Mystery Surrounds Wells Fargo’s Earnings

Posted on July 17th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

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.”

Source: http://www.housingwire.com/2008/07/16/second-liens-still-lurking-at-wells-fargo/

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42 Responses to “Mystery Surrounds Wells Fargo’s Earnings”

  1. WCF had big banners for years urging you to get a home equity line and tie a CC to it etc. Now that the equity has vanished, how does that change the rate to the borrower or does it?

    Dose it now being unsecured change the quality of the “asset” and it’s location for accounting purposes?

    Did these types of loans have fine print to the consumer?

    Will that fine print have an effect on the ability for the consumer to pay the primary loan?

    Was this a credit trap?

  2. Figures don’t lie. Liars figure. When an entity can change their accounting rules to suit itself what can you believe? I found it very interesting how the stock mkt, which is so hungry for any kind of positive “news”, ran up the financial sector after Wells posted their “figures”.

    They, the mkt, don’t seem to care how the numbers came about. “It’s more than the “experts” predicted, so Whoopee! Let’s buy!!

    WC Fields had it right. “There’s a sucker born every day”.

    The truth, as we all know, will eventually come out.

  3. I think the huge rally has more to do with the rule changes on short selling.. everyone is covering – and created a short squeeze. just my opinion tho.

  4. Wells Fargo “like most banks” is getting what it deserves! The people who run banks such as Wells are so naive, I thought they were supposed to be “real smart and accomplished people”. Obviously not. They just play the part well.

    How does a bank get to this point. Years of borrowing money from the FED at 1-2% then loan “sharking” it out to the consumer for 6,7,8,9,10…percent to the people. How can you lose with a business model such as this? Now that banks such as Bear and Indysmac have failed ..why does the taxpayer get to pay the bill? FDIC = taxpayer.

    Wells accounting is very Enron like. Just do what makes us look good, switch up the numbers, hide a little here, don’t mention that, smoke and mirrors. Wells is so undercapitalized right now …but they aren’t much different from the rest.

    Now that the Fed has put the currency printers on overdrive some banks will make it…the people will feel the inflation more and more, remember inflation = a tax on you and me, the devaluing of the US currency will continue…of course things will get more expensive….the currency is being produce out of thin air and pumped into a FIAT system that is BROKEN.

  5. Who is buying the $11b pool and for how much?
    They have to be taking a HUGE hit on that liquidation, no?

    JPM said they have $95b in helocs, with 10% of them underwater. They also said they could see that % rise up to 20% in the future. To me, that means 20% is the absolute minimum. 25% of $95b is $22.5b.

    IMO, it going to take 6-18 months for the helocs losses to be exposed.

  6. Is the list of non naked shortable sacred cows going to put more short pressure on the non sacred ones? If your financial institution was not written in the “book of life”, will that not in effect make the flow of capital (read assets) flow from the non listed to the listed and in addition weaken the ones whose name is not written in the book?

    Talk about getting the hex from government! For those of you that thought that the senator sticking the knife in IndyMac was sabotage, the long bowmen just sent out a hail of arrows.

  7. This post is a terrible example of finding facts to support your conclusions. You misinterpret and misrepresent a lot of facts here to support your thesis that all banks are in terrible financial condition.

    First you imply that the entire $84bb home equity portfolio is second liens. This is not true. $12bb of the home equity loans are first liens.

    Second you imply that WFC uses home prices from a March 30 AVM to calculate LTVs on their Home Equity loans. This is not true, they used a March 30 AVM and May home price indices to extrapolate prices to June 30. Is that a valid thing to do? Probably. Is there a lot of room for fudging with such a model? Sure, but that is the question you should be investigating, not misrepresenting their statements.

    Third you imply that the term “Charge-off” is not used to refer to mortgage losses and that doing so is reason to doubt WFC accounting. This is unbelievable to me, mortgage loans have always been “charged-off”. To say this is rare is an outright lie or shocking ignorance. Every loan a bank has is “charged-off” when it is deemed nonrecoverable, the term has been in common use for decades.

    The accounting change at WFC extended the charge-off date for home equity loans to 180 days from 120 days. This accounting change had zero effect on their earnings if you actually read the report. Their net charge offs were lower by $265mm due to the change but they reserved for all of those $265mm in loans. Why did they do this? Effectively reduce charge-offs by $265mm but increase loss reserves by the same amount? I’d like to know. It’s a very interesting question but one you completely miss by assuming this is very shallow accounting manipulation. If it is manipulation it is at a deeper level.

  8. Wells has been cooking the books for years, will know more details when they go into receivership next year

  9. Good points… I added to the post.

    As a note, about $12 bb 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 $35.6 bb in high risk is almost enough to wipe out all shareholder equity.

  10. Who cares ? It’s too big to fail. It’s as phony as you get. You have a good point. But you see the fundemental does not count.

  11. So they are selling their 1st lien helocs?
    Wells did say 71% of the $11b are over 90%. I wonder what price they will fetch for those loans.

  12. The market is assuming also another thing. The FED and the boys and girls in Washington will be pumping back to life the real estate bubble.

  13. Only the ANNUAL statements of these companies are audited. And those audited figures are generally more trustworthy than the quarterly figures, especially since Enron..

    This is why we had the big downdraft in January, from the release of the AUDITED corporate financial statements.

    Until then, they can play their quarterly accounting games, free from the scrutiny of the auditors.

    Come January, it’s a very, very different story.

    Tony

  14. Spasiba Mister Buzan. I did not know. Thanks a billion. So fundementally, they have to says the truth only once a year. The rest of the time they can make up nice little stories. This is really interesting. This blog is fantastic.

  15. At least Merril Lynch is coming with the truth ! Losses 4,91$ per share. I do not believe the people at Wells Fargo. They are making up stories, like most of them. And congratulations to Merril Lynch for biting the bullet. As for the rest of the bunch with “good results”, they can go fly a kyte. What a bunch of liars !

  16. marc, I have to laugh, I actually thought of you when I saw the merril numbers come out, because they seemed a bit more believable.

    Re: telling the truth only once a year, nice game, if you can get into it, eh? and that is why David Einhorn was just a bit annoyed with Lehman. At least it seems for now he got the last laugh.

  17. In news:
    Merrill’s loss would have been a lot deeper had it not been for a $91 million gain booked on the declining value of the bank’s own debt. The move, while counterintuitive, is a legitimate quirk of mark-to-market accounting.

  18. With so many accounting and valuation issues swirling around why spend time parsing unaudited statements, just wait for the certified 2008 statements.

    Just look at the big picture – will real estate improve in CA and the other places in 2008 where WF wrote so many HELOCs with foreclosures and other forced sales depressing prices? What kind of discount would an investor demand to buy a bundle of these babies? Non-recourse and last man on the totem pole – they have scrap value only.

    Lets get naked & short!

  19. Listen up: In addition to our ‘fuck the short sellers of all banks we need solvent’ to buy us more time out of this jelly of a jam (other piker banks can go fuck themselves – BKUNA et al) .. we have told any banks, brokerages, lending institutions of significance, that they are free to report whatever numbers their crack smoking CFO can dream up whilst inhaling uncut diamond-c. Just this once (winky-wink), we will turn our backs.

    So far, JPM WFC STT PNC MER COF have all taken us up on our offer, not to mention worthless outfits like HBAN FHN FMBI … watch what BPOP comes up with in the morn.

    Theres nothing like the smell of napalmed shorts in the am!

  20. You may be right Michael about shorts covering. I’m a realestate guy not a stock market guy. I look at the fundamentals of the real estate/mortgage market as it is today. I don’t believe for a minute WF is in good shape financially. We’ve been sold a bill of goods before by many other companies and now THEY have to prove us wrong. Anybody that accepts their numbers or any other companies financials verbatim is naive. And that includes our Phony and Fraudy, helicopter Ben and Paulson.

  21. As a additional comment. I’m a salesperson. I deal with people face to face and consider myself a decent judge of character and know when someone is bsing me. Maybe I’m more perceptive than most.

    Why isn’t it I have NEVER read about anyone mentioning Helicopter Ben’s SHAKEY, QUIVERING VOICE when on the Hill? This has been going on since day one with him. Since his first event. Does anyone listen?

    I wouldn’t buy squat for this guy. He gives no confidence. And he is selling us and the WORLD on our state of the economy!

  22. As a further follow up on Shakey Bernake (we should start calling him that), we need a good BS salesman now, not a quivering voice or a Slowped like Paulsen who can’t get his ideas across the first time. It takes 3-4 times at least. Buy then we are all asleep.

    We’ve got the best salesman in the world here, lets put them in charge of the financial PR of this country because now, more than ever, we have to sell ourselves to our Global Creditors. We have nothing else except agriculture. Everything else NOW is service.

    We need slick salespoeple NOW to sell our debt to global creditors. Amatuers like Shakey and Slowped won’t cut it. A good salesperson will keep our debt interest rates lower than these incompetent buffoons ever could.

  23. Please choose the correct answer
    A) The true unemployment rate is 5.4%
    B) Wells Fargo post’s profit in housing crisis
    C) Angelo Mazilo is a man of his word
    D) George W. Bush is an excellent and eloquent speaker
    E) All of the above

  24. OK after I wrote these last two posts I googled “bernake quivering” just to see if anyone else in the universe noticed it. The only posts seem to be related to Ron Paul asking him ques.

    But, it’s been an ongoing thing who ever asks the questions! This guy Bernake is afraid and has been since day one. I don’t want to call him a liar.

    I think he has known from day one, as we are finding out now, how bad of a financial situation we are in today.

    But he is not a good PR person. He wears his emotions on his sleeve for everyone to read. Some people can bs and you would never know it, but he is not one of them. It’s not his fault, he can’t help it. That’s why lie detectors work!

  25. So the next ques is if you were the next Pres. do you have to keep Shakey? I wouldn’t. I’d toss him like a hot potato. Do these candidates Mcain/Obama think this guy is worth keeping? Are they/we stuck? I know if Obama gets in Paulson is gone.

    How do you get rid of a bad decision? Congress? Or just let someone else do the talking? He could have a spokesperson like the Pres.

    Look at Tony Snow rest his soul. That guy was good.
    If we are stuck with Shakey, let’s keep him in the background as much as possible and get a good speaker to talk.

  26. Talk about a watershed moment. I found this article posted a year ago. How quickly we forget.

    Check this quote from Bear Stearns Aug/07

    “The dramatic moves by many of the world’s central banks could imply that we have a whole new ball game when it comes to monetary policy,” says David Brown, chief European economist at Bear Stearns Cos. in London

    He was right about that.

    “Federal funds futures indicate investors are betting the Fed will cut its target rate of 5.25 percent by a quarter percentage- point at its Sept. 18(07) meeting. ”

    Here’s more newd from that time
    `Faced With a Crisis’

    While the Fed hasn’t faced such a challenge with

    Bernanke as chairman,

    “there’s no reason to be

    concerned they’ll feel hemmed in when faced with a crisis,” says Brandeis University economics professor Stephen G. Cecchetti, former director of research at the Federal Reserve Bank of New York

    Where is this guy now!!!

    More Wishful Thinking less than a yr ago. –

    The Fed may have done enough after adding $62 billion to the banking system on Aug. 9 and 10 and pledging further funds as necessary, says Dominic Konstam, head of interest-rate strategy at Credit Suisse in New York.

    Stocks rallied worldwide today and U.S. index futures advanced, while the ECB said today it’s optimistic that “market conditions are normalizing.”

    Normalizing!!! LOL

    That’s what’s happening today. Stocks RALLY over some BS which doesn’t mean crap!

    Here’s someone spot on at the time.-

    “The Fed is going out of its way not to cut rates to resolve the liquidity issue,” Konstam says.

    A major reason for caution at central banks is the risk that a premature rate cut compromises their effort to contain inflationary pressures stoked by the fastest global growth in three decades. Inflation in China accelerated to the highest rate in more than a decade in July, the National Bureau of Statistics said today.

    Here’s more fuel for the fodder which everyone ignored at the time (Less than a yr ago.) =

    Charles Goddard – who sat on the Bank of England’s panel between 1997 and 2000, says that’s what happened after central banks in Europe and the U.S. cut rates in response to the 1998 currency crisis, only to see inflation accelerate and asset bubbles inflate during the next two years.

    “Central banks reduced rates and very quickly wished they hadn’t,” he says. “The rate decision had to be reversed quite sharply to deal with the major upturn that we saw from 1998 to 2000.”

    Do we not learn anything from history? I don’t think we do. Read the whole article here.

    http://www.bloomberg.com/apps/news?pid=20601083&sid=abJ_b1ElEoYQ&refer=currency

  27. “WC Fields had it right. ‘There’s a sucker born every day’.”

    Wrong. It was actually P. T. Barnum who said “There’s a sucker born every minute.”

  28. added to the post

    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 CA and FL whereas Chase’s are more spread out. Chase reported a 5.5% charge off rate in Q2 and Wells less than 36%. A two percent difference is large when you have $84 billion. 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.”

  29. “Good earnings” from JP Morgan.
    Very funny indeed. Very funny.

  30. “…it’s OK not to pay your mortgages,” said Mr Dimon.

    Well, maybe thats a little out of context. I think the real problem is that people who are way underwater realize it makes economic sense to default.And people in non-recourse states with second mortgages and HELOCs hold the right end of the whip because their lenders lose net with a foreclosure. They just made bad loans. Dimon is trying to make this into a morality play.

    JP Morgan Chase used its quarterly report to warn that the crisis gripping the US mortgage market appears to be intensifying.

    Jamie Dimon, the banking conglomerate’s chairman and chief executive, cautioned of a “terrible” outlook, warning that problems in the sub-prime mortgage market have spread into the mainstream mortgage market. His warning came after the bank saw a doubling of prime mortgage losses in the past three months.

    Prime mortgages are given to borrowers with the highest quality credit records, so growing defaults on such loans imply that the US’s economic woes are now impacting even well-heeled borrowers.

    “You saw sub-prime go first, then home equity go, and now you’re seeing prime go. It’s exactly the same loss factors,” said Mr Dimon. “It looks terrible.”

    The senior banker also hit out at what he saw as an increasingly forgiving political climate in the US, which was signalling to citizens that it was acceptable for them to default on mortgages.

    “We have all the politicians telling people it’s OK not to pay your mortgages,” said Mr Dimon.

  31. I have had Wells Fargo accounts for a long time… banking etc. until I moved to Florida. However, I do have an equity line and negative equity. While making less money, unemployed again, I will fight to keep my house, the other debts such as credit cards can take a back seat.

    On a personal loan I had, they would not budge, I had paid down the principal to get the current home loans, but they would not let me make an interest only payment (under $50 at the time) even though I had paid ahead. It would have saved me $450 for that month. That loan paid off last year, but it would have been helpful if they had worked with me.

    However, when I was ten days behind on the equity, they offered to extend that payment which is interest only, but it was only a one time “offer”. It is a sign of the times. Lenders need to work with people, but the also need to show a true account of what their situation really is.

    I was approved on a prime loan, not subprime, but the builder tried to make me go subprime, and stated. As a mortgage underwriter, I knew the traps and insisted on prime, verified income. The cost difference was astronomical.

    Even being in the industry, I was approached with a subprime, imagine the rest of the public being coherced into these horrible loans, with
    despicable terms by the subprime lenders. The prepayment was invented so the brokers would stop churning the loans, which was even in the early nineties, all at a cost to the public. The prepayments had greater yield spread premiums to “soften” the blow to the broker, not the borrower.

  32. To Bill K: It is hard not to notice “shakey Bernake”, but at the same time “p-p-puttering Paulson”, with his surreal stuttering, is far more heartening. If only we were all so intrinsically honest that our attempts to deceive were as blatantly obvious as these two, the world would be a much better place.

  33. “We have all the politicians telling people it’s OK not to pay your mortgages,”

    Likely the same ones that were cheering on the way up saying it was the American dream.

  34. I just don’t get how people are willing to gloss over the heloc portfolio for Wells and JPM. It isn’t blowing up on them yet, but it will. It just might take 2 to 4 more quarters. I don’t see either being able to offload any of that stuff without a huge haircut. If I were Wells, I’d be issuing some stock now before the storm hits and people get a clue as to what they are really holding.

  35. Is this not the biggest load of crap as of late. I know how Chase could have pulled it off, basically by getting uncle Ben to cover some of Bears loss and Chase’s too, (And billing Joe six pack later with turning the dollar into the peso), and then put Bears real assets on their books. Wells? The CA bank. With most of their lending where? CA, NV, AZ. And they made profits exceeding expectations? Yeah right. Who’s buying this crap? Please put you tray tables in their full upright position and fasten your seatbelts as we are about to be screwed.

  36. The American dream has turned into the American’s nightmare. Since we have had so much discussion over the pledge of alligence lately, I took the liberty of rewriting it for political blessing and discussion, Please enjoy it with me: “I pledge alligence to NO flag of the Socialist States of America, and to the republicans for which we stand one nation without God, indecisive, with liberty or justice for none.”

  37. Ray it’s not socialism, it’s national-socialism.Privitaze the profits and socialize the losses.It’s national-socialism.Socialism yes but just for the few.
    The super rich from Wall Street and their clients getting bailed out. The trick is to render the loss systemic. That way when you screw up, you can blackmail the politicians for “bailouts”. You are all toast. Europe also.

  38. Bill K. & Tom Lowe —
    P.T. Barnum of circus fame; his other oft’ quoted bromide:

    “You can’t cheat an honest man.”

  39. […] For many banks this is their largest residential mortgage exposure. For example, Wells Fargo still carries $84 billion and Bank of America and Chase about $100 billion a piece. The banks were very touchy in their recent earnings reports on this topic. Wells Fargo actually changed the definition of ‘default’ from 120 days to 180 days to push out defaults further and hides losses. See my report on Wells Fargo’s mystery earnings. […]

  40. Do you think Mr. Buffet’s due diligence work is to the low standards of the government? Do you think when he owns an 8.8% stake in a company, he uses the accounting numbers the company provides?

    I am thinking that a few of his billions go to pay the best accountants in the world to tell him if a company is cooking their books or poised for greatness. As he continues to add to his 8.8% stake in this company, I believe it is because he sees that when this company develops an east coast presence it will take over the #1 position within a year. Based on past history, Wells won’t have to use gimmicks, fraud, and creatively designed ways to screw the consumer to do so. BTW – My Wells home equity loan and LOC are both rightside up and up to date.

    I will trust his due diligence before your analysis, or the “analysis” of the other posts here.

  41. […] then there’s that mystery surrounding the Wells Fargo Earnings Report… fact or […]

  42. […] Mystery Surrounds Wells Fargo’s Earnings […]

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