It has been well documented that Warren Buffett is Wells Fargo’s biggest fan – and largest shareholder (through Berkshire Hathaway). In fact, in his annual letter to shareholders he states that WFC is likely to increase its dividend the most among his common stock holdings. Given that WFC cut its dividend after taking TARP money, his prediction should not come as a surprise.
Another interesting comment from the Oracle of Omaha was his take on Black-Scholes. He writes that the model “produces WILDLY inappropriate values when applied to long-dated options” (emphasis mine). Then he wryly states that he “would rather be approximately right than precisely wrong.” While I like the comment (during my days as an analyst, I often questioned the value of the 10th iteration of a 50 page model), I believe this is where misses the point – yes, he may be right in the end, but what if all management teams thought they were “approximately right?” Time to move on, this isn’t an article about Buffet.
The reason I raise the issue is because a well-known and respected bank analyst believes WFC is using this theory with regard to the quality of their loan book. In his report, Chris Whalen writes that he believes the management at WFC is engaging in a practice of “extend and pretend.” By extending repayment periods, management delays the time at which they must confess to investors and the markets the true scope of their losses. In March of 2009, Warren said he believes WFC will “do fine earning their way out” of their current problems. It seems WFC management agrees. I digress, on to the list. Where possible, I compared the results with those in 2008 when the world was a much darker place. As read each point, keep in mind that WFC has Tier 1 common equity of $81 billion.
1. I find it odd that the financials are incorporated by reference to the actual 10K. The other large banks put it all in one place. In the staid world of banking, why stand out from the crowd unless you’ve got something to hide?
2. In a jab to Obamacare, WFC reported an annual effective tax rate of 33.9%, up from 30.3% in 2009 “primarily due to the new health care legislation.”
3. 34% of commercial real estate loans – excluding Purchase Credit Impaired (“PCI”, aka toxic assets) loans – were for properties located in California and Florida. Similarly, 37% of 1-4 Family Mortgage Loans were in those same states. These states, to the best of my knowledge, remain in mired in a housing morass. In fact, today we learned that pending home sales fell 2.8%. Upon closer inspection, you will find the West index fell 5.2% to 0.9% below last year!
4. The Pick-a-Pay portfolio – where the borrower has the option each month to select from among four payment options (1) minimum payment (which may not be enough to cover interest), (2) interest only, (3) fully amortizing 15 year payment, or (4) fully amortizing 30 year payment – in California had an average loan to value (“LTV”) of 81%, while the Florida loans had LTV’s of 100%. 33% of the entire mortgage loan portfolio have LTVs of 100% or more (inclusive of those loans where no LTV was available – exclusive of PCI). 57% of the PCI portfolio had LTVs of 100% or more. Back in 2008, the Florida loans had a LTV of 89% and California was 86% – and that was before the modification machine went into high gear. Together, these states alone total $50 billion. At some point, a person with a loan worth more than the house will stop paying. What would the bank be able to sell these properties in foreclosure?
5. In 2010, WFC completed 27,700 loan modifications. Approximately 49,000 modification offers were proactively sent to its borrowers. As part of the modification process, the loans are re-underwritten, income is documented and the negative amortization feature is eliminated. Most of the modifications result in material payment reduction to the customer. Is this how they generated a better performing loan book?
6. Nonaccrual loans in commercial real-estate mortgage loans jumped 41% to $5.2 billion and non-accrual consumer real-estate first mortgages rose 22% (it should be noted that consumer real estate loans are not moved to non-accrual status until they are 120 days past due). Foreclosed assets also jumped 90% to $6.0 billion. In 2008, foreclosed assets were a mere $2.2 billion (extend and pretend?). The PCI portfolio was similar with 20% of the loans 120 days or more past due. These jumps are alarming for a bank that claims its portfolio is better than its peers.
7. Troubled debt restructurings (TDRs) increased 85% to $15.8 billion in 2010. A reserve allowance of only $3.9 billion was set aside for TDRs in 2010. The bank notes that the majority of TDRs do not receive principal forgiveness, however, when they do, the entire amount is charged off. These TDRs seem to be yet another way to “extend and pretend.”
8. Fed fund repos increased 209% to $24.9 billion. In 2007, that source of funding was $1.7 billion. Thanks Ben.
9. Borrowers with FICO scores below 640 make up 21% or $83.7 billion of the consumer loan portfolio. That number jumps to 25% when borrowers where no FICO score was available are added. The PCI portfolio was much worse with 68% of the loans to borrowers with FICO less than 640. These borrowers are at the low-end of the credit spectrum and are likely living from pay check to pay check – if they are still receiving one. In 2009, management stated that loss rates for loans to borrowers with FICO scores of less than 620 was a full 188 basis points (or 36%) higher than those to borrowers with FICO scores higher than 620 (in the 2010 report, management provides groupings of FICO scores from <600 and 600-639, so much for consistent reporting from one year to the next). A 7% loss on $83.7 billion would be quite a dent in the bank’s Tier 1 equity.
10. The company transferred $20 billion of Mortgages Held for Sale (MHFS) to trading assets. MHFS include commercial and residential mortgages originated for sale and securitization in the secondary market or sale as whole loans. In 2008, only $0.5 billion of MHFS were transferred. In addition, 2010 saw $3 billion of loans transferred to securities available for sale – in 2008, that number was $283 million. This suggests that either the securitization market hasn’t completely thawed and/or the bank has been forced to retain more risk on its books.
I promised 10 things, so I won’t go into the litigation facing the company which has been documented by other sources. From the list above, it is clear that the bank has plenty of issues to earn its way out of. Good luck Mr. Buffett.
Some people will suggest that I short the stock if I’m so sure of my analysis. As John Maynard Keynes famously stated, “markets can remain irrational far longer than you or I can remain solvent.”
comfortablysmug
georgetownjack
macrotradr
Naked Bond Bear
The Analyst
Dutch_Book
CJ
Stone Street Advisors 
It is my opinion that the markets might do lots better if you bloggers would keep your negitive comments to yourselves.
Thanks.
Alex, are you alleging that the subject article is either baseless, specious, spurious, unfounded, or otherwise casts the matters discussed therein in a false light? Are you alleging any factual inaccuracies, or any deliberate attempts to deceive or mislead the readers as to the truth of any matters discussed therein?
If so, please name them and back up your aspersions.
If not, please keep your negative comments to yourself, because a market that is based on faulty (if not false) information, and pretenses of dubious institutional integrity, is not a “free market” (an oxymoron in its own right) in any sense of the classical economic term.
Uncle Harley,
My HP12C was working overtime, but it usually comes up with the right numbers. I’m not sure I could have stated it as eloquently as you, but you have accurately captured my sentiments.
Thanks.
GTWNJack
Uncle Harley “high-fives” georgetownjack.
georgetownjack,
If you would include comments that would serve to mitigate your facts then you wouldn’t come accross as if you are purposely misleading people or perhaps just don’t understand some things.
But to answer your question in #5 the answer is yes, when WFC does a troubled debt restructuring, the lower payment does help borrowers to make their payments. After after 6 consecutive pmts they are no longer reported as delinquent and this definately improves their delinquency and loan loss numbers as well as improved their revenue numbers.
Another question I can answer for you is the mention of $2.2B of foreclosed assets in 2008. This is not extend and pretend. On foreclosed assets WFC has already taken the hit to their GAAP numbers, therefor must took a hit to their capital required. However they are doing OK with the number of days a property stays on their REO list relatively speaking. They are motivated to sell these homes because they don’t get the tax bennefit until they realise their loss. In other words there is a difference between GAAP and what is reported to the IRS. There is absolutely no bennefit to keeping a forelosed asset on your books unless you are holding out for a better sale price…. and WFC days to sale is relatively decent.
In #6 apparently you are comparing 2008 #’ with 2010. The reason why the jump in non-accruals is because Wachovia contributed $zero to non-accruals as of 12/31/08 but as time goes on it makes sense that since Wachovia doubled the size of Wells that their non-accruals would double from 12/31/08 to 12/31/10.
Why are you thanking Bernank for WFC purchasing $24B in fed funds? Arent these just overnight loans? who cares? Wells has $72B in money they’ve deposited with the FED. Perhaps I am wrong, please correct me if I am wrong.
#10 is very interesting! Transfers in and out of MLHFS should be mentioned more by serious blogs. If I understand what you say, WFC moved $20B into level three and out of level one. However moving $3B out of level three and into level 1 would be interpreted as a positive for the securities market.
Mr. Schnider,
As an astute commenter, I always appreciate your corrections/clarifications/constructive criticisms (and one day I hope to get a compliment). I will attempt to address the points that you raised below:
5. You have confirmed my point – by not immediately taking a charge, they prop up their loan book. The issue I see is that their competitors will take the hit right away, then if/when it does turn, they can mark the loan back up as a gain. This is exactly what they are doing with the PCI assets. I do not see a difference between the two other than a “pride of underwriting” that may exist internally – we’ll right down the Wachovia assets, but our underwriting is above par – so the loan must be good.
6. I noted the 2008 number only to illustrate the fact that loan book is still deteriorating. What did they not see at the end of 2009 that they saw at the end of 2010. The 41% growth that I quoted was from 2009, not 2008. So it further highlights the fact that a) management doesn’t have a handle on how bad the loans really are, b) they don’t want investors to know, or c) both. The Wachovia book is no longer an excuse – remember, they allegedly wrote down that book at the time of the acquisition (thus, the PCI Portfolio).
8. The large increase suggests that the bank is not seeing attractive credits. Why else would they accept 36 basis points when they could lend those funds to small business or other willing borrower (with appropriate documentation)? However, I agree, there are worse things.
10. Moving mortgages held for sale (MHFS) to trading assets raises a red flag because it suggests that there is a problem with the loans. From Note 1 of the 10K:
When a determination is made at the time of commitment to originate loans as held for investment, it is our intent to hold these loans to maturity or for the “foreseeable future,” subject to periodic review under our corporate asset/liability management process…Consistent with our core banking business of managing the spread between the yield on our assets and the cost of our funds, loans are periodically reevaluated to determine if our minimum net interest margin spreads continue to meet our profitability objectives. If subsequent changes in interest rates significantly impact the ongoing profitability of certain loan products, we may subsequently change our intent to hold these loans, and we would take actions to sell such loans…
This is not an OTTI issue, this is a management is not comfortable issue – again, there is not enough disclosure for an investor to know why the move was made (transferring whole loans is similar). Thus, I view it as a negative.
#10 the bank does need to explain because $20B is a large numbr.
#8 means absolutely nothing, repo’s are normal part of commercial bankinig, now if there is a pattern of large increases the last day of the quarter then you can get suspicious.
#6 seriously georgetownjack, you’ve gone off the deep end if you think Wells doesnt know what kind of shape their commercial real estate loans are in just because they go from $3.7B to $5.2B over the coarse of a year. And just because they got worse you somehow surmise that they don’t want their investors to know? How can you conclude such a thing??? You are truly out in left field. That’s approx 5.5% of their commercial real estate portfolio thats in non-accrual, the whole portfolio actually yielded more in 2010 than 2009 (3.89% versus 3.5%) providing more net interest income ($3.8B vs. $3.4B). These #’ are not hidden or obfuscated.
Mr. Schnider,
10. You are in agreement with me, I’m not sure why you raise it here again.
8. I said I agreed with you. However, if you look at the average balance, you will find that it has gone from $27 billion to $63 billion – so it is not an end of quarter issue. But again – we are basically in agreement.
6. If we can’t have a constructive discussion without personal attacks I will refrain from responding to your comments. This site was built to promote financial literacy in a professional setting. This is not some Yahoo! discussion board, we are about learning.
As for your question/point – a 41% increase, no matter how small in dollar terms is a problem. These things add up. No one number is a death knell, but in aggregate, they pose issues. In addition, $5.2 billion is more than 6% of the company’s Tier 1 common equity – that seems material to me. If you look at the disclosure, you will find that nonaccruals went from $105 million in 2007 to $5.2 billion in 2010. That is a jump of 4,878%! Tell me how this is not an issue? Are we to wait until it grows to $10 billion before we raise the red flag – where should we draw the line?
I sincerely appreciate your commentary and hope we can continue to have a spirited and constructive discourse without the personal attacks.
I apologise for the personal attack.
The point not that delinquencies are not an issue, but rather your article falsley presents WFC’ filings as untrust worthy. You’ve made a very serious accusation that niave people will buy into.
georgetownjack, you just dont get it. Its not just that you slandered the executive management, but you are harming those persuaded by you that WFC is untrustworthy.
For example, challenge youself to never use the term “extend and pretend”. The word extend is a fact, but pretend is a lie.
I am not suggesting that the filings are not trustworthy. I have done nothing more than to highlight data from the filings. As we all know, management tells you what they want you to hear. I always tell incoming bankers that when analyzing financial companies, the numbers are what management says they are – until proven otherwise. Which goes back to my earlier comment: “[they] may be right in the end.” But, to quote Keynes again, “in the long run, we are all dead.” The question you must ask yourself is: would you characterize WFC as conservative? I think not.
The “extend and pretend” line is not mine, but rather Chris Whalen’s – a well respected bank analyst. The phrase has caught on recently, so I included it in my various posts – however, I do agree, it is suggestive.
With regard to management: I believe we can both agree that Jim Cramer has a much larger audience than this humble site. Cramer cast doubt on WFC during his show “Mad Money” – he went so far as to call for the SEC to look into the departure…on live television! If you think this post is slander, do you consider his actions libelous?
And thanks.
“Mr. Schnider”, I am not an astute financier or investor, and I know very little about the mortgage banking industry. Therefore, when you use the terms “falsley [sic] presents … as untrust worthy [sic]” and “slander”, I find these accusations to be quite damning. They suggest that georgetownjack (hereinafter, GTJ) either intentionally fabricated the data he holds up as suspect, or that he deliberately omitted relevant, material, and exculpatory evidence that would otherwise tend to absolve WFC of any suspect filing/publication irregularities. Specifically, I speak of financial statement accounting and disclosure irregularities that ordinarily should cause would-be investors to be inordinately cautious in relying upon the veracity of same; insofar as such reliance thereon may inure to the prospective investor’s detriment.
The gist of GTJ’s article is a *comparison* of WFC’s published financial statements about their book of mortgage business over time. Ostensibly, GTJ undertook this effort in order to: (1) make an informed *judgment* on whether or not Chris Whalen’s characterization of WFC’s publications is both a credible and reliable characterization, and; (2) to share with readers what GTJ’s conclusions were in that regard, whatever the outcome thereof may have been. Indeed, in prefacing his remarks, GTJ sets up the premise of his case by stating in pertinent part:
“In his report, Chris Whalen writes that he believes the management at WFC is engaging in a practice of ‘extend and pretend.’ By extending repayment periods, management delays the time at which they must confess to investors and the markets the true scope of their losses. In March of 2009, Warren said he believes WFC will ‘do fine earning their way out’ of their current problems.”
Therefore, it would appear that this entire matter is about how WFC’s accounting and disclosure methods may be perceived (albeit, strictly, if not skeptically) in comparison to other more conservative methods; i.e., methods that are known to be standard in the industry, and that are revered to be either “best practices” or “benchmarks”. Furthermore, a reasonable, disinterested and dispassionate outsider is likely to view such a comparison of financial disclosures as being similar to comparing a glamorized portrait of a fashion model to an unretouched photograph that discloses all of her acne pits, pimples, moles and warts, before make-up, airbrushing and “creative lighting” techniques are applied. In essence, although both portraits show basically the same face, *beauty* truly does lie in the “eye of the beholder”. The glamorized portrait attempts to *portray* the model in a light that best appeals to the viewer’s fantasies, while the unretouched photo attempts to show the viewer the sight that he is likely to wake up to the morning after a hard night of partying.
This analogy is instructive in that it elucidates the reality of choosing between investments; i.e., you’re eventually going to have to wake up to the unretouched version of the prospective acquisition in order to properly assess the value of your own portfolio; so which representation of the product do you want to be comparing with other investments when you go into the deal? Some of those peccadilloes hidden by the glamor shot could be real deal breakers.
Mr. Schnider, casting aspersions on GTJ’s personal judgment and assessment of the results of his comparisons of WFC’s publications (which amounts to “fair comment”, by the way), requires a much more stringent burden of both: (1) producing evidence of deliberate misrepresentation or material omission in GTJ’s findings, and; (2) meeting a preponderate threshold of persuasiveness with regard to your evidence, such that it is more likely than not to satisfy a lay jury as to both the credibility and the reliability of your accusations to wit: “falsley [sic] presents … as untrust worthy [sic]” and “slander”.
Mr. Schnider, your commentary, on the other hand, appears to me to be nothing but a hackneyed, facial and specious attempt to explain away WTC’s accounting and disclosure methods with a “who cares” mentality, rather than addressing the substantive accuracy of GTJ’s findings. Smoke and mirrors will not do here, Sir. Until you substantively and materially support your accusations of false presentation and slander, I can only dismiss you out of hand as a shill and an apologist for WFC, whose sophistic spin-artistry on the matter at issue evinces nothing more than the hatchet job of a interested party with an axe to grind.
CORRECTION: I meant “facile”, not “facial”.
Uncle Harley,
The authors whole thesis was to persuade the public WFC financial disclosures are trust worthy. Period.
In regards to troubled debt restructurings, without any proof the author claims by not claiming losses now that it somehow bennefits WFC. When in fact it does help WFC by making it more profitable. By the fact that it must stay in non-accrual status for over six months it hides nothing but is plain to see, visible to everyone, continuing to take the hit to GAAP earnings via provisioning for loan losses. There is no pretend earnings here either, it is real interest being collected when they receive a payment, real principal. Now of coarse it looks worse having all of these loans in non-accrual because their GAAP earnings are just as bad as if they had foreclosed upon them because they have to provision for the loan losses anyway. Understand? When they report to the IRS they dont get the bennefit of the tax write off of a loan loss until the house is actually sold. Understand? So therefor if only one or two percent of these borrowers make 6 pmts in a row then the program would probably just pretend. But delaying losses this year doesnt help the executives make more money because their bonuses are determined on what is happening 5 years down the road. Understand? Executives have no incentive to make the company look good now but bad later. But stockholders are comforted in knowing that more than one percent of them are paying, it is actually more like 50%! This is increasing WFC profitably with each passing month.
It bennefits WFC in no way to pretend that assets are paying if they are not, it bennefits them in no way to hold off on a foreclosure (unless the loan is guaranteed). In what way would it bennefit WFC to do these troubled debt restructurings if they were not paying? Their GAAP are improved by it… they dont get a tax write off until they experience the loss. How is extending a loan pretending their earnings are better than they are?
Extend and pretend is a derogatory term used to imply that the bank is using nefarious business practices to increase its stock price, but however I’ve just explained that giving loan extensions is making profits, whereas the author used the term slanderously without any basis. I’ve worked for a privately owned mortgage company as an asset manager and given out hundreds of extentions and it was always to reduce costs and increase revenues. Who do you think I was fooling or pretending about? A loan extension is a win win win for everyone, even the govt gets additional tax money because of WFC earning more income.
I take exception to your claim that my thesis is to “persuade the public the disclosures are not trustworthy.” That is categorically false. To use a term you seem fond of, I find it slanderous. My thesis is very simple: WFC is not as conservative as its peers. By highlighting items from the 10K, I allow the reader to determine whether or not my thesis is correct. In fact, I make it easy for viewers of this post by providing links to the SEC filings.
We are not here to provide stock tips or recommendations. At SSA, we want to teach people to do their own homework – “teach a person to fish, and they will eat for a lifetime.”
I challenge your assertion that delaying losses doesn’t help executives make more money. Perhaps it is YOU who doesn’t understand the game – having been an investment banker for over 15 years covering the financial sector, I have first hand knowledge of how these packages work.
Take a look at the Proxy for WFC – compensation is determined by comparing WFC to its Peer Group. Logically, if the Peer Group has more conservative practices, WFC’s earnings will look better. As a result, which executives do you think will get paid more? I’ll make it easy for you, from the Proxy:
…the HRC [Human Resources Committee of the Board] considered the Company’s demonstrated ability to increase revenue, market share, net income, and profitability over the short- and long-term…
As I’ve said before, in the long run we’re all dead.
Remember Ken Lewis? He was the American Banker “Banker of the Year” just 1 year before being unceremoniously ousted from the helm of Bank of America. If you recall, he “retired” from the bank with $83 million in compensation – what did his shareholders receive? They got left holding a bag of stock that was worth a fraction of what it was the year before.
Finally, I would also challenge your comment that a loan extension is a win-win. First, it artificially inflates housing values. Thus, the true market clearing prices are not known for some time – yet another example of E&P. Secondly, you have either overlooked or ignored the time value of money. A dollar 30 years from now is not worth a dollar 10 years from now. Furthermore, with the printing presses on full tilt, that dollar is not likely to be worth much 5 years from now. How many of these modifications ultimately work? Fitch anticipates that 60%-70% redefault rate. How does that help anyone? The “homeowner” would be better served renting and saving the legal and banking fees. The bank would be better served selling the home today before the shadow inventory raises its ugly head and housing prices fall farther. As I noted earlier, we just saw home resale value fall below the price just one year ago.
At the end of the day, I have time and again provided hard facts. You continue to provide anecdotal evidence. Perhaps it is you with the agenda? I don’t own the stock, nor am I short the stock – I have no ax to grind. Period, full stop. No one is stopping you or anyone else from buying the stock. Please cease and desist with your false claims about my intent.
Mr. Schnider. Your retreat into obscure, esoteric obfuscation as an ostensibly less than subtle attempt to confuse a very simple matter (i.e., the outward appearance of reporting and disclosure improprieties on the part of WFC, i.e., by use of “creative” accounting methods) with a plethora of technical detail, is not only ridiculous, it simply misses the entire point of GTJ’s article.
Moreover, your criticisms are entirely misplaced. I suggest that you take them up with Chris Whalen, insofar as GTJ merely attempted to empirically verify (by corroboration) the underpinnings and premise of Whalen’s thesis, regardless of your hyper-technical disagreement with the merits of said thesis. That GTJ independently replicated Whalen’s findings with a complimentary methodology does not call into question their judgment on the matter, which both GTJ and Whalen apparently came to as a result of their own independent conclusions, whether or not you agree or disagree with said essential judgment.
I remain singularly unimpressed by your snow-job of technicalities, Mr. Schnider. What’s worse is your pathetic attempt to both cherry-pick the facts to suit your self-serving mischaracterizations of same, and then to hold them out as ostensible just cause for attempting to reframe the character of Mr. GTJ’s article in those dubiously-valid terms. You may hope that this distorted debacle of yours masks both your apparent biases as well as your obviously naked apologies for WFC’s poor reporting and disclosure discretion, but I fear, sir, that such a “Hail Mary pass” is both a futile and a lonely endeavor for one so vain as to believe that others will be persuaded by it.
Mr. Schnider, I have no doubt but that your complaints will utterly FAIL in the marketplace of ideas that is subscribed to by provident investors. Good day to you, sir. Bother us no more with your self-aggrandizing rants, for they shall fall upon deaf ears. You have been summarily dismissed.
I meant to say: “…are NOT trust worthy. Period “