Wells Fargo Quarterly Opinion, Q1 2010

Below, please find our recent review of Wells Fargo’s latest quarter.
At the end of the review are pertinent links for both subscribers and
non-subscribers to peruse.

Results Review – 1Q10

In 1Q10, WFC slashed the provisions for loan losses, without any
significant improvement on the loan losses and NPAs side, to offset the
decline in revenues and preventing it to trickle down to the bottom
line. The annualized provisioning rate came down to 2.91% in 1Q10
against 3.2% in 4Q09. If WFC maintained the same provisioning rate as
4Q09 in 1Q10, the pre-tax earnings would have been 13.2% lower than the
reported pre-tax earnings. WFC would have recorded a q-o-q decline of
12.3% in earnings against the reported q-o-q increase of 1.0%.

Our soon to be released mortgage loss model shows the actual trends
of losses in Alt-A and subprime losses below.

Foreclosures on First Lien Mortgages increased from 11.5% on 31st October 2009,to 11.69% as on 31st March, 2010. First Lien Mortgage rates on Prime loans and Alt- A loans also increased by 43bps and 41bps respectively over the same period While Net Charge off rate increased by 2.12% points q-o-q, to 30.49% as on 31st Dec 2009, Delinquency rates dropped by 7bps and 27bps over the same period In case of Subprimes, Net Charge off rates and Foreclosure rates, both rose to 44.58% and 15.6% respectively as on Dec 31 2009, compared to 42.89% and 15.4% as at the end of previous quarter As on Dec 31, 2009, Net Charge-off rates for Business loans marginally declined by 12bps compared q-o-q, while delinquency rates for the segment rose by 9bps Delinquency rates for CRE loans increased marginally by 7bps Net charge-off rates for Credit cards dropped considerably from 10.24% as on Sep 30, 2009 to 9.5% as on Dec 31, 2009, while Delinquency rates fell from 6.58% to 6.4% over the same period Net charge off rates fell from 3.21% last quarter-end to 2.71% as on Dec 31, 2009; similarly Delinquancy rates also fell from 3.68% to 3.49% In case of other loans, both, Net charge off rates and Delinquency rates marginally rose from 1.67% and 1.07% as on Sep 30th, 2009

Total revenues of Wells Fargo in 1Q09 were down 5.5% (q-o-q) at $21.4
billion with net interest income and non-interest income slipping 3.1%
and 8.0%, respectively. The decline in net interest income was driven by
sharp decline in interest income which more than offset the decline in
interest expense. Interest income was down 3.4% (q-o-q) to $13.2 billion
owing to shrinking interest earning assets as well as decline in
average yield. Average earning assets were down 1.4% (q-o-q) owing to
decline in investment portfolio and the average yield on the earning
assets came down to 5.06% in 1Q10 from 5.12% in 4Q09. Loan portfolio,
excluding the impact of FAS 167, shrunk 3.2% (q-o-q). The interest
expense declined 5.2% to $2.1 billion owing to decline in average rate
which declined to 0.79% from 0.81% in 4Q09. Net interest margin slipped
to 4.27% from 4.31% in 4Q09.

Non-interest income came down 8.0% (q-o-q) to $10.3 billion from
$11.2 billion largely owing to decline in mortgage hedge results as well
as decline in net gains on debt securities. Provisions for credit
losses came down sharply by 5.2% (q-o-q) to $5.3 billion from $5.9
billion. Noninterest expense came down 5.5% or $704 million to $12.1
billion largely owing to decline in other expenses by 526 million as
well as decline in compensation expense by $285 million. The decline in
provisions for credit losses and decline in noninterest expense offset
the decline in net revenues and the pre-tax earnings drifted 1.0%
(q-o-q) higher to $4.0 billion. Net income available to common
shareholders was $2.3 billion against $394 million in 4Q09 (owing to
$1.9 billion of deemed preferred dividend upon redemption of TARP
preferred stock in 4Q09).

Boombustblog view

Credit quality of the loan portfolio is the most important barometer
in judging the health and performance of WFC.  WFC has slashed the loan
loss provisioning rates with the decline in the charge-off rates.
However, while on one hand, the decline in charge-offs will increase the
accumulation of nonperforming assets in the balance sheet, the decline
in provisioning shall exacerbate the situation by lowering the additions
to the allowance for loan losses.

While the bank points out that the increase in nonperforming assets
has moderated substantially over the last few quarters, the same was
partly due to relatively higher charge-offs being recorded in the last
few quarters. If the charge-off rate is cut down substantially, the
accumulation of non-performing assets shall continue. In 1Q10, the gross
charge offs came down 0.4% (q-o-q) to $5.87 billion (annualized charge
off rate –3.21%) from $5.89 billion (annualized charge off rate –3.19%)
in 4Q09 while the net charge-offs came down 1.5%(q-o-q) to $5.33 billion
(annualized charge off rate –2.91%) from $5.41 billion (annualized
charge off rate –2.93%) in 4Q09. However, the nonaccrual loans continued
to increase and grew 11.8% (q-o-q) to $27.3 billion or 3.73% of total
loans at the end of 1Q09 from $24.4 billion (3.34% of total loans) at
the end of 4Q09 with nearly 28.0% of the total increase coming from the
acquired pick-a-pay portfolio from Wachovia. However, one third of the
increase in non performing loans was due to consolidation under FAS 167.

Charge-offs in commercial real estate came down 7.3% (q-o-q) to $686
million from $740 million in 4Q09 while the nonaccrual loans in
commercial real estate increased 9.5% (q-o-q) to $7.7 billion.

Charge-offs in residential real estate increased 17.0% (q-o-q) to
$2.9 billion from $2.5 billion in 4Q09 while the nonaccrual loans in
residential real estate increased 18.9% to $14.7 billion.

The net charge-offs were marginally down by 1.5% (q-o-q) to $5.3
billion from $5.4 billion, but the provisions for loan losses declined
9.9% (q-o-q) to $5.3 billion from $5.9 billion in 4Q09. Provisions to
net charge-offs declined to 100% against 109% in 4Q09. Thus, the change
in allowance for loan losses was flat except for addition of $594
million due to consolidation under FAS 167. Allowance for loan losses
was $25.6 billion against $25.0 billion in 4Q09. With non
performing loans growing rapidly, the allowance for loan losses as % of
(non performing assets+90 days past due loans) or the provisioning ratio
came down to 68.5% in 1Q10 from 72.6% in 4Q09. Texas
ratio increased to 34.8% from 33.3% in 4Q09.

Purchased credit impaired (PCI) portfolio

The losses continue to accrue on the purchased credit impaired (PCI)
portfolio from Wachovia on which WFC is not recording any charge-offs or
increase in nonaccrual loans…..

The balance of this review is available to all paying subscribers
here, with a full set of charts, tables and graphics: WFC 1Q10_Review. Pro subscribers can
also reference the full forensic report here: WFC
Investment Note 22 May 09 – Pro. Retail subscribers should access
it through the subscription content link in the main menu, under
commercial and investment banks.

Next up will be Morgan Stanley’s review as wells as our periodic
review of Alt-A and subprime mortgage losses. Given the state of affairs
in Europe (see the Pan-European
Sovereign Debt Crisis series), I believe it is
wise for investors and interested parties to review my rather prophetic
proclamation,
The Next Step in the Bank Implosion Cycle???.
If my longer time readers remember, it was the intrabank fear to lend to
one another that caused the illiquidity fissures that revealed the
shenanigans at Bear Sterans and Lehman, predicating their collapse.
Well, Europe is playing that tune again, and probably on a larger scale.
See Bloomberg’s Banks
in Euro Area Increase Borrowing From ECB, Don’t Lend to Each Other ,
and this is AFTER a trillion dollar bailout package was announced.

The curious may also search my site for more Wells Fargo research and
opinion

Comments

[AnonymousMonetarist]

Reggie,

Any idea what QSPEs and VIEs currently total out to be?

Smells Fargo

Total Qualifying Special Purpose Entities(09/30/09): $1,796,209,000,000
Total On Balance Sheet Assets(Grant's 03/19/10): $1,262,354,000,000
Total Tier 1 Capital as a % of QSPE : 5.2%

[Carl Spackler]

Thanks for extrapolating the Tier 1 ratio out.  These guys are quite susceptible to a credit earthquake (and any unforeseen ripples) at that level.

WFC must have "quantitative easing" continue for a couple years to stay alive (maintain those Net Interest Margins to provide eventual capital support for credit support they must provide to the infirmary that is their SPVs...thanks Wachovia).

[ZackAttack]

(Edited because can't reed gud. Everything I wanted to know wuz already their.)

[Rogerwilco]

All dressed up, must be time for a "strategic" merger. BAC + WFC = Godfather theme + California Dreamin'.

Satan is smiling.

[Al Huxley]

I can't believe how well their stock has held up, in comparison to most of the other financials.  I'm pretty sure that when the US real estate market starts blowing up again as the mortgage resets really kick in, these guys have a long way to fall.

Thanks for the analysis Reggie.

[Common_Cents22]

This is a "wells" notice to fear!