KBW, a firm specializing in bank stocks, expects Wells Fargo to show $120 billion in “stress test losses”, meaning losses under the assumption of a supposed worst case of recession through the first quarter of 2010 and unemployment reaching 12%. Note that the 12% figure (according to Bloomberg) was included in the analyst’s report;. This differs from the scenarios originally announced (did I miss some revisions?):
Tests a baseline and an adverse case looking two years into the future.
Uses three metrics: GDP, Unemployment and Housing Prices.
Baseline case 2009: -2.0% GDP, 8.4% unemployment and a 14% decline in housing prices.
Adverse case 2009: -3.3% GDP, 8.9% unemployment and a 22% decline in housing prices.
Baseline case 2010: +2.1% GDP, 8.8% unemployment and a 4% decline in housing prices.
Adverse case 2010: +0.5% GDP, 10.3% unemployment and a 7% decline in housing prices.
In any event, $120 billion is a doozy for a bank the size of Wells. To put it in perspective, as of year end, the San Francisco bank had $1.3 trillion of assets and shareholders equity of $99 billion. Thus if the losses forecast in the supposed downside scenario materialize, Wells is insolvent beyond any shadow of a doubt.
And as we have discussed elsewhere, the Carmen Reinhart/Kenneth Rogoff work on past financial crises found (as of last year) that the US was following the trajectory of a typical crisis country. If that continues, the total decline in GDP will be 5% (worse than the assumptions above) and unemployment will peak at 7% over the pre-crisis level, or close to 12%. And all the other crisis countries faced a backdrop of global growth, so if anything, we should expect that the odds favor things turning out worse, not better.
No wonder Wells underreserved for credit losses in the first quarter. Best to keep up appearances as long as possible, particulalry if you might be able to get a Hail Mark stock offering completed.
And no wonder chairman Richard Kovacevich berated the tests as “asinine”:
“Is this America — when you do what your government asks you to do and then retroactively you also have additional conditions?” Kovacevich said. “If we were not forced to take the TARP money, we would have been able to raise private capital at that time” and not needed to cut the dividend to preserve cash, he said.
This is one of the biggest whoppers I have ever heard, since it wraps so many lies in one statement. First, the money being “forced” on the banks was a huge charade. The money they got was on considerably better terms than best of the bunch Goldman was able to secure at the time, and with the markets hanging on a thread, they were happy to take it. Indeed, by all accounts last October through December the banks were delighted. It was only when the government started getting tough about executive comp that the tune changed.
Second, TARP or no TARP, Wells would have been forced by its regulators to cut dividends. Blaming it on TARP is specious.
Third, when you are a regulated entity, as Wells is, you are subject to whatever audits and inspections the regulator deems necessary. In this case, the excuse is the TARP, but we have been saying since Bear went under that first thing the regulators should have done is go over the big financial firms in intrusive detail to find out how solvent they were. The TARP seems to be an excuse for the Treasury to get some regulatory mojo back (although as we have said before, the stress test looks to be a fig leaf rather than a serious exercise).
Fourth, there has been no capital for bank. Sovereign wealth funds shut their wallets long ago; PE firms look more interested in de novo banks than the diseased hulks on government life support; Goldman is going to get its offering off only by virtue of a big rally and good first quarter earnings. Wells is no Goldman, and the idea that it was only government mandated dividend cuts that kept it from raising equity is an utter canard.
So if Kovacevich was complaining about a watered-down, industry friendly version of the inspection that should have taken place, it’s a no-brainer that they expect not to do so well. But mirabile dictu, their earnings announcement sparked a big rally. Never underestimate the credulousness of true believers.
From Bloomberg (hat tip reader Scott):
Wells Fargo & Co., the second- biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.
KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote.
First-quarter net income rose 50 percent to about $3 billion, Wells Fargo said last week in announcing preliminary results that topped the most optimistic Wall Street estimates and sparked a 32 percent jump in the stock. The bank attributed the profit to a surge in mortgage originations and revenue from Wachovia Corp., acquired in December. Full results are scheduled for April 22.
“Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”
Wells Fargo raised its provision for loan losses by $4.6 billion in the quarter, below Cannon’s estimate of $5.4 billion. FBR Capital Markets analyst Paul Miller wrote after the announcement last week that he expected a $6.25 billion increase.
19 comments
Comments are closed.
Thank you.
please get the word out.
I am hoping that truth will win out eventually.
Optimists!! 120 B after their accounting tricks.. sure..
Perhaps I’m being too cynical, but this whole rally is starting to smell like a huge bank-driven pump-and-dump scheme, with banks announcing inflated earnings in the hope of selling more stock before the true state of the banks becomes impossible to deny. Goldman’s trying to sell more shares, and I imagine Wells and others would be happy to do the same if they can find enough suckers.
I have long been cynical, but I always try to question my bearish stance. I’ve been in Roubini’s camp for about 18 months, and during all that time, I despaired about the lack of will to do anything about the problems that seemed so obvious (or at least so obviously *possible*). In the last few months, however, the despair has reached epic proportions. I hope the politicians really know something I don’t know (that this charade is really for some greater purpose), but I am finding this harder and harder to believe. It seems that all policies are directed to help enrich the kleptocrats, the most insecure of all our population, those who have a $100 million but still don’t feel it’s enough.
This just can’t end well. It just can’t.
I am also cynical! I second James B
there will always be suckers (tax payers, investors)…. and there will always be winners (banks) and there will always be abettors (Fed, Treasury)!
Yves,
From Blooomberg's article it seems to me that you (we) have not missed any revisions on the "stress" "tests" assumptions but that KBW Inc.’s Frederick Cannon did an analysis using his own assumptions.
Two pieces of info regarding the the comment that this whole rally is starting to smell like a huge bank-driven pump-and-dump scheme:
First: Wells Fargo
Wells Fargo on April 9th. surprised by preannouncing a record profit of ~$3B in the first quarter, without giving details.
During that day Wells Fargo shares rose 32%, Bank of America's 35%, JPMorgan's 19% and Citigroup's 13%.
Why did Wells Fargo preannounce?
Maybe because 1) preannouncing allows not to disclose details and… 2) its first quarter profit includes a $1.5B profit from the sale of shares of Rohn & Haas to Dow Chemical at a 50% premium (which is undisclosed, obviously something that is not going to happen again and that has nothing to do with its banking business)???
Maybe Wells Fargo believed that the shares were going to go up with the surprise preannouncement but no so much down when the actual announcement with details is made on April 22nd?
Maybe some Wells Fargo's traders or affiliates bought Wells Fargo shares, or calls on Wells Fargo shares in advance of the surprise preannouncement?
Maybe Wells Fargo is trying to reinforce the image that it is in a solid position to make a government intervention more difficult from a political/communicational viewpoint?
BTW, this is another annoying transaction in which Warren Buffet shows everywhere: as a shareholder of Dow Chemical (actually financing the acquisition of Rohn & Haas by acquiring preferred shares of Dow Chemical) and of Wells Fargo. It would be great to know when Wells Fargo acquired the Rohn & Haas shares. Also, whether Berkshire or some of its affiliates bought Wells Fargo shares or calls on Wells Fargo shares in advance of Wells Fargo surprise preannouncement?
Second: Goldman Sachs.
Goldman Sachs fiscal quarters used to end in Feb, May, Aug and Nov.
When becoming a bank holding company GS changed its fiscal quarters to ending in March, June, Sept. and Dec.
EPS for 1FQ09 were expected to be $1.64
EPS for Jan-March came out at $3.39
GS and other banks rallied like nuts given the positive surprise reported by mass media. (The WSJ went particularly nuts in idolizing GS.)
I don't know for what period the estimated EPS were estimated, whether it was for Dec-Feb or for Jan-Mar (I would assume it was for Dec-Feb because the analysts had historical info for GS previous fiscal quarters).
EPS for December was… -$2.15…
So, EPS for December-Marh was $3.39-$2.15=$1.24, 22.5% lower than the three-month estimated EPS!
igarciao
Perhaps that’s why they want the results kept secret.
Who knows what to believe anymore.
The market is going up; that’s all I know right now.
Wells Fargo was very active with home loans in California and Florida although it did refrain from going in for a lot of ARM’s. Reggie Middleton did some good analysis of Wells Fargo last year and just applying the default rates that other banks are using gives some ugly numbers for the bank. I believe it was the middle of last year that Wells changed its accounting so that loans that would have been counted as delinquent would not show up for a few months further down the line. I would guess having taken over Wachovia there would be no reason why they could not apply the same rules to Wachovia’s loan book. 120 billion does sound too high to me, where as 40 billion would not. Even with the profits due to low borrowing costs and loan interest rates, loans in real estate construction probably are not going to be performing very well over the next few months.
Reggie’s Doo Doo Bank Drill down
But, but, but, Wells Fargo just announced a big profit this first quarter! Stocks are up on the announcement, and now we’re finding out that they really are over $100 billion in the hole??
They didn’t just make this fictional announcement just to get the stock market going back up again, did they?
how can so many shenanigans be played with our financial system? where is the SEC? where are the cops if this is all true? where are the investors?
How can banks report bad numbers when lacked accounting rules (even non-existent) allow them to make numbers up?
A better quarterly statement: “All toxic waste has been unloaded at the Federal Reserve’s windows. All mortgage loans have been put on a 40 year maturity time line. Quarterly dividends will be increased. Our borrowing costs are low and will be happy to loan @ 9%” Note: FDIC insured
Isn’t Wells (and its brethren) going to be able to sell off its toxic assets to the taxpayers at face value? So why would they worry about losses on those assets? What am I missing? Isn’t it merely our (the taxpayers’) problem?
«Perhaps I’m being too cynical, but this whole rally is starting to smell like a huge bank-driven pump-and-dump scheme,»
You are a naive innocent optimist here.
The last 15 years (at least) seem to have been a huge central-bank driven pump-and-dump scheme, where a series of gigantic asset bubbles has been created to let old money cash in USA assets at high prices, to buy new primary and secondary sector assets in growing economies as the USA economy stalled and then started to shrink (restate the last 10-15 years of GDP removing the financial sector profits for example).
Most of the assets liquidated by the insiders have been bought at fancy prices by pension and other equity funds, and stuffed into the 401ks of suckers. And the original plan was to create a huge surge of demand for more high priced stock by turning all pension accounts into stockbroking ones. Fortunately that failed and most pensioners will be able to draw on their OASDI payback which at least is indexed to CPI.
«I have long been cynical, but I always try to question my bearish stance. I’ve been in Roubini’s camp for about 18 months,»
I have been in his camp for at least 10 years :-). Since the dot.com boom run to such proportions that it was clear that it was class warfare, it was government policy, and could only end in tears for nearly all.
In 1995 the trend line for most asset prices became much steeper, and in 2001 it started to plunge back, but the central banks made sure to stabilize asset prices at several times above trend. If I had any doubts in 1999 about what was going on in the long term, I lost then in 2001.
But I thought Wells made 3 BILLION in profit. Now ya tells me it lost 120 BILLION?
Lincoln: If a dog’s tail is a leg, how many legs does a dog have?
….(wait for it)….. 4
Calling a tail a leg does not make a tail a leg.
If we were not forced to take the TARP money, we would have been able to raise private capital at that time and not needed to cut the dividend to preserve cash.Yeah, right. And if you believe that, I have a condo for you in Miami that’s sure to double in value in 4 years.
Vinny GOLDberg
Yves — a quick correction — the balance sheet number you give — $481 billion is actually the FYE ’06. The asset side of the balance sheet for WFC as of FYE ’08 is over $1.3 trillion. The potential loss of $120B makes much more sense given the more recent size of the balance sheet……
Jeff,
Thanks for the catch. How embarrassing, I spent some time poking around Wells’ website with no success and gave up and went to Yahoo. I’ll never do that again.
Upfront Disclosure – I've made 100k personally shorting Wells in the last year and am currently short 8000 shares
1) Yves – I was going to comment that you had Wells balance sheet and book equity way wrong but somebody beat me to it. This does cast a lot of doubt on your general credibility, not that you made the mistake of misreading the Yahoo columns, rather that you thought it (a) was plausible that KBW would project 120B of losses on a 480B balance sheet or (b) that you did not know that Wells/Wachovia has a 1 trillion+ balance sheet a priori. I mean, seriously, this website passes itself off as an authority on bank regulation and its author doesn't have the order of magnitude right for one of the four mega US banks balance sheets. Not impressive.
2) The commenter who claims that Wells made 1.5B on the Rohm & Haas merger is flat out mistaken. Evergreen Asset Managment is a mutual fund company owned by Wachovia/Wells. They held the ROH stake in their asset management accounts. So whatever the quality of Wells earnings (and I think they are low), they do not include the ROH stake.
That was held by Wells asset management clients.
Anon of 11:26 AM:
!. I do not pass myself as an expert on bank regulation. I comment on pending changes based on my knowledge of how banks and brokerage firms actually work. Those are two different matters. I am not nor have I ever been a bank regulator or an lawyer in those areas nor have I ever passed myself off as one.
2. I am not a securities analyst, nor have I ever claimed to be one. I have done quite a bit of financial analysis (I get hired to evaluate transactions, and I do effectively have the skills of a special situations analyst) but I am not a stock jockey and I have repeatedly made that clear.
3. I have never studied Wells or any retail bank, truth be told. My expertise in in capital markets businesses and wholesale banking. I thus have no sense of its business mix, save that it is not one of the major credit card players and it does a lot of mortgage lending, and is one of the biggest servicers.
4. Because of 2 and 3, I needed to look up the information. I do not read bank balance sheets in the course of my day job (although I did when I was at Goldman and do possess the skills); I get brought in to work at the business unit level and am thus always working with internal operational data, not external financiials.
I tried doing it correctly, could not find the SEC filing readily, and went someplace which normally has current SEC information (i’ve cross checked in the past) and had it wrong.
5. Given 3, the heavy losses on mortgage paper, and my lack of knowledge of Wells’ business mix, I did not consider the “reasonableness” of the KBW assessment, since I had no basis for making such as assessment.