Is Wells Fargo a Lehman in the Making?

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Banking maven Chris Whalen has a must-read piece on the reckless real estate risk taking underway at Wells Fargo, the sanctimonious #4 bank. While I sometimes take issue with Chris on his readings on capital markets related businesses, he is solid on his knowledge of traditional banking and also has access to very good intelligence in that arena.

Thanks to the crisis just past, we tend to think of banks as creating danger to bystanders via their over-the-counter trading operations: securitizations, CDOs, derivatives, all that stuff that is now loosely termed as “shadow banking.” But the US crisis prior to that was the S&L and the less widely recognized LBO debt meltdown of the early 1990s, both traditional bank lending. Even though economists airily wave it away as damaging but not catastrophic, it didn’t look that way at the time. Citibank nearly failed and the entire banking sector was really wobbly. Greenspan engineered an extremely steep yield curve to help banks earn their way out of the hole faster.

Wells is in the awkward position of being a monster traditional bank, when its big retail bank competitors, Citi, Bank of America, JP Morgan Chase, also have substantial capital markets businesses. Citi has long had a leading foreign exchange and money markets business, and has a corporate cash management operation which in and of itself makes it too complicated to fail. Bank of America absorbed Merrill. JP Morgan, in addition to having a large investment banking business, also has a huge derivatives/tri party repo clearing business. That means they have more diversified sources of earnings.

Whalen points out how real estate dependent Wells is. In this way, it is not unlike Lehman and Bear, subscale players in investment banking who put their chips on real estate as a way to (hopefully) grow faster and catch up with the big boys. The difference between the now-dead investment banks is that they were at a competitive disadvantage by being smaller (in a crude simplification, you have to have pretty close to 100% of the infrastructure of the leaders, and since there are real returns to scale, for instance, big network effects in trading, the further you are away from 100% of their trading volume, the worse your economics are. That means competitors can poach not just individuals but entire teams, since they will produce more on a platform with bigger activity). Wells isn’t so much at a competitive disadvantage via not being as big, but is instead a prisoner of having been overweight real estate historically.

As Whalen makes clear, Wells is engaging in accounting games to make it look better than it is. The San Francisco bank is hardly alone it that, but Whalen depicts it as worse in this regard than its peers. It is only taking losses on its least bad real estate loans, and using those to value the rest of its portfolio. On top of that, as we pointed out, Wells has been releasing loss reserves aggressively since early 2009, something which we suspect will prove to have been ill advised (oh, except for the senior executives who collected bonuses between then and now). And lacking other high margin businesses to earn its way out of its hole, Wells is doubling down in real estate lending, and on top of that, engaging in yet more dodgy accounting. Per Whalen:

There is an old saying on Wall Street that when a company does not say anything to investors and the analyst community, then it is all bad. Since the start of the crisis, Wells has made an art form out of failure to disclose, particularly when it comes to the credit loss, doubtful and past-due experience on the bank’s retained loan portfolio and related loss reserves. While Wells’ peers among the largest banks have increased written and oral disclosure regarding loan losses and related data during the past three years, Wells consistently has stonewalled the investment and analyst communities. Most recently, Wells has even defied a subpoena from the SEC, failing to produce documents for a formal investigation regarding possible fraud in the creation of residential mortgage backed securities that the bank sees as “inappropriate.”…

Several participants at the HW conference told me that Wells is literally buying market share by writing loans which are not economic, but then enhance current earnings by booking the estimated value of the “customer relationship” up front in the quarter when the loan is closed. If this type of accounting gimmickry makes you recall the days of the bubble, then you are on the right page.

Whalen argues that Wells will take a hit when Basel III is implemented because banks will no longer be able to afford to retain mortgage servicing rights. This is his only worry that I discount, because Basel II was never adopted in the US and there are reasons to think Basel III will not be either.

The picture is just as troubling on the commercial real estate side:

Wells has become the leading lender to commercial property developers. One of the oldest and most respected players in the New York commercial real estate community tells HousingWire that Wells is writing business that is at least half a point lower in cost than loans available from other banks and with far easier terms.

Note that you can lose more than 100% of your money on development lending. You foreclose, losing the value of your loan, and you have to raze the partly completed project. Back to Whalen:

But to the point about Wells Fargo, the bank’s aggressive lending to both retail and commercial borrowers could come back to haunt the giant lender in years to come. Many of those commercial property financings that the largest U.S. mortgage lending is putting on its books in the New York market are premised on the idea of rising lease rates in the next few years, but nothing could be further from the case.

In fact, say most of the commercial real estate developers I know in New York, lease rates are likely to keep trending lower over the next few years as the oversupply of real estate starts to become a glut.

Some of the most prominent office buildings in the city are half empty, including the showcase structure at 9 West 57th St. where your humble commentator is writing this missive. The developers are pulling the space off the market rather than accept the $50-60 per square foot that is commonly paid for prime Manhattan office space today.

The private equity firms that are buying these Manhattan commercial deals funded with loans from Wells Fargo are assuming that the Silicon Valley world of media is somehow going to soak up all of the empty commercial space in New York City…

But the sad fact is that most of the large financial institutions I know are pushing back against rent increases in major New York properties – and moving offices to reduce expenses.

This has the smell of something that will end badly, but it may take a couple of years to play out. As Whalen said, stay tuned.

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  1. Ex-Csfb

    Careful Yves…look what happened to Breitbart’s coroner. Just saying… . For example, Fuld and Callan still walking around free roaming the Hamptons with the other pond-slime, Schapiro in power, there’s no security in telling the truth.

        1. chitown2020

          WOW….Just like whistleblower and EX-FBI agent Ted Gunderson. His videos are on you tube. The video entitled the CIA and Satanism was really revealing. God rest their souls. This is not right.

      1. JR

        Koo-koo, koo-koo, koo-koo.

        One minute of Google research debunks. Two minutes if you want to be thorough.

  2. jake chase

    The strategy seems to be increasing market share with the expectation creating phony profits, capturing bonuses, inflating the stock price, and ultimately laying off all the bad loans on the Fed. Don’t bet it won’t work, but I wouldn’t bet that it will work either. It is probably a good idea to avoid all financial stocks, inasmuch as all reported results are simply fantasy.

    1. Jim A

      Somebody wiser than me said that the only numbers from management that he believes are the ones on the dividend check.

  3. mary

    For a quick and amusing refresher course
    on what happened with the S&L “crisis”
    and how absolutely nothing has changed
    in any fundamental way:

    Martin Mayer oughtta be in pictures.

    The same C-Span page offers all of the
    S&L hearings as “Related Programs”. I
    gotta say it: Plus ca change…

  4. Lil'D

    They appear to be going all-in. Might be a stupid risk, but their chance of winning big isn’t negligible. Remind me not be long the equity… calls maybe, but WFC – nah.

    1. robert157

      “Might be a stupid risk…”

      What risk. If the gambles go bad the people will pay the loss, not Wells Fargo. If the gambles prove right, Wells Fargo keeps the profit. It’s a heist, not a risk.

  5. Barney Flintstone

    Chris Whalen has been a bank shillster, but then sometimes so is NC. Underneath of all the Lehman-esqueishness there’s some social destruction. Whalen is one of those guys who sees the forest, and only certain trees within it. Debtors can 1.) go to hell 2.) enjoy the indifference and lack of due process 3.) get out of the way of the bulldozers.

    1. Brian

      Whalen “is” a bank shill. His writings are notable for leaving out critical facts. One in this case is the pretense that WF is a “lender”, when only a conduit for laundering money. If WF can not provide any legal answers to the SEC or any other court in years, there is a reasonable chance there is an unreasonable answer to the questions being asked of it.
      Money laundering is more profitable than legal activity.

  6. Brett

    If there is a ton of vacant commercial real estate in New York City, they ought to renovate those into residential apartments. The supply of apartments in New York is abysmal compared to demand, thus the sky-high rents and low vacancy.

    1. Bent

      Not enough apartments? No, that isn’t correct. It’s a game of keep away, just like with the post war cabins throughout the US that were/are hopelessly over inflated in cost via Wall Street criminogenics. There is more than enough to go around and always has been. The rentiers are subsidized to keep ’em vacant. There is no free market, or some simplistic right wing excuse of fairy tale supply n’ demand.

    2. mary

      Bravo Brett. The same goes for all urban
      centres: Bring life back to our cities.
      Suburban sprawl is a blight, cities need
      citizens. Thanks so much for your comment

  7. chitown2020

    Chris is a banker but I like Chris. Chris has revealed a lot and I have learned a lot from him. His Bloomberg interview a while ago entitled Foreclosuregate is a Cancer was very informative, a must watch for everyone. As for Wells Fargo i despise them. When they bought out WAMU they pulled our small business credit line and put us out of business after 25 years. That and a massive property tax hike by Cook County caused our home and commercial property to go into foreclosure. I am fighting both foreclosures pro se as a result of all of the corruption in Cook County. If GE cant run their business without credit… one can. That is because we live in a credit based economy.
    That is why the multinationals are thriving and small business is dying. Not including the fact that the FED is stealing from all of us and handing our wealth to their TBTF institutions and they ARE NOT PAYING THEIR BILLS WITH IT….THEY ARE EXTRACTING ALL OF OUR REMAINING WEALTH under the guise of debt which is their debt, NOT OURS and it is
    massive and UNSUSTAINABLE. The U.S. GOVT is aiding and abetting this and the politicians are allowing this robbery to continue and bankrupt and destroy us. This is being done to flatten us….this is called GLOBALIZATION…How do you like me now….? I would also like to add..Wells Fargo fraudclosed on my brother in law via the Homeowners Ass. after he lost his job as a bricklayer because he fell behind on the homeowners Ase. Fees and had him evicted 3 years ago without a day
    in court in a judicial state. I agree Chris Whalen…this is another Hitler plan……..

    1. chitown2020

      I should say that I agree with what Chris said in his tv interview. Its another Hitler Plan…boom…cut to commercial..

      1. chitown2020

        You are right. Thank You. The woman who worked for Wachovia lives in our subdivision. My husband found out that she told someone that my husband was insolvent right before all hell broke loose. That was only true when they pulled our credit line. That is what should have been done to these manipulating crooks. Different name…same FED beast.

        1. chitown2020

          Things that make you go hmmmm. We were turning a good profit before this occurred. We paid all of our bills on time for 25 years…never a day late.

          1. Ivention

            Well Ivent, I’m glad you weren’t entrapped on a more severe level, which appears to be happening to more regular folk, more often. Perfectly timed sometimes too.

          2. chitown2020

            Hi ivention…you are right, it could have been worse. At least we were able to reinvent ourselves. Though we are struggling and it has been really tough we are still here. Many have committed suicide. Many have never recovered from this manufactured mess. BTW..Who is this..?

          3. chitown2020

            I believe deception is the crime of our time. Some say it is bank plunder. I say what allowed them to plunder and steal…? Their weapons of mass deception. I heard a report that BOFA has been pulling small business credit lines with impunity for no reason. The FED is stealing our country under the radar of most. That is the only way they will accomplish their evil end game plan…the same way they created it….secrets, lies and deception that enables them to commit fraud and steal. Half the country are still believing their lies. That is how they will pull off the theft of our National Sovereignty. For gosh sake…how many people know that the healthcare bill is not about healthcare at all. It is a coup de tat of our infrastructure disguised as providing affordable healthcare. They plan to microchip us via healthcare and the gold backed dollar. We need to issue our own currency backed by our own natural resource revenues…electric and natural gas and ABOLISH THE
            FED…that is the only way to maintain our National Sovereignty. We have everything that we need right here in America. Globalization is a scam that only benefits the Globalists.

  8. Douglas P. Snitch

    The Lehman boys made off with exorbiant parachutes in bankruptcy. Fine motor cars, houses, Manhattan lounge, prime marbled beef and a propaganda presence on the web, all paid for – with millions upon millions in loot. It’s a kleptocracy that walks on water, and if Stumph Fargo wishes to avoid the same fate they better up their game, harumph!

  9. briansays

    9 west 57th
    brings back fond memories of the mid 80’s
    got shipped to nyc for my first and only visit to work on a deal for an entire month and on an expense account
    for a boy from oc cali i was amazed
    didn’t think i could live there but still wow
    the museums
    literally got lost in the metroplitan first time
    lunch at a small shop at trump tower back when the donald was riding high
    evening cocktails at a bar at the plaza
    the 24/7 buzz
    2 weeks to the day after standing in line to see mao’s tomb in beijing standing in line to see the statute of liberty
    a contrast in the ideology reflected so well in tourist demeanor
    from stoic and silent to festive party
    the memory 107th floor observation deck of wtc
    bringing home the later horror of 9/11

    i luv nyc!!!

    1. Bain Says

      I like NYC too, but Wells Fargo is really awful, I hope everyone abandons them in droves. The red and yellow, yeech.

  10. Hugh

    The whole banking sector is insolvent. It keeps going because it has been zombified. Indeed it is a curious symbiotic relationship. The banking sector had previously zombified the political process. Now political zombies keep alive bank zombies that vivify the political zombies. I suppose you could say this is only logical: an undead banking system for an undead political process.

  11. binx

    Wait, I’m perplexed. In what Income Statement line item is Wells Fargo booking accounting “Customer Relationship” gains up front? Servicing income, net? Net gains on mortgage loan origination/sales?

    How does Whalen know that their revenue recognition is inappropriate/overly optimistic?

    1. macca

      the customer intangibles are in other assets and carried, net, at $1.6B as on 12/30. Note 10 in 10-k has the details and you can see the roll forward from year to year (BOP – amort + new intangibles = EOP). These # are too small to matter to overall resi economics. I too would like to see some numbers behind how this accounting is something to focus on…

  12. Nice Espresso

    One homeowner to another, no bitterness here:

    “(us news) A woman engaged in a bitter battle with Wells Fargo over foreclosure of her southern California home was arrested late Thursday at the tony residence of the bank’s CFO in San Marino, where she and dozens of supporters were protesting.”

  13. Rehabber

    Wells probably still has a good bit of RE frin Wachovia, and its constituent roll-ups (First Union, Core States, SouthTrust)-all were big players in their local commercial RE markets. And of course there was Golden West with the exploding pick-a-pay ARMs that brought Wachovia down.

    1. Douglas P. Snitch

      …..and allowed managment to steal from their own bank while victims were left holding the predatory time bombs.

    2. Coke

      This may be why they “went down” along with the rest of economy, but why they remain free of criminal investigation means they didn’t go down, but “got away.”
      The solution remains in the hands of the people, massive defaults are needed, unaffordable mortgages and school loans. Only through peaceful action can we bring the beligerants to heel.

  14. Skeptical

    Two points worth noting:

    1. The topic of Whalen’s piece, commercial real estate lending, is very, very different from residential mortgage lending. We should be cautious about comparing apples and oranges.

    Whether or not Wells’ lending is imprudent depends entirely on the current appraised values on the properties and the advance rates on those properties. Whalen’s piece is based on anecdotal comments he heard from other bankers, who believe that Wells is buying market share and playing accounting games, instead of applying appropriate credit standards.

    That may very well be true, but, given the ways that large banks’ financial statements can be impenetrable, we will only know for sure when it’s too late.

    2. Commercial real estate lending is very, very different from the capital markets business.

    One of the reasons why Wells seemed relatively strong at the time of the 2008 meltdown was because it played a fairly minor role in underwriting and selling securitizations. Wells dumped its toxic loans on to the greater fools who bought the RMBS.

    Whether or not Wells is setting itself up for disaster may depend on who is wiling to be the stuffee for its dubious commercial real estate loans.

    Both of these points should remind us that, relatively speaking, it is far easier to negotiate loan workouts with a couple of hundred multi-million dollar commercial loans than it is to negotiate loan workouts with a couple of million home loans, which were originated with fraudulent documentation.

    Wells may be setting itself up for a fall, but it may be premature to infer the same broad systemic dangers posed by private label RMBS.

    1. Kenny

      “it is far easier to negotiate loan workouts with a couple of hundred multi-million dollar commercial loans than it is to negotiate loan workouts with a couple of million home loans,”

      That’s bullshit, and you know it.

      1. Skeptical

        Have you ever heard of economies of scale? Anyone who has worked on loan workouts will tell you, all loan workouts are very time consuming and labor intensive, but it takes a lot less effort and manpower to sort out a single $50 million loan than 100 $0.5 million loans.

        Multi-million dollar loans, and loan workouts, are negotiated by sophisticated lawyers on both sides who know what they are doing.

        Retail mortgages were often originated under fraudulent circumstances with defective paperwork. And the borrower rarely has the resources or sophistication to sort out everything. Which is why the banks have implemented an assembly line process for foreclosure fraud,

        1. Fredy

          “Retail mortgages were often originated under fraudulent circumstances with defective paperwork.” That’s the second time you’ve droned that point. Are you trying to redefine origination fraud? Or just ‘keeping it simple stupid’?

          1. Skeptical

            I’m saying it’s harder to establish what actually happened at the time of closing if origination fraud in home mortgages was viral and the documents were defective. That’s far less likely to be a problem with large commercial deals. I thought that was self evident.

    2. Yves Smith Post author

      You have it wrong re what Whalen is saying. Go read the post, or his piece in Housing Wire.

      Wells is NOT securitizing the home loans he’s railing about. That’s why Whalen is so up in arms. They are keeping them on balance sheet as earning assets. Ergo the exposure to losses if/when they come a cropper.

      I made it clear that the risk most people had been focused on was capital markets risk (trading books) but the risk at Wells was traditional banking risk (on balance sheet loan exposures).

      Get the basics straight before shooting.

      1. Skeptical

        A second look at Whalen’s piece confirms my original impression about, “Wells Fargo doubles down on housing.” It has a fair amount to say about imprudent commercial loans, but not very much about residential. And the narrative is written in a way that tends to conflate the two. Those are the basics.

        Yes, Wells has a 25% market share in residential mortgages, largely due to the withdrawal of other large banks. But how much of that volume is sold or guaranteed by the GSEs, who support about 95% of all originations? By all accounts, the credit standards for all residential loans are much more stringent than they were before the bubble.

        Again, my point was that the comparison with Lehman and Bear only goes so far. They collapsed because their RMBS and CDS exposures wiped out their liquidity and, in Lehman’s case, precipitated a wider meltdown. For Wells and other large banks with bad loans on their books, they may be setting themselves up for future losses, and even insolvency, but not the kind of systemic problems posed by Lehman and Bear.

      2. F. Beard

        they come a cropper Yves Smith


        Where do you get all this non-American slang? Is NYC some kind of foreign enclave?

        Sometime I feel like a foreigner in my native land. :)

  15. smellslikechapter11

    You note: “you can lose more than 100% of your money on development lending. You foreclose, losing the value of your loan, and you have to raze the partly completed project.”

    Possible but not very likely. But my experience in the current market is that the vulture guys (my clients) love partially built deals becuase they have plans, permits and a clear idea of what it takes to get it done. This is where they see the value added opportunity. Whether they can really add value, that’s another story for another post.

  16. Chris

    For a long time, in my memory at least, the accounting profession had embraced the concepts of using fair value and mark to market for the valuation of assets and liabilities on the balance sheet.

    The rest of the world is well on the way to implementing this with paper profits and losses brought through the income statement.

    Not in America though. You are special.

  17. curly

    It’s interesting that you all are bashing Wells. You forget that Wells now owns a huge brokerage firm that, unlike Merrill, was debt and derivatives free at the time of the acquisition as part of the Wachovia Bank clean up. Wells’ derivatives positions are miniscule compared to JPM/Chase and BOA. I would take a look at the bailout pecking order in the grossly underreported GAO report of 2011 before I wasted any more time going after Wells. Just Google “16 trillion”, and the Bernie Sanders web site housing that GAO report will pop up. The actual bailout list is on page 131.

    1. lorie levine

      In 2005 Wells Fargo Corporate Trust Services of Minneapols scammed thousands of invrestors of hundreds of millions, under the guise of reorganizing investments for American Business Financial Services. People lost everthing because they converted investments into preferred stock(“for accounting purposes”) and then filed for bankruptcy six months later,and getting away with this premeditated, planning. Gee, financial planning is above reproach!

  18. Warren

    Wells has a solid reputation as an underwriter. One of the takeaways from the Justice Department’s Goldman indictment on the Abacus deal was that John Paulson didn’t want any Wells Fargo underwritten loans put into the CDOs that were designed to fail. Presumably, Wells’ loans were written with solid underwriting criteria whereas there were lots of dog loans available to Paulson that were written by banks that didn’t use adequate credit criteria. I think Chris Whalen is a sharp guy but he has had a bug about Wells Fargo for quite some time. Somehow, Warren Buffet isn’t too concerned with Wells’ accounting practices. I don’t own any WF but do follow the stock.

  19. curly

    Allow me to expound on my previous post. The Dodd-Frank financial reform bill that really isn’t much more than a dangling band-aid….derivatives are growing again…did have one interesting provision: a partial audit of the Federal Reserve. The point was to see where all the money went between 2007-2010. So now we know, but the report was an absolutely huge media coverup. Sixteen trillion dollars, making TARP look like the proverbial drop in the bucket, went out to the global financial oligarchy so they could keep the doors open. Where are all of those hundreds of trillions in derivatives today? We certainly don’t hear much about them anymore. The 2009 suspension of mark-to-market accounting took care of that. They’re out there somewhere.

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