Why the Wells Fargo CFO Quit and Pick-A-Pay Games

10 Feb

What, exactly, would cause a highly paid executive to abruptly quit his job? The executive in question is Howard Atkins, former CFO of Wells Fargo (NYSE: WFC). In 2009, Mr. Atkins’ total compensation was $11.6 million. That was up from $4.9 million in 2009 and $5.7 million 2007 – that’s not bad living by any standard. It’s no secret that I have often been critical of WFC and their financial reporting. It’s not that I have a vendetta against the company – as a New Yorker, I don’t run across them in my every day life. I don’t own the company’s stock or options nor do I have a short position. So, why do I continue to shine a light on the company? Quite frankly, I believe the company does not receive the same level of scrutiny that its peers receive. I believe this is likely due to the fact that Berkshire Hathaway (NYSE: BRK.A) is their largest shareholder. As many of you know, investment banking is driven largely by fees received from capital raising and Mergers & Acquisitions. Buffett’s empire of portfolio companies crosses numerous sectors. Those companies, from time to time, find it necessary to utilize the services investment banks. Those services typically result in hefty fees. Why upset uncle Warren? Just a thought, but I like conspiracy theories.

Back to the topic at hand. Why would a 59 year old man (he turns 60 this week), making north of $10 million, quit with no stated future plan? The folks over at The Street.com say it was for “personal” reasons. I will let them speculate on what those reasons may or may not be. I would rather take a look at some numbers. As I suggested in an earlier post, the Wells Fargo numbers look suspect when compared to its universal banking peers. I won’t rehash the comparison here, rather, I plan to focus on a “then and now” review of the “toxic” assets the company acquired when it took over Wachovia back in the dark days of 2008.

In particular, let’s focus on the pesky loans the bank picked up from Golden West by way of its acquisition of Wachovia. When I think of Golden West, I am reminded of Countrywide Financial. You may recall Bank of America acquired Countrywide for $4 billion and has subsequently taken charges of more than $8 billion related to that gem. I digress. 

On page 11 of the Wells Fargo/Wachovia merger presentation, management indicates that the Pick-A-Pay mortgages would have lifetime losses of $32 billion on a book or $122 billion, or a 26% loss. The net result leaves $90 billion of Pick-A-Pay loans (pro forma at 6/30/08), the most toxic of mortgages, on the company’s books. Many bulls point to this “mark down” as the reason Wells is able to report better than industry averages on their loan portfolio. The devil is in the details. Have you ever danced with the devil by the pale moonlight?

Fast forward to the most recent quarterly release. The Pick-A-Pay assets are currently on the books for $74.8 billion. The presentation proudly states that the portfolio is performing “better than expected.” Upon closer inspection, it becomes clear that the outperformance was manufactured. To wit: on page 34 of the presentation, it states that the “carrying value of $74.8 billion in first lien loans…[is] down $20.5 billion from 4Q08 on paid-in-full loans and loss mitigation efforts.” On page 21 of the presentation, management tells us that the Pick-A-Pay portfolio is performing $2.4 billion better than expected. Remember that number.

Peeling back the onion further reveals that there was fully $3.7 billion (page 34) in modification principal “forgiveness.” It further states that the “modification redefault rate has been consistently better than the industry average as [the company has] strived to give customers an affordable, sustainable payment.” Without these modifications, it appears that the $2.4 billion outperformance would have been $1.3 billion underperformance. But wait, there’s more!

Of the Pick-A-Pay mortgages that were deemed “Purchase Credit Impaired” or “PCI,” only 62% of the portfolio was “current.” Deeper in the presentation (page 30, to be exact) we find out that 81% of the Pick-A-Pay nonaccruals are held at “recoverable value.” The remaining 19% have “not yet been written down.” On that same slide (page 38) we find out that charge-offs to date are equal to 28% of the original balance. Recall, at the time of the acquisition, the estimated losses were 26%. Add to that, 35% of the mortgages have loan-to-values of ≥80%. I believe it has been well documented that house prices remain depressed and are well below their 2008 levels. Yet, management still makes the representation that the loans are performing “better” than expected. As Chris Berman says: c’mon man!

A conservative stance would be to write at least some of these “assets” down to reflect the reality that the loans won’t be repaid in full, if at all. Wells reported $126.4 billion equity ($90.9 million of tangible equity) at year end; $4.1 billion in non-accrual loans is not going to bring down the house by itself. However, I have only examined $74.8 billion – or approximately 10% – of a $757.3 billion loan book. This begs the question as to where else has management taken liberties to make their loan book look healthier? I believe it is about time for management to take a good hard look at the loan book and stop marking to myth.


5 Responses to “Why the Wells Fargo CFO Quit and Pick-A-Pay Games”

  1. Mr.Schnider February 11, 2011 at 3:46 pm #

    Two things, my understanding is that the Pick a Pay loans are performing better relative to what was estimated back at the time Wells merged with Wachovia. Wells wrote down enough principal balance on the pick a pay loans to cover what they thought would ultimately be charged off in the next three years. The regulators and accountants are now putting some of the principal back on the balance sheet because they haven’t used up 2/3rds of what was written down. So yes, the pick a pay portfolio is performing better than originally estimated.

    Secondly, loans go into non-accrual after they become 90 days delinquent. But they don’t get written down until they become 120 days delinquent. Wells wrote down other pick a pay loans under “purchase accounting” practices and no longer can just write them down anytime they feel like it. But rather GAAP has them provision for loan losses which impacts the reported bottom line to share holders.

    • georgetownjack February 11, 2011 at 4:52 pm #

      Mr. Schnider,
      You are correct, the loans were written down and it is the remaining Unpaid Principal Balance that is on the books which is then negatively amortized if the performance is better than expected. With regard to your points:

      1) “my understanding is that the Pick a Pay loans are performing better relative to what was estimated back at the time Wells merged with Wachovia”
      -That is what they want you to believe. If you follow the link to the original report, you will see what the expectation was, a $32 million loss. However, as I noted – without the slight of hand that is a loan modificaiton, the “better performance” would be be underperformance.

      2)”loans go into non-accrual after they become 90 days delinquent. But they don’t get written down until they become 120 days delinquent”
      – I am glad you raised this point. If you look at the most recent presentation – in the appendix no less – on page 38 you find that Wells does not take a charge until loans are 180 days past due (DPD). In fact, on that same page they indicate that of the loans 180 DPD, there have been no charge offs! Take a hard look at page 38, I think you would agree that “conservative” is not a way to describe the accounting. Maybe they will ultimately be right, however, the rest of the industry thinks like you – 120 DPD is enough to start marking loans down.

      Again, I appreciate your insight – keep me honest!

  2. realBillBrown February 14, 2011 at 7:43 pm #

    My understanding is that Wells CFO is on an UNPAID leave of absence. If it isn’t for health reasons, and it’s not for impropriety, then why wouldn’t his leave be PAID?

    Like you, I’ll allow the mass media to wonder aloud about potential tawdriness. But something is not right here, or they would be paying him. It’s not chump change, either, that he’s *not* getting.

  3. Rugby Store February 16, 2011 at 3:32 pm #

    Larry King once stated, “I remind myself every morning: Nothing I say this day will teach me anything. So if I’m going to learn, I must do it by listening.” That’s exactly how I feel. I am grateful to have learned something new today.

  4. Bung Ho Likah February 16, 2011 at 11:50 pm #

    I have had the unfortunate experience of working at a moderate distance from the new CFO and I can tell you he is an incompetent arrogant sleaze. I am relatively certain the outgoing CFO could no longer play along in good conscience with regard to the disclosure of asset values. Now management has their lackey in place. No longer an “independent” financial fiduciary exists on the management board. This was a 2 step process. First they promoted Sloan to Chief Administrative Officer where he waited in the wings for the right moment…Then to CFO. Nowhere near qualified to be CFO.

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