Wells Fargo, which all of us in the mortgage business know should have stock piles of bad loans, was dismantled today by the Wall Street Journal.
The Journal, as well as most of the Street thinks they ‘avoided large subprime slip-ups’ but that is not the case. They were a significant subprime lender through their retail, wholesale and correspondent channels.
They were also top second mortgage lender with $84 billion of this less-than-subprime paper still on their books. Their ‘Prime’ jumbos, which they still hold a great deal of, had some of the best (easiest) qualifying in the industry allowing up to 50% debt-to-income ratios, qualifying at interest only payments on a 95% combined loan-to-value deal in the $1 million range. They still consider these loans, many with a 621 credit score and above, to be ‘Prime’. In the near future these will likely preform much closer to Alt-A than ‘Prime’. Lastly, the vast majority of their residential mortgage holding are in the bubble states with CA making up the most.
Wells Fargo was one of the first to really get into the Level 3 accounting scheme, which is likely where they keep dumping all of their bad paper. In Q2 of 2007, the following story broke, which very few understood at the time.
Jonathan Weil wrote Wells Faro’s deceptive accounting on Aug 22, 2007 in Bloomberg:
Aug. 22 (Bloomberg) — There’s the kind of earnings investors can take to the bank. And then there’s the kind the bank can show to investors. Word to Wells Fargo & Co. investors: Beware the second kind.
About $1.21 billion, or 35 percent, of its $3.44 billion in pretax income came from Level 3 net gains on the $18.73 billion portfolio of residential mortgage-servicing rights that Wells Fargo marks at fair value. These assets, known as MSRs, consist of rights to collect fees from third parties in exchange for keeping mortgages current, by doing things like collecting and forwarding monthly payments.
Today, the Journal put out a story entitled ‘Wells Fargo Stirs Doubts: Mo chinks are appearing in Wells Fargo‘s armor.” They point out some nifty things, but not all of their skeletons are mentioned.
“Wells Fargo, the No. 3 bank by market capitalization, trades at just over two times its book value, double the multiple the market is placing on J.P. Morgan Chase,.
Wells Fargo’s bottom line got a sizable boost from volatile trading income and a write-up of some mortgage-related assets. Investors shrugged, bidding Wells Fargo’s shares up nearly 50% since then.
10q released Friday bolsters the fear that Wells Fargo’s earnings aren’t all they are cracked up to be.
more (Wells Fargo) assets are being classified as level three.The illiquidity often reflects reduced demand. This usually leads to banks taking big write-downs on those assets.
Level-three mortgages jumped $3.3 billion to $5.28 billion, but in the quarter Wells Fargo booked only a $43 million net loss on them. Wells Fargo declined to give more detail.
Past-due prime mortgages rose for many banks in the second period. Wells Fargo doesn’t break out a prime-mortgage delinquency rate.
Second-quarter filing said that level-three assets included collateralized debt obligations, securities that have caused huge losses for several banks.
The bank didn’t give the size of its CDO holdings or any changes in their value. It didn’t even mention CDOs in its first-quarter level-three data. Other banks’ disclosures of CDOs regularly contain such information.
Wells Fargo didn’t saywhether $860 million of CDOs cited in its 2007 annual report were the same ones referred to in the second-quarter filing.
Sharp run-up in short-term debt at Wells Fargo in the second quarter, which rose 60% to $86.1 billion…the bank could have problems if that funding source becomes less available.
In my opinion, Wells Fargo’s big problems lie in their $84 billion in second mortgages, which are worth pennies on the dollar. They have skirted this issue with everything they’ve got for the past year. For those of you who want to know more about the big banks and their home equity problems see:
FITCH – BIG BANKS HOME EQUITY WOES fitch-home-equity-woes20080314.pdf
What I don’t understand is if Warren Buffett is so big on our country facing up to its debt problems, why is he supporting and buying into one of the banks that is going to the most effort to deny that it was one of the greatest enablers of unsound debt practices (home equity lending), and is now covering up both its role and the fallout from it?
**Below are two posts I have done over the past couple of months detailing second mortgages and Wells Fargo in particular. Please have a look.
Posted on May 2nd, 2008
Fresh news out…S&P pulled a slick one. They STOPPED rating second mortgage RMBS citing “anamolous and unprecedented” borrower behavior. Here is a little piece from Bloomberg that enhances the previous story very well, calling all Home Equity loans ‘junk’.
Remember, this is a near $1.3 TRILLION market with the bulk belonging to very few banks such as BofA, Wells, Chase, CITI, Countrywide, WAMU, National City, GMAC and IndyMac. I put a couple of nice quotes below. This could turn out to be a fairly large story in the making.
Home Equity Lines of Credit and loans (HELOC, HEL’s, second mortgages) were the true ‘Home ATM Machine’ and could be a big wipe-out for the big banks. These loans were mostly used to avoid Mortgage Insurance on purchase and refinance loans over 80% LTV and went up to 100% of the house value in recent years. As a matter of fact, an appraisal or full documentation was often not required. These loans were very easy to get and primarily relied upon an electronic evaluation of the property value and credit score alone.
They are almost always a total loss when in default. This is because in many cases, the first and second mortgage add up to more than the property is worth, so the second mortgage lender does not get anything in foreclosure – it all goes to the first. As a matter of fact, most second mortgage holders do not even bother with foreclosure proceedings any longer, choosing more traditional means of collection.
A few months back banks began to freeze consumers out of accessing the available credit on the Home Equity Lines. Countrywide kicked if off by freezing 122,000 in one swoop and WAMU follow-up shortly thereafter with a 50,000 line freeze.
Since then, most large named banks have began to freeze lines originated prior to 2008 or with original combined loan-to-values over 80% in regions where property values are substantially dropping. This just so happens to be the regions where these loans were done the most.
This hurt thousands who were not prepared. Many use these lines for highly legitimate purposes such as running a business, college tuition, a rainy-day fund or that brand new Mercedes. Now, it looks as though the days of extracting all the cash out of your home through Home Equity Lines are gone for good. This is probably a good thing in the long run, but just as with Jumbo money virtually vanishing overnight, these loans vanishing overnight will reduce housing affordability further extend the housing slump and perhaps cause some real damage to consumer spending.
For those of you interested in seeing the Big Banks Exposure to Home Equity Loans, this is a link to the Fitch report. It is ugly. Many of these banks have not yet begun to take write-downs on these loans. FITCH – BIG BANKS HOME EQUITY WOES fitch-home-equity-woes20080314.pdf
Posted on July 17th, 2008
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 Cavanaghsuggested 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, secondliens 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.”