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At the start of the financial crisis in 2007, the top four retail banks — Bank of America, Citigroup, JPMorgan Chase and Wells Fargo — were printing money by turning residential mortgages into securities of various toxic flavors and selling them to investors. In many cases, these securities were deliberately fraudulent, part of a breakdown in the legal protections against such activities put in place during the Great Depression.
Wind the clock forward to 2012 and three of these four behemoths have largely withdrawn from the secondary market for home loans, especially loans purchased from other banks. Weighed down by litigation and other concerns, Bank America, Citi and JPMorgan have been withdrawing from most aspects of the market for real estate finance other than writing new business for their own portfolios and then only profitable business.
But the last of the four banks, Wells Fargo, has thrown caution to the wind and is aggressively writing new business in both residential and commercial real estate loans. The $1.3 trillion asset lender is now the dominant player in the secondary market for mortgage loans and has actually managed to grow its market share and assets when other large banks are shrinking their books.
In New York City, for example, the backyard of JPMorgan and Citigroup, 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.
In residential, Wells Fargo enjoys a market share above 25% and continues to grow and grow. This hyper-aggressive stance is not hard to explain. Unlike the other zombie banks, Wells does not have a significant securities or capital markets business to fall back on, not that these markets are doing particularly well at present. The only significant business line that Wells can use to support its earnings and balance sheet is real estate lending. Thus the quality of the bank’s future earnings are largely a function of whether the U.S. real estate market starts to recover in earnest.
The other issue for Wells is that it needs to keep adding new business and revenue to stay ahead of the cost of resolving bad loans still on the books or in process between foreclosure and disposal. Like all of the largest banks, Wells has been dragging its feet on resolving bad assets because delay is the only option. By focusing its sales of REO on those properties with the lowest “loss given default,” Wells is able to make its bad loan position look better than it really is and also keep the weight of loss from hurting earnings.
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.”
Today in many metropolitan areas around the U.S., Wells is the most aggressive lender in the marketplace — and also the least willing to share its credits with other banks. Whereas in the past Wells would invite the likes of Comercia or FifthThird into a commercial transaction, today the bank rarely syndicates credits and almost always retains its own production internally rather than sell the credits to investors.
Wells is now also the chief protagonist of the smaller banks. The San Francisco-based giant has turned converting the residential mortgage customers of smaller banks into an art form.
The aggressive posture of Wells stands in sharp contrast to the other three TBTF banks — JPM, BAC and C — which have largely stepped back from correspondent lending and have also seen their market share overall in terms of new mortgage originations fall sharply relative to Wells. One former Wells banker said to me at the HousingWire REthink conference: “At Wells you do the business first, then figure out the issues later. They are the most aggressive lender in the U.S. and have been for some time.”
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 dot.com bubble, then you are on the right page.
A representative of one of the largest buy-side mortgage conduits in the U.S. told Institutional Risk Analytics that the accounting treatment of “customer relationships” by Wells is allowing the bank to take market share from all other lenders, large and small, but that the medium-term impact on the bank’s balance sheet and earnings could be decidedly negative when the bank eventually is forced to moderate its aggressive sales tactics.
Alan Boyce of Absalon told the REthink conference that Basel III and litigation risk are causing the largest banks to exit the mortgage market. He contends that Wells is “the last man standing” in the mortgage origination sector, but that even this giant lender will be forced out of the mortgage market by regulatory changes such as Basel III that make it impossible for banks to retain MSRs.
David Akre of Whole Loan Capital also noted at REthink that many smaller banks are no longer willing to selling loans servicing released to Wells, but that the rules put in place by the housing GSEs are making it impossible for smaller banks to sell mortgage servicing rights. Akre reckons that unless the GSEs change their rules regarding loan putbacks and MSRs, the shrinkage mortgage origination by smaller players will continue.
Overall, most of the participants at the REthink conference predicted that home prices will likely trend lower through 2012, but then stabilize and move sideways for years.
The combination of a shrinking pool of financing, large inventories of unsold homes, negative regulatory changes such as Basel III, and a dwindling pool of qualified borrowers adds up to a continued decline in the rate of home ownership in the U.S.
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, a fantastic delusion that seems to also appeal to New York Mayor Michael Bloomberg.
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. Thus one has to wonder whether Wells Fargo won’t be feeling a bit of indigestion from its headlong pursuit of market share in the U.S. real estate market. Stay tuned.
Christopher Whalen is a regular columnist for HousingWire and senior managing director of Tangent Capital Partners.
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