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This look at Wells Fargo (WFC) strangely begins with an investigation into 3.875% mortgage loans - fixed for 30 years - offered by Arbor Custom Homes near Portland Oregon.
3.875% is rather interesting given that current mortgage rates are much higher as the following Table of Mortgage Rates from Bloomberg shows.
The Lending Partner for Arbor Homes is Wells Fargo. How can Wells offer a fixed rate of 3.875% for 30 years given the current rate term structure and conditions in the MBS/CDO markets?
The only answer I can come up with is Wells Fargo is going to promptly bundle and dump those securities straight into the insolvent arms of Freddie Mae (FNM) and Fannie Mac (FRE). Who else would take them?
Furthermore, the Portland area is saturated with homes already (see the section Happy Valley Foreclosed in Housing gridlock: Trapped in Suburbia for more details).
Leading the Way Home
Wells Fargo claims to be Leading the Way Home to Stabilize Hard-Hit Communities.
Wells Fargo Merger Gives 478,000 Wachovia Customers Access to New Wells Fargo Solutions if Their Mortgage Payments Become At-Risk.That is a rather self serving way of looking at things. Notice the grouping of current with less than 90-days past due.
Through active calling and letter-writing campaigns, workshops, regional outreach events and door-to-door contact, Wells Fargo Home Mortgage has reached 94 percent of its customers who are two or more payments past due. For every 10 of these customers, it has worked with seven on a solution, two declined the help, and the remainder cannot be reached or a solution simply cannot be found. Of the customers who received a loan modification, one year after the loan was modified approximately seven of every 10 of these customers were either current on their loans or less than 90-days past due.
Here is a more accurate way of phrasing things: 30% of Wells Fargo's reworked mortgage loans are 90 days past due or longer, one year after loan modification. That does not sound so good does it?
Moreover, hidden in the 70% grouping is an undisclosed percentage of customers who are not even current. What percentage is that?
Odds are high that those not current shortly after a rework are going to fail. What's the percentage? Wells Fargo does not say. With that backdrop, it's time to dive into Wells Fargo's 4th quarter earnings and balance sheet details to see what we can find.
Wells Fargo 4th Quarter Earnings
Please consider Well's Fargo's 4th Quarter 2008 News Release announcing a net loss of $2.55 billion, $0.79 per share, after significant de-risking and merger-related actions.
“Despite the unprecedented contraction in the credit markets, we remained ‘open for business’ and continued to lend to credit-worthy customers. We made $106 billion in new loan commitments during 2008 to consumer, small business and commercial customers and originated $230 billion of residential mortgages.Wells Fargo's Balance Sheet
The allowance for credit losses, including unfunded commitments, totaled $21.7 billion (Wells Fargo and Wachovia combined) at December 31, 2008, compared with $8.0 billion (Wells Fargo only) at September 30, 2008.
The Wachovia acquisition was completed on December 31, 2008, and therefore Wachovia’s results are not consolidated in Wells Fargo’s income statement. Wells Fargo’s balance sheet includes Wachovia’s period-end balance sheet data net of closing purchase accounting adjustments.
click on chart for sharper image
Wells may be open for business, but the amount of securities it is seeking to dump increased from $86+ billion to $151+ billion. Goodwill, which may easily be worthless, increased to $22+ billion.
Note that Wells has $110+ billion in junior mortgage liens. That is a lot of risk. Total consumer loans, most of which is mortgage related is a whopping $474+ billion. That's a lot of risk. And given that commercial real estate is just now starting to crumble badly, commercial and commercial real estate exposure of $356 billion is a lot of risk. Will $21 billion in loan loss provisions cover that? I doubt it.
Off-Balance Sheet Exposure
The balance sheet shows the risk we can easily talk about. What about the off-balance sheet risk? There was no mention of off-balance sheet exposure in the 4th quarter news release so inquiring minds are looking at balance sheet statements from the Wells Fargo's 3rd quarter 2008 release.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONSWhat Exactly Are QSPEs?
Almost all of our off-balance sheet arrangements result from securitizations. Based on market conditions, from time to time we may securitize home mortgage loans and other financial assets, including commercial mortgages. We normally structure loan securitizations as sales, in accordance with FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities – a replacement of FASB Statement No. 125. This involves the transfer of financial assets to certain qualifying special-purpose entities (QSPEs) that we are not required to consolidate.
Those wondering about QSPEs are reading The CPA Journal July 2004 Issue.
Basically, an off–balance-sheet entity is created by a party (the transferor or the sponsor) by transferring assets to another party (the SPE) to carry out a specific purpose, activity, or series of transactions.If you were ever wondering why all these 49% ownership arrangements appear all over the place, now you know.
Regardless of their legal form, off–balance-sheet entities share the following characteristics:
- They are often thinly capitalized.
- They typically have no independent management or employees.
- Their administrative functions are often performed by a trustee who receives and distributes cash in accordance with the terms of contracts and who serves as an intermediary between the SPE and the parties that created it.
- If the SPE holds assets, one of these parties usually services them under a servicing agreement.
The challenge for investors is the difficulty in spotting these transactions. Unfortunately, the magnitude of the dollar amounts involved in these transactions notwithstanding, any available disclosures about them are buried in footnotes. There is no easy way of estimating the amount of assets or liabilities that are subject to these arrangements.
As the Enron crisis brought attention to the use of SPEs, FASB responded by issuing a proposed interpretation of existing accounting principles aimed at putting many off–balance-sheet entities back onto the balance sheet of the companies that created them.
The current accounting standards require an enterprise to include in its consolidated financial statements subsidiaries in which it has a controlling financial interest. The existing common definition of “control” is met when a parent company has more than 50% of the voting stock in a subsidiary. Over the years, however, companies have found ways to obtain economic control of other entities without owning 50% of the voting stock, thereby avoiding consolidation of these entities.
Not Practical To Tell The Truth
It's ridiculous for corporations to be hiding 49% of stuff off the balance sheet. Much of that stuff is now highly toxic. Citigroup (C) alone is sitting on $800+ billion of it, down from about $1.1 trillion.
New rules were supposed to go into effect late last year requiring corporations to put such assets back on the balance sheet where they belong. I talked about this in Not Practical To Tell The Truth on August 1, 2008.
FASB Postpones Off-Balance-Sheet Rule for a YearWells Fargo claims it is "well capitalized". Is it? By what measure? What is hidden off its balance sheet that we do not know enough about? Can anyone believe what any financial institution says when it is perfectly clear all these games are being played?
On July 30th, FASB Postpones Off-Balance-Sheet Rule for a Year.
The Financial Accounting Standards Board postponed a measure, opposed by Citigroup Inc. and the securities industry, forcing banks to bring off-balance-sheet assets such as mortgages and credit-card receivables back onto their books.
FASB, the Norwalk, Connecticut-based panel that sets U.S. accounting standards, voted 5-0 today to delay the rule change until fiscal years starting after Nov. 15, 2009. The board needs to give financial institutions more time to prepare for the switch, FASB member Thomas Linsmeier said at a board meeting.
"We need to get a new standard into effect," Linsmeier said, though "it's not practical" to begin requiring companies to put assets underlying securitizations onto their books this year.
Citigroup's Mysterious Shadow Assets
Of that $11 trillion in total bank off balance sheet entities, Citigroup has $1.1 trillion of it. Enquiring minds may wish to consider Citigroup's $1.1 Trillion in Mysterious Shadow Assets.
If Citigroup is looking for an award, it can take the blue ribbon for greed, arrogance, and stupidity in the off balance sheet category. There are plenty of other categories and more blue ribbons will be awarded. Nominations are being taken now.
Clearly, the Fed is engaged in delaying tactics. However, those tactics are increasing mistrust. It was hard enough before to measure a corporation, but given toxic assets everywhere one looks, it is even harder now.
Balance Sheet Is The Future
In periods of deflation, where asset prices are rapidly depreciating, a key point to remember is balance sheet concerns are paramount. Minyan Peter discussed this issue along with goodwill writeoffs in Deflation Accounting Signals Bleak Future.
For those who have not yet done so, I also highly recommend reading read Bank Earnings 102: The Best of Times, The Worst of Times when Minyan Peter, former treasurer for a large Midwest bank, first penned the phrase "The income statement is the past. The balance sheet is the future."
Diving into the balance sheet of Wells Fargo, I do not like what I see. Of equal concern is what I don't see, things hidden in QSPEs.
Bernanke wants us to believe everything is under control. When everything is hidden, how could one possibly know?
Every quarter is another disaster and every quarter more taxpayer money is handed straight over to the banks and brokerages that caused the problem. All this talk about helping the consumer get loans is a lie. No one is really concerned about the little guy; the concern is to bail out insolvent banks, by hook or by crook, using Fannie Mae as the slush fund.
Once that is accomplished, taxpayers will be left holding the losses in an insolvent Fannie Mae. Is it any wonder mistrust is high and growing?
Mike "Mish" Shedlock
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