A Game of Credit Cost Smoke and Mirrors at Wells Fargo?
Wells Fargo & Co. (WFC) managed to bring some holiday cheer into financial markets Thursday, just ahead of the Easter holiday, with its pronouncement that it expects to post a record quarterly net income of $3 billion — or 55 cents per share — when it officially reports Q1 2009 earnings later this month. But more than a few voices are already questioning the results, warning that this quarter's big gain is more likely to be a flash in the pan than a market turning point. In particular, Wells Fargo reported that they will absorb just $3.3 billion in charge-offs on bad loans for the quarter, and just $4.6 billion in loss provision expense; both numbers are well below most analyst estimates, and are the primary reason Wells will report earnings trumping earlier Street estimates. "The shocker was that they only had only $3.3 billion [in] charge offs," said Whitney Tilson of hedge fund manager T2 Partners, in a CNBC interview Thursday afternoon. "It's weird, because in Q4 Wachovia and Wells Fargo together had $6.1 billion in charge-offs, and then in a quarter in which things were terrible, those charge offs fell by 50 percent ... They're going to have a lot of losses over the next couple of years, [and] anyone baselining at $3.3 billion in charge offs per quarter is crazy." Know what else is weird? That Tilson is still long Wells Fargo, after hearing all of that. CNBC's Fast Money crew was quick to gloat over the positive results for WFC on air Thursday, however, poking fun at FBR Capital Markets analyst Paul Miller, who had recently been a guest and recommended shorting Wells Fargo stock over the bank's exposure to souring loans. "He [Miller] wasn't wrong, he was 27 percent early," cracked Jeff Macke of Minyanville.com and a regular Fast Money panelist, referring to the bounce in WFC's shares in Wednesday trading. Of course, one day of trading does not a trend make. "We believe that credit quality materially deteriorated in the first quarter, and that Wells Fargo is under-reserving for expected future losses," FBR's Miller wrote in a Wednesday research brief. "We reiterate our Underperform rating." More questions from Miller: "[W]e remain cautious based on what we don't know. Most importantly, what happened to nonperforming loans and what would have been net charge-offs excluding purchase accounting adjustments? What are the trends in WFC's Option ARM portfolio? Did the company write up the MSR and what was the new capitalized cost of servicing? Was there any benefit from an increase in level 3 assets given recent accounting guidance?" If the Fast Money crew had any desire to do basic analysis before running their collective mouths, they might have been able to pull up this chart -- which should speak volumes about the value of skepticism here: This shows the ratio of loan loss reserves/total loans at the four major U.S. banks still standing. Wells Fargo is in white. Notice anything? You know, like which bank is comparatively weakest on reserving activity against its loan book? This chart doesn't include updated Q1 numbers for Wells, as the bank did not provide an updated loan total on Wednesday -- meaning it doesn't include Wachovia. Historically, Wells has justified its lower reserves by maintaining a comparatively higher-quality loan book; can the same argument really be made now? With Wachovia's option ARMs lurking? Because there's an ugly truth about credit costs: they come home to roost eventually, irrespective of any games played with loss reserves in the interim. Write to Paul Jackson at firstname.lastname@example.org. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.