Wells Fargo’s Surprising Profits? Time to Go Short…
Well Fargo more than surprised Wall Street and every other street in this country when it announced last Thursday some of the most amazing Q1 results imaginable. And if they had stopped with the overwhelmingly good news a little sooner, perhaps I would have just shrugged my shoulders and said to myself, “Huh. Well what do you know about that? Good for them. Maybe the worst is over after all.”
But they didn’t stop. They went on and on and on until I couldn’t stand the amount of good news I was reading in their pre-earnings press release. It was like everything I’d read about our banks over the last so many months had been a lie and good old Wells Fargo had proven it so. They didn’t just beat expectations by walking the walk; they had apparently grown wings and learned to fly.
They Draw the TARP Like a Gun…
Here’s where, while reading their press release, I started to get a little queasy:
Wells Fargo continued to extend significant amounts of credit to U.S. taxpayers in the first quarter 2009. More than $225 billion of credit extended to U.S. taxpayers since early last October, nine times the amount received from U.S. taxpayers through the U.S. Treasury’s Capital Purchase Program investment.
Really? That’s truly incredible. The problem with the statement isn’t whether it’s true or not, I’m sure it can be interpreted as being accurate. The problem with the statement is that it screams PR Department. No way did anyone that’s ever taken an accounting class write that sentence. An Ad Man (or woman) wrote that sentence. That’s a sentence that was run up a flagpole to see how many would salute it.
Why? It’s simple really… the two numbers don’t have anything to do with one another. It’s a meaningless comparison. First of all, the U.S. Treasury’s Capital Purchase Program investment, is more commonly referred to as the TARP, or Troubled Assets Relief Program, and it’s not a popular thing to bring up these days, especially is you’re a bank who received $25 billion from it.
Next, the credit Wells Fargo is claiming to have extended since last October, wasn’t extended to “U.S. Taxpayers”. I happen to have an account at Wells Fargo and they’ve never referred to me as a “U.S. Taxpayer”. Generally, they refer to me as a “customer,” or an “account holder,” or sometimes a “borrower”. Never a U.S. Taxpayer. Yet, in just two short sentences of this press release, they mention U.S. Taxpayers three times. I wonder if my statement will now refer to me that way. Somehow I doubt it.
The Wells Fargo press release also said that the bank: “Funded over $100 billion in mortgage loans, helping over 450,000 homeowners either purchase a home or lower their payments through refinancing;
Those figures suggest an average loan of about $222,222, which means that a whole bunch of them would seem highly likely to be conventional conforming loans, eligible to be shipped off to Fannie and/or Freddie, or they’re FHA insured loans. This means that Wells originated mortgages that it knew could be shipped on over to the government’s coffers for a handsome fee. It certainly doesn’t mean Well Fargo is back in the lending business and happy days are around the corner.
Another thing… these loans that Wells originated with the idea of shipping them to the GSEs or insuring them with FHA didn’t require the use of any TARP funds. Wells Fargo doesn’t need TARP funds to make such loans. So, to draw a comparison between credit extended as being nine times the amount the bank received from, what did they call it… oh yeah… the U.S. Treasury’s Capital Purchase Program investment, is at least a little smarmy, in my view at least.
Oh, hell… the fact is, tying the amount of “credit extended” to TARP funds is ridiculous. The TARP funds were invested by the government to recapitalize banks, not to provide funds that would be lent to borrowers, and making statements in a press release that tries to show the TARP money as being put to work is so far over the top that I bet it made the C-Suite executives at Wells blush. Really fellas… easy there… we’re paying attention to stuff now, remember?
Besides all that… I’m no banker but I’m thinking that refinancing loans the bank currently owns can’t be considered a sustainable formula for success, can it? My grandmother would refer to that as cutting off the end of the blanket and sewing it onto the other end… to make it longer.
And at the Finish Line it’s Rohm & Haas by a Nose…
Back on January 27, 2009, while most of us were still either celebrating Obama having been inaugurated as our 44th President, or walking around disillusioned about the same, Wells Fargo was busy placing a bet by buying 56 million shares of a company by the name of Rohm & Haas. (Don’t worry, I’d never heard of them either.)
It seems that the courts were about to decide the little matter of whether DOW Chemical would be compelled to complete its acquisition of Rohm & Haas at the $79 per share price set last year… you know… before everything went to sh#t. The market was saying that the odds were 50/50 as to which way the decision would go. Wells Fargo was betting that Rohm & Haas would win the day, and as it turned out… they did.
As a result of what was really pure speculation, Wells was able to add $1.3 billion to its Q1 results, 51% of its walk-on-water numbers, but this kind of windfall has nothing to do with Wells Fargo’s banking abilities and I think it would be fair to assume that it’s extremely unlikely to happen again in Q2, or Q3 or Q4, for that matter. It’s nice when you can hold a stock for 75 days and pick up $1.3 billion, but it’s also nice when the long shot you bet $1,000 on came in at the track.
From Whence We Came…
You have to understand where we came from to appreciate how spooky the Wells Fargo press release sounded when I read it for the first time.
According to Credit Suisse, way back in 2006 Wells Fargo was #1 with 13% of the total sub prime market! Woo-hoo! The next closest were at 8%. Not only that, but also back in 2006 Wells Fargo was #3 with a 10% market share in Alt-A mortgages. In 2006, 81% of Alt-A mortgages, which are one level up from sub-prime to begin with, were “liar loans,” meaning that they were made without concern for documentation. And Wells was the number one lender of jumbo Alt-As in California, so it’s hard to imagine that they’re out of the woods… er… redwoods.
And that’s just Wells Fargo Bank… then they bought Wachovia, and that can’t have made things any easier, one would think.
Mark to Messy Accounting…
For the past two years, I for one have been screaming about FAS 157, the Financial Accounting Standards Board (‘FASB”) rule that required banks to write down the value of their hard-to-value assets to the market price on a given day. If there wasn’t on a market on that day, the assets could be written down to zero. FAS 157, adopted in November of 2006, had the effect of pouring gasoline on the fire that was already burning, and by the end of the year in 2006, we started to hear about the enormous write downs being taken by all of the major banks and Wall Street firms.
Well, no one can that our government doesn’t have impeccable timing, because now that trillions of dollars have been erased from corporate balance sheets and most of Wall Street is literally gone, they finally suspended FAS 157 just in time for the first quarter to end in 2009.
It’s sort of like closing the barn door after the horse has run out, and then opening it again just in case there were any more horses left in there. Shoo, horseys, shoo!
So, now Wells Fargo could have moved a whole gaggle of hard-to-value assets over to what’s referred to as Level 3 Assets, in which case they have discretion on where to set their value. In other words, the CDOs and CDOs Squared that can’t be sold today and may never be sellable… no one really knows… can now be valued at God only knows what, if moved into the Level 3 column.
In the last quarter of 2008, Wells Fargo set aside reserves of $17 billion. Six billion of that was for Wells Fargo and eleven billion was for Wachovia. Here we are a scant three months later, real estate values have continued to drop, and Wells reserves just $3 billion total? I want to believe that this is the result of more than fancy pants accounting, really I do. Hold my hand, close your eyes and repeat after me: There’s no place like Wells… there’s no place like Wells…
Just Follow the Bouncing Dividend…
July 16, 2008: Wells Fargo Raises Dividend by 10% to 34Â¢ a share! Woo-hoo! Stock jumps 33% in a single day!
March 6, 2009: Less than eight months later… Wells Fargo Lowers Dividend to 5Â¢ a share.
April 10, 2009: Well Fargo Reports Shockingly Good Q1 Results.
Dr. Watson: “By George, Holmes… I really think you’ve got something there. How on earth did you do it?”
Sherlock Holmes: “Elementary, my dear Watson, elementary.”
Except in this Sherlock Holmes script, when Holmes said “elementary,” he actually meant elementary… as in elementary school. A little addition is all it took.
What About Wells Fargo and Loan Modifications?
Here’s what Wells Fargo says about their performance on loan modifications:
Through active calling and letter-writing campaigns, workshops, regional outreach events and door-to-door contact, Wells Fargo Home Mortgage has reached 94 percent of its customers who are two or more payments past due. For every 10 of these customers, it has worked with seven on a solution, two declined the help, and the remainder cannot be reached or a solution simply cannot be found. Of the customers who received a loan modification, one year after the loan was modified approximately seven of every 10 of these customers were either current on their loans or less than 90-days past due.
My God… I absolutely adore whoever they’ve got writing copy over there. Whoever it is, they are nothing short of masterful. I wonder why they grouped “current” with “less than 90 days past due”.
Here’s how one of my favorite economists, Mish, whose alter ego is Mike Shedlock, phrased the same data:
30% of Wells Fargo’s reworked mortgage loans are 90 days past due or longer, one year after loan modification.
Gee, now that doesn’t sound nearly as upbeat. I like the other way better.
Once Mish gets a hold of something, he doesn’t let go easily. He’s like a toddler yelling “Mine!” as you try to take away his baba. So, Mish goes on to point out:
Moreover, hidden in the 70% grouping is an undisclosed percentage of customers who are not even current. What percentage is that? Odds are high that those not current shortly after a rework are going to fail. What’s the percentage? Wells Fargo does not say. With that backdrop, it’s time to dive into Wells Fargo’s 4th quarter earnings and balance sheet details to see what we can find.
Wells Fargo 4th Quarter 2008 Earnings
Go get ’em Mish… get ’em good…
Consider Well’s Fargo’s 4th Quarter 2008 News Release announcing a net loss of $2.55 billion, $0.79 per share, after significant de-risking and merger-related actions.
“Despite the unprecedented contraction in the credit markets, we remained ‘open for business’ and continued to lend to credit-worthy customers. We made $106 billion in new loan commitments during 2008 to consumer, small business and commercial customers and originated $230 billion of residential mortgages.
The allowance for credit losses, including unfunded commitments, totaled $21.7 billion (Wells Fargo and Wachovia combined) at December 31, 2008, compared with $8.0 billion (Wells Fargo only) at September 30, 2008.
The Wachovia acquisition was completed on December 31, 2008, and therefore Wachovia’s results are not consolidated in Wells Fargo’s income statement. Wells Fargo’s balance sheet includes Wachovia’s period-end balance sheet data net of closing purchase accounting adjustments.
Wells may be open for business, but the amount of securities it is seeking to dump increased from $86+ billion to $151+ billion. Goodwill, which may easily be worthless, increased to $22+ billion.
Don’t stop there Mish… you’ve got ’em on the ropes… go for the knock out… you’ve just got to love a guy like Mish… my boy knows his accounting, don’t you think? He’s wicked smart. Go, young man…
Wells has $110+ billion in junior mortgage liens. That is a lot of risk. Total consumer loans, most of which is mortgage related is a whopping $474+ billion. That’s a lot of risk. And given that commercial real estate is just now starting to crumble badly, commercial and commercial real estate exposure of $356 billion is a lot of risk. Will $21 billion in loan loss provisions cover that? I doubt it.
Mish doubts it? Oh, nooooooo… hey, Wells Fargo… I think Mish just kicked your balance sheet butt.
Off-Balance Sheet Exposure
Then Mish wanted to look at Wells Fargo’s off-balance sheet exposure, and who am I to say no to Mish?
The problem is that the Q4 press release doesn’t mention anything about off-balance sheet exposure, so Mish says that inquiring minds are looking at balance sheet statements from the Wells Fargo’s 3rd quarter 2008 release: OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS.
Here’s what it says in Wells Fargo’s Q3 2008 release:
Almost all of our off-balance sheet arrangements result from securitizations. Based on market conditions, from time to time we may securitize home mortgage loans and other financial assets, including commercial mortgages. We normally structure loan securitizations as sales, in accordance with FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities – a replacement of FASB Statement No. 125. This involves the transfer of financial assets to certain qualifying special-purpose entities (QSPEs) that we are not required to consolidate.
Holy Jeff Skilling, Mish! What the heck is a QSPE? A “qualifying special purpose entity? Uh oh…
Mish referred us to the July 2004 issue of The CPA Journal, which is exactly where I would have gone to look first, had he not brought it up… ahem… oh yeah… well, prove I wouldn’t have… Anyway, here’s what it says:
Basically, an off-balance-sheet entity is created by a party (the transferor or the sponsor) by transferring assets to another party (the SPE) to carry out a specific purpose, activity, or series of transactions. Regardless of their legal form, off-balance-sheet entities share the following characteristics:
- They are often thinly capitalized.
- They typically have no independent management or employees.
- Their administrative functions are often performed by a trustee who receives and distributes cash in accordance with the terms of contracts and who serves as an intermediary between the SPE and the parties that created it. And if the SPE holds assets, one of these parties usually services them under a servicing agreement.
According to Mish, the challenge for investors is spotting these transactions. He says that no matter how many billions may be involved, any disclosures about them are invariably buried in footnotes, and therefore even Mish says there’s no easy way to figure out how many assets or liabilities are subject to these off-balance sheet arrangements.
And that was enough for me. Check please. I’m done with buying bank stocks. You do whatever you want.
Apparently, after Enron and Jeffrey Skilling’s Magical Mystery SPEs almost bankrupted half the country, the Financial Accounting Standards Board leapt into action. They wanted to get the off-balance sheet stuff back onto the balance sheet where people could see it and add it up… stuff like that. So, they decided to make a rule saying that a company is required to include in its consolidated financial statements all subsidiaries in which it has a controlling interest. Sounds okay to me. Problem solved?
Of course not. It depends on the definition of control. See, companies and FASB have a relationship that’s kind of like Wylie Coyote and the Roadrunner. Control used to mean owning more than 50% of the voting shares, but oh that coyote is a sly one. Over the years, companies figured out how they could have economic control over an entity without owning 51% of its voting shares, and thereby avoid having to consolidate these “qualifying special purpose entities”. In case you ever wondered why all these 49% ownership deals started popping up on financials all over the place, well, there you have it. Mystery solved, and we’re screwed.
Now, being a nice guy, I’d normally let you go lie down at this point, but I just can’t bring myself to do it. Try this on for size. It’s straight from the mouth of Mish:
It’s ridiculous for corporations to be hiding 49% of stuff off the balance sheet. Much of that stuff is now highly toxic. Citigroup alone is sitting on $800+ billion of it, down from about $1.1 trillion.
Oh my goodness, oh my goodness… but don’t worry though… I’m sure Wells Fargo isn’t anything like Citigroup. Wells probably doesn’t have a dime more than… oh… let’s say… half a trillion?
Actually, new rules were supposed to go into effect late last year requiring corporations to put such assets back on the balance sheet where they belong, but it just wasn’t practical at the time… as Mish puts it, “to tell the truth”. The truth is darned impractical sometimes, isn’t it? I hate it when that happens.
Anyway, they delayed the truth telling rule for a year. Do you suppose I can use that defense this year if I lie like all get out on my tax return this year. “Oh, I’m sorry… I would have disclosed all that off-tax return income, but it just wasn’t practical.”
I looked it up, figuring it had to be in the news somewhere. Here’s what it said:
The Financial Accounting Standards Board postponed a measure, opposed by Citigroup Inc. and the securities industry, forcing banks to bring off-balance-sheet assets such as mortgages and credit-card receivables back onto their books.
FASB, the Norwalk, Connecticut-based panel that sets U.S. accounting standards, voted 5-0 today to delay the rule change until fiscal years starting after Nov. 15, 2009. The board needs to give financial institutions more time to prepare for the switch, FASB member Thomas Linsmeier said at a board meeting.
“We need to get a new standard into effect,” Linsmeier said, though “it’s not practical” to begin requiring companies to put assets underlying securitizations onto their books this year.
These people are just peaches and cream, aren’t they. Citigroup opposes the rule? Now there’s s shocker. And at the very least, these companies need time to begin telling the truth? I agree completely. Give them all the time they need.
So, Wells Fargo claims it’s “well capitalized”. That’s interesting. How many billions are in a “well,” anyone have their converter chart… you know, the one that converts BS into English. Is Wells Fargo well capitalized? Mish asks:
By what measure? What is hidden off its balance sheet that we do not know enough about? Can anyone believe what any financial institution says when it is perfectly clear all these games are being played? Clearly, the Fed is engaged in delaying tactics. However, those tactics are increasing mistrust. It was hard enough before to measure a corporation, but given toxic assets everywhere one looks, it is even harder now.
And if it’s hard for Mish, it’s completely out of the question for me…
The thing that Mish wants us to remember is that in periods of deflation, where asset prices are rapidly depreciating, the key point to remember is that balance sheet concerns are paramount. And specific to Wells Fargo, here is what Mish had to say about the bank’s balance sheet:
Diving into the balance sheet of Wells Fargo, I do not like what I see. Of equal concern is what I don’t see, things hidden in QSPEs. Bernanke wants us to believe everything is under control. When everything is hidden, how could one possibly know?
Every quarter is another disaster and every quarter more taxpayer money is handed straight over to the banks and brokerages that caused the problem. All this talk about helping the consumer get loans is a lie. No one is really concerned about the little guy; the concern is to bail out insolvent banks, by hook or by crook, using Fannie Mae as the slush fund.
Once that is accomplished, taxpayers will be left holding the losses in an insolvent Fannie Mae. Is it any wonder mistrust is high and growing?
Nope. No wonder at all, Mish.
Well, that’s it and that’s all, boys and girls. I’ve had about enough of the sleaze and slime for one day. Normally I go and lie down after an outing like this one. But this time… I think I better take a shower… see if I can’t wash some of this off…
Here’s the link to the Wells Fargo Press Release, in case you’ve still got the stomach for it:https://www.wellsfargo.com/press/2009/20090409_Prelim_Earnings