Doo-Doo Bank Drill Down: Part 1 - Wells Fargo
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:
- 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
- Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
- Counterparty risk analyses - counterparty failure will open up another Pandora's box
- The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
- Municipal bond market and the securitization crisis - part I
- 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
- Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
- More on the banking backdrop, we've never had so many loans!
- As I see it, these 32 banks and thrfts are in deep doo-doo!
- A little more on HELOCs, 2nd lien loans and rose colored glasses
- Will Countywdiw cause the next shoe to drop?
- 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
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).
|Other real estate mortgage||38,415||36,747||33,227||32,336|
|Real estate construction||18,885||18,854||17,301||16,552|
|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|
|Other revolving credit and installment||55,505||56,171||57,180||53,701|
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.
Within its home equity exposure 37% of loans are in California comprising 7% of its total loan or 64% of its shareholders equity.
In 1Q2008 Wells Fargo's annualized loss rate on home equity loan portfolio increased to 2.12% from 1.42% in December 31, 2007.
As of December 31, 2007 nearly 29% of the bank's home equity exposure had LTV greater than 90%. With housing prices expected to continue to decline over the reminder of 2008, Wells Fargo's significant exposure in high LTV home equity loans with concentration towards California could pose a much harder time for the bank in the quarters to come.
A more granular view of Wells Fargo's loan portfolio shows us the following (I've highlighted areas to take notice of)...
|Other real estate mortgage||4.5%||10.6%||2.8%||2.5%|
|Real estate construction||0.2%||9.0%||4.5%||4.3%|
|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%|
|Other revolving credit and installment||-1.2%||-1.8%||6.5%||0.5%|
|Loans 90 Days or More Past Due and Still Accruing|
|Other real estate mortgage||24||10||140% increase??|
|Real estate construction||15||24|
|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 Non Accural Loans||1,631||1,559|
Increasing provisions and chare-offs
In 1Q2008, WFC's NPAs increased from 1.16% of total loans over 1.01% in 4Q2007. Overall NPAs increased to $4.5 bn from $3.9 bn in 4Q2007. NPAs in real estate construction loans witnessed highest increase of 49% to $438 mn in 1Q2008. NPAs of C&D loans stood at 2.32% of total C&D loans, followed by real estate 1-4 family mortgage (1.91%) and lease financing (0.83%)
Wells Fargo's gross charge offs increased to 0.46% of total loans compared to 0.37% of total loans in 4Q2007. C&D loans witnessed the highest increase in charge-offs with an increase of nearly three-fold to $29 mn in 1Q2008, showing signs of increased stress in these loans. Real estate 1-4 family junior lien mortgage, credit card loans and Other revolving credit and installment had charge-offs of 0.61%, 1.68% and 0.98% to total loans, respectively.
However despite increase in NPAs and increase in charge offs, Wells Fargo provision for credit loss sequentially declined to $2.0 bn in 1Q2008 from $2.6 bn in 4Q2007. (0.52% of total loans in 1Q2008 from 0.68% of total loans in 4Q2007) raising concerns over possible inadequacy of provision amount.
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.
|Delinquincie as a % of Loans|
|Other real estate mortgage||0.06%||0.03%|
|Real estate construction||0.08%||0.13%|
|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 Non Accural Loans||0.42%||0.41%|
|Other real estate mortgage||152||128|
|Real estate construction||438||293|
|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 Non Accural Loans||3,259||2,679|
|Real estate and other nonaccrual investments||21||5|
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...
|Delinquincie as a % of Loans||% increase|
|Other real estate mortgage||0.06%||0.03%||130%|
|Real estate construction||0.08%||0.13%||-38%||<----- Questionable!|
|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 Non Accural Loans||0.42%||0.41%|
|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|
|Goodwill||13,148||13,106||12,018||11,983||11,275||0%||Goodwill is increasing along with Charge-offs/NPAs, HMMM!!!|
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.
|Recoveries||% increase||% of total|
|Other real estate mortgage||1||1||2||3||2||0%||0%|
|Real estate construction||1||0||1||0||1||100%||0%|
|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%|
|Other revolving credit and installment||125||111||105||139||149||13%||53%|
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 %
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|
|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|
|% of total||33%||49%||18%|
|Loan Portfolio (March, 2008)|
|Commercial and commercial real estate:|
|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%|
|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%|
|Other revolving credit and installment||55,505||14%||196||6%||0.35%||543||277%||0.98%|
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|
|Real Estate 1-4 Family Mortgage Loans by State (December 31, 2007)||% of family
|Commercial Real Estate Loans by State (December 31, 2007)|
|% of Real
|New York||331||949||1,280||2%||0%||3.9%||New York||5%|
I will produce a valuation report for WFC soon, as well as a few more drill downs from the Doo-Doo 32 list.