Wells Fargo lost $2.55 billion in the fourth quarter. Wachovia, which it acquired on December 31st, lost $11.17 billion. Add those numbers together and you’ve got a $13.72 billion loss for the combined entity.
But here’s the good news: despite the fourth quarter losses, Wells Fargo actually made money in 2008. Diluted earnings were $0.75 per share. Earnings! At a big bank! Horray!
Wells seems to have impressed investors with what it is playing as a conservative approach to future losses. The bank says it built credit reserves by $5.6 billion for future expected losses, it took a charge of $473 million in its securities portfolio and wrote down $413 million in write-downs on mortgages. The phrase people are using is that after these write-downs, the balance sheet of Wells is healthier because it is more closely geared to reailty. Remember, toxic assets are only toxic to the extent that they are over-valued.
Wells didn’t include the Wachovia numbers because the acquisition wasn’t completed until the end of the fourth quarter. Or is it the other way around: the acquisiton wasn’t completed until the end of the fourth quarter so Wells wouldn’t have to combine the awful Wachovia numbers with its own. The acquisition was set up after federal regulators supported Wells Fargo’s bid to buy Wachovia over a bid from Citi. (Side note: can you believe the audicity of Citi thinking it could acquire Wachovia?)
Wachovia’s deep, deadly troubles largely stem from its acquisition a few years ago of of California-based mortgage lender Golden West. It’s a familiar story to anyone who followed the destruction across Wall Street. Lehman Brothers and Merrill Lynch also acquired sunshine and sand state mortgage lenders. These deals became so attractive because the banks were convinced they had discovered a magical money machine in the form of mortgage backed securities. It was a vertical integration strategy: they could originate loans in-house so they could package them into MBS.
Everyone thought they made their money selling these things, but a lot of the money was never made. Instead, the banks held the MBS and made paper profits from their appreciation. When the market turned against them…well, you know that part of the story.
Wells Fargo’s shares are soaring, probably because people are pretty impressed–or at least not totally depressed–with these numbers. Sure, it’s a loss and the Wachovia stuff is fugly. The analysts had predicted better numbers–predicting earnings of 33 cents a share while Wells reported a loss of 79 cents a share–but no one listens to analyst consensus on banks anymore. Missing ‘expectations’ means less than it once did. But the stock had been bloodied this month, falling 45% since the start of the year. And now all those write-downs and loan loss reserves seem to be restoring confidence in Wells’ balance sheet.
It doesn’t hurt that Wells is keeping its dividend and says it doesn’t need anymore government money. The bank had already taken $25 billion from the government and, almost miraculously, managed to raise $13 billion through a common-share offering in the actual, real-life market place.
The size of the write downs on the Wachovia portfolio is truly huge: $37.2 billion on a $93.9 billion loan portfolio. That will also be read as reassuring to many investors, showing that Wachovia is at least taking seriously its responsibility to be honest with investors about the mark to market value of its assets.
Some of the exuberance over the Wells Fargo numbers today may be a bit irrational. Wells admits that declining home prices drives the deterioration of the performance of its credit portfolio. Wells Fargo has still has $78.2 billion in residential mortgages and $75.8 billion in second mortgages. Add in Wachovia’s portfolio, and you see how truly huge Wells mortgage balance sheet is. It now holds $247.8 billion in first mortgages, and $110.1 billion in second mortgages. With housing priced expected to deteriorate through the rest of the year and into 2010, Wells Fargo could be in for even more write downs. It will remain to be seen if their self-styled conservative approach to reserves and write-downs will really be conservative enough.
Well Fargo says its home grown mortgages, many of which are subprime, are of better credit quality than is typical. It says it held to tight credit standards even in its subprime and ARM books, calculating appropriate loan levels by the highest payments a borrower would have to make instead of the interest only starter rates. As for the Wachovia portfolio, well that’s most likely just a toxic waste dump.