Wells Fargo was one of the first to use heavy Level-3 placement of toxic paper early in 2007. Last quarter there was a debate on how they valued their mortgage servicing rights. If you remember, Wells beat last quarter from “mortgage banking.” Yeah, right. It seems like questions arise every quarter regarding the quality of their earnings, and yesterday was no different.
This story concerns their massive $84B Home Equity Line/Loan portfolio, of which much is now under water due to massive house price depreciation. Technically (and realistically) these have become unsecured. This is a real problem for banks. By my estimates, Wells Fargo wildly under-reserved on their home equity exposure.
Not only did Wells change the time line for placing a loan into “default” by extending the term out 60 days, essentially hiding 60 days of defaults, but they are also using AVMs to determine value from March of 2008, even though the median home price has fallen 5.4% since then.
A 5.4% fall could have thrown double-digit percentages of home equity loans into an even more serious negative equity position, which would have required additional loss reserves. Wells does not seem to care. Maybe Buffett should urge them to come clean? Or does the sage of Omaha think (real) home prices will come back to the frothy peak of the bubble, even in California?
As a note, about $12B of Wells home equity exposure is in first lien home equity loans, which do have a much lower default risk. However, such a massive amount is over 90% that even if you deleted all the other exposure, the $35.6B in high-risk is enough to do serious damage to shareholder equity.
From Housing Wire:
Despite second quarter results that were better overall than analysts had expected, Wells Fargo & Co. remains under growing pressure from a deteriorating $84 billion home equity portfolio, bank executives said Wednesday morning
Wells has a substantial $84 billion portfolio of home equity loans — and half of those are located in hard hit states like California and Florida; of that total, it has carved out the worst $11 billion for liquidation, with rest remaining as part of its “core” home equity portfolio
In the second lien portfolio set up for liquidation, the percent of loans that saw borrowers miss two or more payments rose during Q2 to 3.6 percent, up from 2.79 percent one quarter earlier. The $73 billion “core” home equity portfolio saw a similar rise to 1.88 percent in 60 day delinquencies, compared with 1.71 percent in Q1.
So delinquencies continued to rise during Q2; net credit losses, however, did not. Charge-offs on second liens were actually down $104 million compared with first quarter 2008 — but don’t let that fool you.
The improvement was primarily due to a change in how the bank handles its home equity portfolio charge-offs; earlier in Q2, the bank extended its charge-off policy from 120 days to 180 days, in an effort to give troubled borrowers more time to reach a loan workout (or to protect earnings, take your pick.
Jamie Dimon, CEO of Chase, which originated roughly the exact same quality of home equity lines and loans, said much worse things about their exposure and performance. Keep in mind he has to paint the best picture he can. Wells Fargo’s report on this topic did not even come close to being as realistic, and half of Wells’ loans are in California and Florida, whereas Chase’s are more spread out. Chase reported a 5.5% charge off rate in Q2 and Wells less than 3.6%. A two percent difference is large when you have $84B. Who is wrong… Dimon or Wells?
“Home equity loans are also proving to be problematic; JP Morgan holds $95.1 billion in the category, and saw net charge-offs rise to $511 million in Q2 from $447 one quarter earlier. High CLTV seconds in particular are “performing poorly,” according to the company’s investor presentation.
Chief financial officer Michael Cavanagh suggested that roughly 10 percent of the seconds on JP Morgan’s books are currently underwater — meaning that the borrower owes more on their combined mortgages than their home is worth.
“That could be headed to 20 [percent],” he said on the earnings call. “We can’t predict how homeowners will react when they go into negative equity.
“We’re assuming they won’t act well, but it’s possible things aren’t as bad as we expect.”
Wells Fargo changed its policy to hide defaults:
“In the second quarter, Wells Fargo changed its policy toward charged-off home equity loans to 180 days delinquent from 120 days “to provide more time to work with customers to solve their credit problems and keep them in their homes,” the company said on Wednesday. The change deferred roughly $265 million of charge-offs in the second quarter. Approximately 900 customers with $90 million of home equity loans have been modified due to the change, Wells Fargo said.”
Finally, Wells Fargo used old valuations from March. Since then the median home price in CA — where they are home equity-heavy — has fallen 5.4%. This could have thrown double-digit percentages of home equity loans into an even more serious negative equity position, requiring additional loss reserves:
“As second lien borrowers see equity in their homes evaporate due to price depreciation, second liens become extremely vulnerable to loss. Which is why this stat matters more than most: approximately $35.6 billion of Wells Fargo’s $84 billion in home equity loans had combined loan-to-value ratios above 90 percent, according to the second quarter report. And that’s a figure based on automated value models, or AVMs, that were run in March 2008; were those AVMs run again today, it’s almost a sure bet that the number has gone up even further.”