2008-07-16 We Beat Our Asses:

In a first quarter 2008 reporting redux, Wells Fargo came out with all their guns smoking so badly that investors could hardly see a thing. Now they beat estimates again, and if you listen and sniff just long enough, I’ll bet all that sh!t will start to smell like a rose. So far we have Q2 current data for 2.-4., but surprisingly cannot find the exact write-downs number for the quarter.

1. Tally for Write-Downs/Charge-Offs: $2.9 B + $? = ?
2. Tally for cash raised: = $0.0
   
3. Current level of Level III assets at $23.0 B
   
4. Current level of loan loss reserves at $1.50 B

We now sum all the distresses to get a lower bound Well Fargos current Misery Index > $27.4 B

2008-06-21 Mickey Mouse Assets:

Wells Fargo said that 4% of total assets were valued by level 3 accounting methods. In other words, by no method at all. From the first-quarter 2008 10Q:

We use fair value measurements to record fair value adjustments to certain financial instruments and determine fair value disclosures. (See our 2007 Form 10-K for the complete critical accounting policy related to fair value of financial instruments.)
Approximately 23% of total assets ($136.7 billion) at March 31, 2008, and 22% of total assets
($123.8 billion) at December 31, 2007, consisted of financial instruments recorded at fair value
on a recurring basis. At March 31, 2008, approximately 83% of these financial instruments used
valuation methodologies involving market-based or market-derived information, collectively
Level 1 and 2 measurements, to measure fair value. The remaining 17% of these financial
instruments (4% of total assets) were measured using model-based techniques, or Level 3 measurements. Substantially all of our financial assets valued using Level 3 measurements consisted of MSRs or investments in asset-backed securities collateralized by auto leases. In first quarter 2008, $1.1 billion of mortgages held for sale were transferred into Level 3 from Level 2 due to reduced levels of market liquidity for certain residential mortgage loans. Approximately 1% of total liabilities ($6.2 billion) at March 31, 2008, and 0.5% ($2.6 billion) at December 31, 2007, consisted of financial instruments recorded at fair value on a recurring basis.
Liabilities valued using Level 3 measurements were $408 million at March 31, 2008.

2008-06-11:

Reggie Middleton has put out a good analysis of Wells, with a price target of about $16 — roughly 38% below the current price. A great in-depth read extending and adding to our points below.

2008-04-16:
The financial media reported Wells Fargo’s fiscal first quarter earnings today to the favorite old familiar tune of “they beat estimates.” But the spin could not confuse the clear, unmistakable implication that the easy money corner has been turned and the future is grim. And don’t be confused by the fact that the bank still turned a profit — even an investor jumping from a window is above the ground until he hits it. Some of the particulars include:

Net charge-offs, the cost of bad loans that won’t be fully repaid, jumped to $1.53 billion from $1.21 billion in the fourth quarter. Charge-offs for consumer loans, which include credit cards, home-equity lending and automobile financing, rose 26 percent to $1.21 billion.

It is the $1.5B in write-offs that we write down, to bring the bank’s running total from $1.4B to $2.9B.

2008-04-08:

New Liquidity Drains Threaten Bank Lending

To be considered a “well-capitalized bank” by U.S. regulators, an institution can’t have more than 10 times its capital in risk-weighted assets. More than 99 percent of American banks qualify as well capitalized. But bond downgrades are going to throw a monkey wrench into that machine and threaten to bring it to a grinding halt.

2008-02-19:

Several (very vocal) bullish opinions on Wells have surfaced in the past week. Most notably, Barron’s expects at least 15% upside from here (about $30 today), and Buffett has apparently increased Berkshire Hathaway’s stake to 9.4%.

These calls all appear to be based on the dubious thesis that Wells has “escaped the subprime mess.” While that might be technically true (so far), we find it to be of little comfort given that it is now beyond painfully obvious that the problems in the mortgage market and credit markets extend far beyond subprime. As we covered in our earlier analysis (below), Wells sits on vast holdings (about $141B) of questionable sorts of loans, including $24B or so of subprime, second-lien and Alt-A loans. Approximately 1/3 of its overall exposure is in California.

Indeed, Wells has only taken a $1.4B write-down on a $12B sub-portfolio of third-party second-lien loans. There may be billions more in write-downs lurking in that pile alone.

Some of us here at BankImplode.com are short Wells, and we can’t figure how these bullish calls are anything more than self-delusion. If this indeed produces a rally (as any actual or rumored move of Buffett tends to do), we suspect it will be of the “sucker’s” variety.

Wells (and its proponents) seem to be gambling that much of the mortgage market collapse is due to exotic financial vehicles, rather than to a genuine decline in ability-to-pay. Thus, the logic would presumably go, if Wells holds most of its exposure in its own long-term investment portfolio, it won’t be impacted by faltering intermediaries and a collapsing secondary market, and the crisis will blow over. But the root problem is in inability to pay; Wells’ delinquencies are rising along with everyone else’s, and mortgage securities are therefore unlikely to ever come back all the way in value. Ever. So they can run, but they can’t hide. The result (we predict) will be write-downs and earnings disappointments for years to come.

Initial Writeup, 2008-02-04:

Wells Fargo, the fifth-largest US bank by assets, and the second-largest mortgage lender, has begun to feel the heat of the economic slowdown and the credit crunch in the fourth quarter 2007. As of yet, it has taken (we think) only a $1.4B charge against a special liquidation portfolio (see below for details). But most of the impact to date has been in general charge-offs and increases in loan loss reserves (which have tripled). Despite these issues, the bank still returned a profit in the latest quarter (though it fell sharply; by 38%).

If that were the end of the story, Wells would be sitting pretty. Unfortunately for them, the closet contains more skeletons. Friedman Billings noticed this, and downgraded the bank, writing:

Wells Fargo has $141 billion in residential real-estate loans, with about a third of that located in California, Friedman wrote in a note to clients. The firm cited a report from Downey Financial which suggested that its non-performing assets rose 150% during the fourth quarter, and 35% in December, when compared with November.

“We believe that Wells Fargo is not immune to industry weakness,” FBR wrote.

We don’t think they’re immune either, especially when major projections are now putting price declines in California in the 30-50% range. Further, the bank retains approximately $24B in subprime loans, according to late-2007 Deutsche Bank data.

While banks such as UBS, Citigroup, and Morgan Stanley may be in the eye of the storm (or further), Wells has just barely begun to feel the first sprinkles.

In fact, Wells has recognized the looming issues and is attempting to front-run the problems by carving out some of the worst junk in its portfolio for liquidation. MortgageDaily reported back in November 2007 that the bank has started by moving $11.9B of third-party-originated second-lien (home equity) loans into a separate bundle, on which it planned to take (has taken?) a $1.4B charge.

We see two problems with this strategy. The first is the assumption that the losses on these assets will only be around 10%. From what we’ve seen, these sorts of assets may fetch bids as low as ten cents on the dollar in today’s paranoid fixed income markets. But the paranoia is somewhat justified: against falling values, second liens are essentially worthless in a huge fraction of cases (especially recent vintage, which characterizes this special Wells portfolio). In other words, if you wanted to go with more of a “mark to market” impairment on this portfolio, the write-down would need to be more like $8.3-10.7B.

The second problem is the assumption that the rest of Wells’ $141B hoard is pristine. But just because Wells originated these, doesn’t mean their underwriting was that much better (see below), or that borrowers aren’t facing tough circumstances as we enter a recession (with unemployment already rising), or that collateral values falling don’t hurt everyone. So there will be write-downs (and/or markedly higher loan loss reserves) on the other $130B or so of loans. Mark our words.

Finally, the bank has the dubious honor of being the only lender sued by the city of Baltimore for reverse red-lining. And it is also a defendant in a similar suit by the city of Cleveland, along with 20 other banks and lenders.

Should these municipalities win anything back, they will likely inspire countless imitators across the country, manifesting as significant “litigation impairments” on Wells’ balance sheet for years to come. But you won’t find this kind of risk accounted for in the current financials.