio (March, 2008)
  Loan
Portfolio
% of
Total
NPA % of
Total NPA
NPA/
Loans
Charge-
offs
% of
NPA
% of
Loans
Commercial and commercial real estate:
Commercial 92,589 24% 588 18% 0.64% 259 44% 0.28%
Other real estate mortgage 38,415 10% 152 5% 0.40% 4 3% 0.01%
Real estate construction 18,885 4.9% 438 13% 2.32% 29 7% 0.15%
Lease financing 6,885 2% 57 2% 0.83% 12 21% 0.17%
Total commercial and commercial real estate 156,774 41% 1,235 38% 0.79% 304 25% 0.19%
 
Real estate 1-4 family first mortgage 73,321 19% 1,398 43% 1.91% 81 6% 0.11%
Real estate 1-4 family junior lien mortgage 74,840 19% 381 12% 0.51% 455 119% 0.61%
Credit card 18,677 5% 0 0% 0.00% 313   1.68%
Other revolving credit and installment 55,505 14% 196 6% 0.35% 543 277% 0.98%
Total consumer 222,343 58% 1,975 61% 0.89% 1,392 70% 0.63%
 
Foreign 7,216 2% 49 2% 0.68% 68 139% 0.94%
Total Loans 386,333 100% 3,259 100% 0.84% 1,764 54% 0.46%

High Risk Product Overview

• Starting in 2007, Wells Fargo segregated its national home equity group into liquidating and core (or remaining) portfolios in order to manage the riskier HE loans more efficiently. The HE loans generated through wholesale channels and not behind a Wells Fargo first mortgage, and all home equity loans acquired through correspondents, were identified and clubbed under a liquidating portfolio which amounted to $11.5 bn as on Mar 31, 2008 (total HE portfolio as on that date was $83.5 bn). Long story short, it is much more dangerous to rely on prudent underwriting from a brokered loan than from a direct channel loan. Amazingly enough, we had the exact same problem with brokers in the S&L crisis. I guess 1,200+ lending institution failures wasn't enough to teach a lesson that lasted more than 15 years. For more on this, see A comparison with the same during the S&L crisis.

• As per the bank's 2007 annual report, the loans in the liquidating HE portfolio are largely concentrated in geographic markets that have experienced the most abrupt and steepest declines in housing prices.

The liquidating HE portfolio represents the most risky portion of the bank's HE portfolio as highlighted by an annualized loss rate (two payments or more past due %) of 5.6% for liquidating portfolio against 1.6% for the core portfolio in 1Q08.

HOME EQUITY (March 31, 2008) % of loans two payments or more past due   Annalized Loss Rate    
  Liquidating Core Total % of Home Equity % of Toal Loans Deliquency rates Liquidating Core Liquidating Core Total
California 4,417 26,331 30,748 37% 7% 3.5% 3.3% 2.0% 8.5% 2.2%  
Florida 582 2,595 3,177 4% 1% 3.8% 5.4% 3.8% 10.6% 4.4%  
Arizona 275 3,785 4,060 5% 1% 2.3% 3.4% 1.9% 5.6% 1.9%  
Texas 219 2,805 3,024 4% 1% 2.3% 0.7% 1.1% 1.9% 0.2%  
Minnesota 139 4,546 4,685 6% 1% 1.5% 3.1% 1.2% 7.9% 1.1%  
Other 5,866 31,994 37,860 45% 8% 1.9% 2.2% 1.4% 3.0% 1.0%  
Total 11,498 72,056 83,554 100% 19% 2.5% 2.8% 1.7% 5.6% 1.6% 2.1%
 
Real Estate 1-4 Family Mortgage Loans by State (December 31, 2007) % of family
mortgage
real estate
  First
mortgage
  Deliquency
rates
Junior lien
mortgage
Deliquency
rates
Total
California 20,782 29.1% 5.1% 28,234 37% 12.0% 49,016 33%
Minnesota 3,009 4.2% 3.6% 4,209 6% 4.4% 7,218 5%
Arizona 2,986 4.2% 5.3% 3,451 5% 6.9% 6,437 4%
Florida 3,127 4.4% 7.0% 2,851 4% 11.4% 5,978 4%
Colorado 2,612 3.7% 3.5% 2,889 4% 5.9% 5,501 4%
Washington 2,476 3.5% 2.4% 2,938 4% 3.5% 5,414 4%
Texas 3,551 5.0% 4.6% 1,805 2% 4.2% 5,356 4%
New York 2,200 3.1% 4.1% 2,275 3% 4.1% 4,475 3%
Nevada 1,625 2.3% 6.6% 1,642 2% 9.9% 3,267 2%
Illinois 1,616 2.3% 3.9% 1,444 2% 4.7% 3,060 2%
Other 27,431 38.4% 3.8% 23,827 32% 4.5% 51,258 35%
Total 71,415 100% 4.4% 75,565 100% 7.8% 146,980 100%
 
Commercial Real Estate Loans by State (December 31, 2007)
  Other real
estate
Real estate
const
Total % of
CRE
% of
Total Loans
Deliquency
rates
  % of Real
Estate cons
California 13,922 6,050 19,972 36% 5% 5.1% California 32%
Texas 2,934 1,135 4,069 7% 1% 4.6% Texas 6%
Arizona 1,926 1,262 3,188 6% 1% 5.1% Arizona 7%
Colorado 1,669 873 2,542 5% 1% 3.5% Colorado 5%
Washington 1,441 652 2,093 4% 1% 2.3% Washington 3%
Minnesota 1,319 382 1,701 3% 0% 3.5% Minnesota 2%
Florida 636 913 1,549 3% 0% 6.8% Florida 5%
Utah 719 581 1,300 2% 0% 3.3% Utah 3%
New York 331 949 1,280 2% 0% 3.9% New York 5%
Oregon 803 441 1,244 2% 0% 2.5% Oregon 2%
Other 11,047 5,616 16,663 30% 4% 3.7% Other 30%
Total 36,747 18,854 55,601 100% 14% 4.3% Total 100%

I will produce a valuation report for WFC soon, as well as a few more drill downs from the Doo-Doo 32 list.

 


 

Reggie Middleton

Author: Reggie Middleton

Reggie Middleton
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Reggie Middleton

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