Last week, the CFO of Wells Fargo suddenly resigned for "personal reasons" and was immediately replaced by CAO Tim Sloan. The departure was promptly buried, and everyone moved on. Not so fast, says Institutional Risk Analytics' Chris Whalen, who speculated that there is much more here than meets the eye. In a report released yesterday, Institutional Risk Analytics notes that "The departure of Atkins, we are led to believe, was not merely the result of personal issues, but reflects an ongoing internal dispute within WFC’s executive suite regarding the bank’s disclosure." As a result of this action, IRR went ahead with the following rating action: "We are downgrading from “Neutral” to “Negative” the outlook for the forward operating results for Wells Fargo & Co. (“WFC”/Q3 2010 Stress Rating: “B”/Outlook: “Negative”). Recent management changes, the poor quality of WFC disclosure and unresolved issues regarding on and off balance sheet exposures to the GSEs and private investors and/or insurers led to this downgrade, as discussed below."
As expected, Whalen is quite florid in his description of the troubles at Wells:
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, WFC 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 WFC’s peers among the largest banks have increased written and oral disclosure regarding loan losses and related data during the past three years, WFC consistently has stonewalled the investment and analyst communities.
TheStreet compiles the key points from Whalen's report:
“Wells Fargo(WFC) is involved in an "ongoing internal dispute" over financial disclosure, prompting the departure of its CFO and leading some officials at the bank to contact regulators over concerns the bank is being too aggressive in its accounting…"The departure of Atkins, we are led to believe, was not merely the result of personal issues, but reflects an ongoing internal dispute within [Wells Fargo's] executive suite regarding the bank's disclosure," he writes…Whalen then goes on to argue that Wells Fargo's "public behavior suggests significant problems in the bank's internal systems and controls as defined by the Sarbanes-Oxley law. We further understand that some officials of [Wells Fargo], increasingly uncomfortable with the bank's aggressive public disclosure regime, have reached out to regulators because of concerns regarding accounting issues…After mentioning the alleged internal dispute, Whalen goes on to accuse Wells Fargo of having poorer disclosure than peers among the largest banks when it comes to mortgage-related loan loss exposures…"While [Wells Fargo's] 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," Whalen writes…Whalen also has harsh words for Bank of America(BAC), writing that loss rates on residential mortgage backed securities and whole loans for the overall market suggest the pictures painted Wells Fargo and Bank of America are too rosy…This overly optimistic view "is also visible in many other large US banks, but [Bank of America] and [Wells Fargo] are the worst offenders in our view," Whalen writes, adding, "simply stated, the loss rates are far too low compared with loss experience visible on RMBS and whole loans."”
Quantifying the possible transgressions shows some potential for messiness:
To give you some context, of the $2 trillion in principal amount of private label RMBS outstanding at the end of 2007, 25% have prepaid, 8% has been written off and almost 30% are now delinquent. Keep in mind that the worst credits in this large body of loans have already been charged-off in the form of the 8% liquidation, but 30% of the remainder are now delinquent. Yet WFC and BAC want us to believe that their realized losses and delinquencies are an order of magnitude lower that private label RMBS.
Far more significant than the GSE claims, WFC and BAC face potentially catastrophic losses from private label RMBS claims from investors and/or insurers. Again, if you look at the double-digit loss experience data on private label RMBS, and then compare this actual experience with the loss disclosure from BAC (WFC has provided none), the two pictures simply do not coincide. And remember that the losses on RMBS from servicer reports are cash losses, not estimates or an accrual fiction of the type commonly used by banks with respect to their retained portfolios.
For everyone axed in the name, we suggest getting a copy of the report and parsing it very carefully. After all nobody in the sellside community even reads Wells' financial paperweights, er, statements. And as for Warren Buffet, should things at Wells turn sour, we are confident that Uncle Sam will be there to provide his latest Congressional Medal of Freedom recipient with that free taxpayer funding that is so rightfully owed to the octogenarian billionaire who no longer has to worry about downside in any investment decision: such are the benefits of being a TBTF investor in this great socialist country (where John Paulson is rapidly trying to become first runner up in the same category).