Wednesday, October 21, 2009

Behind the Numbers At Wells Fargo


Wells' Fire Engine Red Flags

Dig deeper into Wells Fargo's third quarter report, and here's what you'll find. It's got a massive consumer loan portfolio that it picked up when it bought Wachovia a year ago.

Wachovia had been brought low by its disastrous decision to buy the damaged Golden West Financial, which popularized the now excoriated 'pick-a-payment' loan program, which essentially let borrowers defer interest payments and add them to the loan's principal.

Many of these loans carry low initial rates that are just now starting to reset higher, backfiring on Wells as the recession continues.

Pick-A-Payment Losses

Ok now this is where it gets to be a funhouse hall of mirrors. Amidst the pie charts and graphics and footnotes, you'll see this in Wells Fargo's report: $107.3 billion in pick-a-payment loan principal still due and owing at the bank.

Now, a new accounting rule that just took effect this past summer says banks must book the value of those loans as of the time they're reported to shareholders. It's part of the 'fair market' rules you may have heard about.

So now Wells says these loans are really only worth, watch this: $87 bn. It calls this the carrying value of these loans.

That $20 billion could potentially come out in the wash as a future writedown-and $20 billion is nearly half Well's $53 billion in Tier 1 capital, Tier 1 being the capital cushion bank regulators says all banks must have to support their businesses.

But where did that $20 billion swing downward come from? Dig deeper into Wells' disclosures, you'll see that of those $107.3 billion in pick-a-payment loans, Wells says $57 billion are what's called 'impaired,' meaning, they're either not paying any interest, they're in default, or they are flat out delinquent.

Out of that pile of rotten apples, Wells says it thinks just $37.9 billion are worth anything at all.

What do you want to bet that it's not actually $37.9 billion, but the full $57 billion are worth nothing at all, given that home foreclosures are rising, wages are falling, as unemployment continues to rise?

Wells' Souring Commercial Real Estate Loans

It gets, well, worse at Wells. The bank says it also has $135 billion commercial real estate loans, much of which it picked up from Wachovia--$43 billion of this sum is at risk. About a third of Wells Fargo's commercial real estate loan book is tied to properties in California or Florida, two states slammed hard by downturn in real estate.

Wells' Off-Balance Sheet Uglies

There's more. Wells also has $174.4 billion in off balance sheet assets, with some $109 B that could come back onto its balance sheet if a new accounting rule takes effect next year.

And Wells executives are staring morosely at a mountain of rotten paper, $55 B in other toxic assets, called level 3 assets. Supporting all of this is its $53 billion in Tier 1 capital, as well as $98.1 billion in net worth on a hard asset, or tangible, basis.

Cookie Jar Reserves Swamp Interest Income

Meanwhile, Wells' loan loss reserves have grown to $24.5 B, double its $11.7 B in net interest income for the third quarter. Net interest income is the lifeblood of any bank, it's the money that comes in the door from loans, mortgages, credit cards, you name it.

When cookie jar reserves swamp interest income, watch out, that's a fire-engine red flag. Wells' credit reserve ratios are also well below what JPMorgan Chase and BofA have now. fargo/

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