Reggie Middleton's Boom Bust Blog

This is the first of several drill downs into the list of 32 banks in deep doo-doo. Before I go on, let's outline the articles in this series thus far...

The Asset Securitization Crisis Analysis roadmap to date:

1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I  
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrfts are in deep doo-doo!
10. A little more on HELOCs, 2nd lien loans and rose colored glasses
11. Will Countywdiw cause the next shoe to drop?
12. Capital, Leverage and Loss in the Banking System

Well, the first bank on the drill down list will also be 2nd of the banks that I will deliver a forensic analysis on (the first was PNC Bank). That bank is,,, (drum roll in the backgroud, crescendo.... I know some of you hate it when I do this........) Wells Fargo! I can hear a few of you naysayers cackling behind your computer screens as I type this. Wells Fargo is a big name brand bank (cackle, cackle)! Wells Fargo has Warren Buffet as its largest investor (cackle, cackle)! Wells Fargo this and that and blah, blah and (cackle, cackle).... All I can say is, beware of name brands (I actually felt compelled to address this in earlier posts). I have made more than a couple of dollars benefiting from name brand hubris and smaller investors who would rather be told what to do than read a balance sheet! Time will tell if I am right or not on Wells Fargo, just be forewarned - several of the banks on teh Doo-Doo 32 list have already taken a trip to the confessional! The score card for the credit crisis to date, Reggie Middleton - 10, big name brand investors - 0 (not to toot my own horn, I'm sort of a modest guy and I know I have a big mistake/loss coming soon, it just isn't going to be this one).

 I actually have a lot of respect for Buffet, though. Hell of a fundamental investor and cash flow king, and charming public persona as well as being modest (at least he's got me beat). My appreciation differs from that of many, though. His investment track record is quite impressive for it stands the test of time as consistent. As a smaller, unknown investor, he  was the most impressive, but now he is an icon and his very words and even a scent of investment from him actually moves markets. Even though he has a much larger capital base to work from (which makes it harder to generate large proportionate returns), his influence can be confused for investment acumen. All in all, he is one to be admired, but the investment results stemming from alpha have to be seperated from the ability to manipulate and move the market (unless that actual ability can be defined as alpha - topic for another day). We all make mistakes though, and Wells Fargo is a mistake waiting to happen. Let's walk through this company as I see it. Of course, since Wells Fargo failed to cooperate with me in releasing their numbers, I used statistical data to back into their probable delinquincies where they weren't directly available from their public filings.

   
Wells Fargo observations

Loan portfolio:

 

Large exposure in Construction and Development (C&D) loans: Of its total loans of $386 bn, Wells Fargo (WFC) had $19 bn exposure in construction and development loans in 1Q2008. WFC’s exposure was the fourth largest among all US banks in absolute amount after Bank of America, Wachovia and BB&T, comprising nearly 36% of its shareholder’s equity (this is unadjusted for bullsh1t). In 1Q2008, C&D loans witnessed the highest stress with NPA to loan ratio of 2.32%, followed by real estate 1-4 family first mortgage with NPAs to loan ratio of 1.91%. C&D NPAs (Non-performing or dead assets) witnessed a 114% increase over 1Q2007 and 38% increase over 4Q2007. In Wells Fargo loan portfolio, as of December 31, 2007 California represented nearly 32% of total C&D loans, Florida represents 5%. These areas are experiencing extreme stress due to thier high (the highest in the country) residential delinquency, foreclosure and REO rates.

 

This stress is real, and is already causing losses in the condo construction and sales markets, retail malls and now office buildings.  Please see my primer and series on the Commercial Real Estate Crash and ongoing series of financial shenanigans and excessive debt issues of General Growth Properties for additional information.

Sizeable Real Estate loans exposure in troubled markets:  Wells Fargo had $148 bn loan in 1-4 Family Mortgages (WFC has a high correlation to industry-wide losses) which represented nearly 38% of the banks’ total loan. Out of these loans nearly 51% comprised junior lien mortgage loans (much higher probability of total loss and no recovery). After C&D loans, real estate loans have highest NPAs as proportion of total loans.  In 4Q2007, real estate 1-4 family first mortgage NPAs to total loans stood at nearly 1.91% of total loans with total NPAs of $1.4 bn. In terms of geographic exposure, real estate loans from California and Florida comprised 33% and 4% of total real estate loans (i.e 13% and 2% of WFC’s total loan portfolio).

 

WELLS FARGO	1Q-2008	4Q-2007	3Q-2007	2Q-2007
Loan Composition
Commercial	92,589	90,468	82,598	77,560
Other real estate mortgage	38,415	36,747	33,227	32,336
Real estate construction	18,885	18,854	17,301	16,552
Lease financing	6,885	6,772	6,089	5,979
Total commercial and commercial real estate	156,774	152,841	139,215	132,427
Real estate 1-4 family first mortgage	73,321	71,415	66,877	61,177
Real estate 1-4 family junior lien mortgage	74,840	75,565	74,632	72,398
Credit card	18,677	18,762	17,129	15,567
Other revolving credit and installment	55,505	56,171	57,180	53,701
Total consumer	222,343	221,913	215,818	202,843
Foreign	7,216	7,441	7,889	7,530
Total Loans	386,333	382,195	362,922	342,800

 

Wells Fargo haa increased their loan assets every quarter for the past 4 quarters. Those past 4 quarters are just past the peak of the largest equity real asset and credit bubble of the century? Question: Why is Wells Fargo increasing the amount of these quickly depreciating assets on its books while the underlying properties are rapidly decreasing in price? 

 

Large Second Lien Home Equity exposure with rising NPAs: As of 3Q2007, Wells Fargo had second highest home equity loans exposure among all US banks in absolute amount. In 1Q2008, Wells Fargo had $83 bn loans in home equity comprising nearly 19% of total loans and a staggering 174% of its shareholder’s equity.

·  Within its home equity exposure 37% of loans are in California comprising 7% of its total loan or 64% of its shareholders equity.

·  In 1Q2008 Wells Fargo’s annualized loss rate on home equity loan portfolio increased to 2.12% from 1.42% in December 31, 2007.

·  As of December 31, 2007 nearly 29% of the bank’s home equity exposure had LTV greater than 90%. With housing prices expected to continue to decline over the reminder of 2008, Wells Fargo’s significant exposure in high LTV home equity loans with concentration towards California could pose a much harder time for the bank in the quarters to come. 

A more granular view of Wells Fargo's loan portfolio shows us the following (I've highlighted areas to take notice of)...

WELLS FARGO	1Q-2008	4Q-2007	3Q-2007	2Q-2007
% Change
Commercial	2.3%	9.5%	6.5%	7.3%
Other real estate mortgage	4.5%	10.6%	2.8%	2.5%
Real estate construction	0.2%	9.0%	4.5%	4.3%
Lease financing	1.7%	11.2%	1.8%	8.8%
Total commercial and commercial real estate	2.6%	9.8%	5.1%	5.8%
Real estate 1-4 family first mortgage	2.7%	6.8%	9.3%	9.3%
Real estate 1-4 family junior lien mortgage	-1.0%	1.3%	3.1%	4.2%
Credit card	-0.5%	9.5%	10.0%	6.7%
Other revolving credit and installment	-1.2%	-1.8%	6.5%	0.5%
Total consumer	0.2%	2.8%	6.4%	4.8%
Foreign	-3.0%	-5.7%	4.8%	10.7%
Total Loans	1.1%	5.3%	5.9%	5.3%
Loans 90 Days or More Past Due and Still Accruing
Commercial	29	32
Other real estate mortgage	24	10	140% increase??
Real estate construction	15	24
Lease financing	68	66
Total commercial and commercial real estate	314	286
Real estate 1-4 family first mortgage	228	201
Real estate 1-4 family junior lien mortgage	449	402
Other revolving credit and installment	532	552
Total consumer	1,523	1,441
Foreign	40	52
Total Non Accural Loans	1,631	1,559

 

Increasing provisions and chare-offs

·  In 1Q2008, WFC’s NPAs increased from 1.16% of total loans over 1.01% in 4Q2007. Overall NPAs increased to $4.5 bn from $3.9 bn in 4Q2007. NPAs in real estate construction loans witnessed highest increase of 49% to $438 mn in 1Q2008. NPAs of C&D loans stood at 2.32% of total C&D loans, followed by real estate 1-4 family mortgage (1.91%) and lease financing (0.83%)

· Wells Fargo’s gross charge offs increased to 0.46% of total loans compared to 0.37% of total loans in 4Q2007. C&D loans witnessed the highest increase in charge-offs with an increase of nearly three-fold to $29 mn in 1Q2008, showing signs of increased stress in these loans. Real estate 1-4 family junior lien mortgage, credit card loans and Other revolving credit and installment had charge-offs of 0.61%, 1.68% and 0.98% to total loans, respectively.

· However despite increase in NPAs and increase in charge offs, Wells Fargo provision for credit loss sequentially declined to $2.0 bn in 1Q2008 from $2.6 bn in 4Q2007. (0.52% of total loans in 1Q2008 from 0.68% of total loans in 4Q2007) raising concerns over possible inadequacy of provision amount.

· From April 1, 2008 onwards, Wells Fargo has changed its home equity charge-off policy to 180 days from 120 days previously. Amid current deteriorating credit markets with residential sector showing no signs of recovery, it is quite understandable that the bank has changed the policy in a bid to defer recognition of provision and charge-offs.

 

WELLS FARGO	1Q-2008	4Q-2007
Delinquincie as a % of  Loans
Commercial	0.03%	0.04%
Other real estate mortgage	0.06%	0.03%
Real estate construction	0.08%	0.13%
Lease financing	0.99%	0.97%
Total commercial and commercial real estate	0.20%	0.19%
Real estate 1-4 family first mortgage	0.31%	0.28%
Real estate 1-4 family junior lien mortgage	0.60%	0.53%