Wells Fargo - What is Real, What is Not
Wells Fargo -- what a press release, eh?
The company blew some serious smoke last Thursday to brag about earnings and indirectly tout its stock. "Brag" and "tout" are strong words - and purposely chosen. The focus on "three billion in profits" and "fifty five cents per share" and some of the adjectives in the press release sent the stock soaring this morning. I tend to focus on some other things -the balance sheet among them - and I zeroed in on "provision expense of approximately $4.6 billion, including $1.3 billion credit reserve build, bringing the allowance for credit losses to $23 billion." Twenty three billion, wow, what a big reserve! Not really.
Wells bought Wachovia and with that purchase came options ARMs - lots of option ARMs, the majority (analysts estimate 60%) in California. Total exposure at Wells to option ARMs was $122 billion at time of purchase and if I read their incredibly complex financial documents correctly their exposure is now between $90 and $100 billion. Let's say $95 billion. Wells stated $59 billion were "credit impaired" and wrote down $24 billion in Q4 related to the Wachovia purchase. They are forecasting a 29% default rate going forward. Wow! Aren't they conservative. Home owners whose option ARM mortgages that will reset in 2009 and 2010 face an average monthly mortgage payment increase of 63 percent. These resets peak - get this - in August of 2011 based on the dates option ARMs were let. So, given these realities, what is the ultimate default rate going to be in the coming quarters? is it going to be just 29%?
Ratings agency Fitch sees it at around 45%. Goldman Sachs says 61%. Whitney Tilson, an analyst with Amherst Securities covering this market better than most, believes option ARM defaults, as a class, could go as high as 70%. Moody's recently downgraded Wells in part due to option ARMs, saying the 29% number is probably too low and will have to continue to mark down assets through 2009 and 2010.
Who is right, Wells at 29%, Fitch at 45%, Goldman at 61% or good old Whitney at 70%? Fitch is a ratings agency, Goldman makes money trading these forecasts, so, let's split the difference and say it is 53% of $95 billion. That is roughly $50 billion - or $20 billion dollars more than their internal models are projecting.
Those projections have prompted them to reserve $23 billion for future losses - in everything, not just option ARMs. The bank also held $118 billion in home equity lines and $138 billion in commercial real estate loans at yearend 2008. Simply put, WFC has a great many more write downs coming and their shareholders will be significantly diluted as they raise more capital either from Uncle Sam - most probably the case - or the private sector, although I don't see Warren Buffet stepping to the plate with more dough, do you?
Agreed, their write downs will come over time as they hold these mortgages and these only have to be written down as they are truly impaired. That means shareholders face many more quarters of greater than anticipated write downs.
Bottom line: I believe WFC is blowing some serious smoke here. The operating earnings they discussed are real -- but the possibility they will need more capital never made it into their press announcement. Stay away - and when the market stabilizes a bit, put WFC on your short list of short prospects.
