Friday, 23 October 2009 01:00

I've Been Warning About Wells Fargo Since Spring of '08 - The Doo Doo

I run a rather interesting site. I believe I provide uncommon analysis, and due to that fact it is not necessarily appreciated by the masses. Point in case: I say X company is fundamentally weak and the share price subsequently goes up and/or they report "record" earnings. There are some that then regard my analysis as wrong or irrelevant, or worse yet not applicable because it uses the fundamentals. It is unfortunate that such a large cross section of investors now truly believe that fundamentals no longer apply - or worse yet believe short term price movement is the grand arbiter of value! Fundamental analysis is basically the measurement of value against risk. When one believes these principals no longer apply, then one no longer has confidence in the capitalist system and/or one has been hoodwinked by the most recent bubble/burst. This is where I believe we are now, and so shortly after just three bubbles were blown and popped in the last decade. - with one just popping last year! That's right three, literally one every three years or so -, real estate/credit, and now the government induced equity bubble. We can arguably throw 2007 oil in there as well. Those that follow me know that this is what I do for a living - see "The Great Global Macro Experiment, Revisited".

Understanding my proprietary investment style

As you can see, there is a reason why they call this BoomBustBlog! Many people believe we have hit that trough in March of this year. I don't. Even if we did, we have literally approached bubblicious territory again which sets us up for another spin at the asset cycle.

Alas, I digress... Back to the point. I am a capitalist and believe in the principals of capitalism. Thus, I do tend to adhere to the fundamentals. Sooner or later, the market always returns to the fundamentals. The ensuing ride may be rough, but it is also nearly always guaranteed. This brings us to Wells Fargo 3rd quarter earnings report and their "record" earnings. As a quick recap of where I am coming from re: Wells then on to a review of their Q3-09 results...

  1. Doo-Doo bank drill down, part 1 - Wells Fargo - I introduce Wells as a founding member of the Doo Doo 32 list of banks to encounter distress in the Spring of 2008. Here I was the first to introduce the blogoshpere to Wells extremely aggressive accounting games, namely extending the definition of the term delinquent in order to hide HELOC losses!
  2. The open source mortgage default model I released an open source spreadsheet that detailed defualts in almost all states sourced from independent government sources. Apply these loss rates to Wells portfolio and the truth is evident.
  3. Fact, Fiction, Farce and Lies! What happened to the Bank Bears? I attempted to stress the difference between economic and accounting losses. Yes, Wells has "record" accounting profits, but also has record economic losses as well.
  4. Beware of Bank Earnings Propaganda - They are still in BIG trouble!- self explanatory
  5. Wells Fargo reports in a few hours and I wonder how forthcoming they will be with their credit losses
  6. Wells Fargo Q2 2008 Highlights <!-- -->
  7. Green Shoots are Being Fertilized by Brown Turds in the Mortgage Markets

Subscriber links with the real heavy analysis can be found at the end of this article.

Reggie Middleton on Wells Fargo's 3Q09 Reported Performance

Results Review - 3Q09

Wells Fargo & Co. (WFC) reported higher-than-expected earnings for 3Q-09, beating consensus estimates for the second time in a row, primarily on back of increased revenues from mortgage banking. Although WFC's reported EPS at $0.56 was up 14.0% y-o-y, it declined 2.0% q-o-q in 3Q09. A y-o-y growth in earnings reflected strong growth in non-interest income (up 169.8% y-o-y) and net interest income (up 83.1% y-o-y) led by higher customer base and increase in product offerings to its existing customers, partially offset by increased provisions for credit losses (up 144.9% y-o-y and 20.2% q-o-q) during the same period. Excluding the impact of gains from mortgage servicing rights (MSR) and hedging gains (included in mortgage revenues and overall constituting a part of non-interest income), the Company's earnings declined in 3Q2009 on q-o-q basis. The contracting base of interest earning assets (q-on-q) along with higher loan losses provides a significant headwind to the company's valuation in the near-term.

In 3Q-09 WFCs' net charge-offs increased to $5.1 billion, or 2.5% of average loans (up 156.2% y-o-y and 16.5% q-o-q) primarily due to higher charge-offs from Wachovia's loan portfolio which contributed 33.8% to total net charge-offs. Wachovia's net charge-off rate deteriorated sharply to reach 1.66% in 3Q09 from 0.92% in 2Q09 while WFC's legacy loan portfolio charge-off rate rose 2 basis points to 3.37% in 3Q09 from 3.35% in 2Q09. Further, non-performing assets also rose 27.9% q-o-q to $23.5 billion as of September 30, 2009, or 2.9% of total loans, reflecting deterioration in the Company's consumer loans and Wachovia's commercial and commercial real estate nonaccrual loans.

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The major support for WFC came from mortgage banking revenues which increased to $3.1 billion (up 243.8% y-o-y), representing 13.7% of the total consolidated revenues in 3Q09 compared with 8.6% in 3Q08. Out of total mortgage banking revenues reported in 3Q09, $1.5 billion were related to "non-recurring" mortgage servicing rights (MSRs) and hedging gains. Excluding the impact of these items, the Bank's non-interest income contracted 4.7% q-o-q to $9.3 billion in 3Q09 as compared to $9.7 billion in 2Q09. In 3Q09, non-interest revenues (including MSR and hedging gains) accounted for 48.0% of the total net revenues against 47.7% in 2Q09 and 38.5% in 3Q08.

More importantly, net interest income declined 0.7% q-o-q to $11.7 billion in 3Q09 from $11.8 billion in 2Q09 despite 0.06% increase in net interest margin off lower average earning assets in 3Q09. Net interest margin, however, declined significantly on y-on-y basis - to 4.36% in 3Q09 from 4.79% in 3Q08 - as decline in yield on interest earning assets exceeded the decline in yield on interest bearing liabilities. The tough credit environment and decline in loan demands contracted the total interest earning assets in 3Q09. WFCs' total loan portfolio contracted 2.6% q-o-q to $800.0 billion in 3Q09.


Net income to common shareholders reached $2.6 billion (increasing 2.4% q-o-q in 3Q-09) primarily off higher mortgage banking revenues (which included $1.5 billion gains from MSRs and hedging gains in 3Q09 versus $1.0 billion in 2Q09), lower non-interest expenses over 2Q09 off FDIC charge of around $565 million in 2Q09 and decline in tax rate of 2.0%. Excluding the impact of gains from mortgage services rights and hedging gains (recorded in 3Q09 and 2Q09), and FDIC charge off recorded in 2Q09, net income in 3Q09 declined 47.7% to $1.1 billion from $2.2 billion in 2Q09.

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In 3Q09, provision for loans losses increased significantly to $6.1 billion or (3.06% of total loans), up 20.2% q-o-q, while net charge-offs rose to $5.1 billion (2.48% of total loans) with an increase of 16.5% q-o-q. Total non-performing assets (NPAs) also increased to $23.5 billion (2.93% of total loans) from $18.3 billion (2.23% of total loans) at the end of 2Q09 and $6.3 billion (1.53% of total loans) at the end of 3Q08. The growth in NPAs was driven by deteriorating Wachovia's loan portfolio.

Here I introduce you to another "I told'ja so" starting as far back as September of 2007:


The allowance for credit losses totalled $24.5 billion or (3.1% of total loans) in 3Q09 as compared to $23.5 billion or (2.9% of total loans) in 2Q09. An increase in $1.0 billion credit reserve was estimated by the management as inherent losses on its portfolio as of 3Q09, particularly from commercial loan portfolio. Further, loans 90 days or more past due and still accruing increased to $18.9 billion, or 2.4% of total loans, in 3Q09 as compared to $16.7 billion, 2.0% of total loans, in 2Q09. The banks' Texas ratio also worsened to 32.5% in 3Q09 compared with 29.9% in 2Q09 and 20.7% in 3Q08.

In closing, and in short on WFC, I told you so. Many times, and these days, most of the time, the economic truth is not reflected share prices, CNBC nor accounting numbers. You can be sure to get the unbiased record from your buddy Reggie, though. So as to not simply pick on Wells, JP Morgan, this country's most respected bank, is really in the same position save a trading arm that had artificially high margins that are already on the decline (I will post an article on FICC risks and revenues next). See "Reggie Middleton on JP Morgan's Q309 results" and "If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 - JP Morgan, then download:

More rabble rousing links of interest:

Wells Fargo Subscription Content

WFC Off Balance Sheet Exposure WFC Off Balance Sheet Exposure 2009-10-19 04:11:50 259.25 Kb - The complete off balance sheet review

WFC Research Note Sep 2009 WFC Research Note Sep 2009 2009-09-30 13:01:30 281.29 Kb - The Skinny on that CDS exposure. Are they doing the AIG thing too???

WFC Investment Note 22 May 09 - Retail WFC Full Forensic Analysis & Research Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb

WFC Investment Note 22 May 09 - Pro WFC Full Forensic Analysis & Research Note with Anticipated Capital Requirements under revised SCAP/Stress testing 22 May 09 - Professional 2009-05-27 01:56:54 853.53 Kb This is the document that ties all of the ancillary research togther and includes our best estimate as to the amount of capital Wells Fargo will need to raise!

Wells Fargo ABS Inventory Wells Fargo ABS Inventory 2008-08-30 06:40:27 798.22 Kb

Last modified on Friday, 23 October 2009 01:00


  • Comment Link Reggie Middleton Monday, 26 October 2009 06:56 posted by Reggie Middleton

    I agree with your theory in principial, although you cannot generalize upon all REITs. Some are better than others, and many have false cashflow that aren't generated from operations but from financing. My subscription material has my full opinion on the REITs that I covered.

  • Comment Link 1uncrugbyplayer Sunday, 25 October 2009 00:34 posted by 1uncrugbyplayer

    Dear Reggie,
    I have recently discovered your insightful blogs/analysis and I notice that you have several thorough investigations of REITS. Most of these were done I gather back in 2008 except for the recent Realty Income analysis. It has been my contention, based on a variety of sources I have read, that the REIT space is significantly overvalued perhaps for the following reasons: Wall Street underwriters have raised billions for REITS in the past 12 months or so and therefore go to great lengths to have their retail force promote "favorite REITS" to their clients, yields are still much higher than what banks and most other "classes" of investments seem to offer for the "income investor" therefore continue to have support from the average retail investor who is looking for yield, and despite the cry from some voices that commercial real estate is on the "precipice", cash flows seem strong enough to continue to support investor "distributions". Having a suspicion that "all is not well in Denmark", I have been taking bites of leveraged ETFs whose aim is to make money for those who feel the REITS will falter significantly relatively soon. Could you outline in brief why my perception is either correct or misplaced and provide some facts that bolster youir position? I appreciate any time you might devote to this topic.
    Most sincerely,

  • Comment Link Ned Friday, 23 October 2009 07:37 posted by Ned

    The quality of your work-product is excellent. Unfortunately, Wall Street is a con-game, energized with blantant, self-serving hype & bullshit. But as you know, in time the fundamental take hold. Eventually rates will rise, low loan origination will contact still greater, margins will be squeezed as cost of funds rise, legacy costs will have no lower to fall, multiples will contact and the financial will make the round-turn that's already overdue. Ned.

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