Faith in Wells Fargo

Banks are making enormous amounts of money. They make it every day because the amount they are paying you is now invisible, but their costs are going down because most of them have made mergers and are fantastic in taking costs -- plus, the lower rates have brought in a huge amount of business.

But nobody believes because they are supposed to have so many bad loans on the books. The bank that is the least trusted at this point is the one that I trust the most: Wells Fargo (WFC - commentary - Trade Now). I trust it because before the Wachovia merger, the company had very few bad loans and had been an originator and then a seller of subprime.

I know it looks like the bank has a huge amount of subprime, but in a fantastic interview yesterday with the CharlotteObserver.com, CEO John Stumpf answered a question about his huge subprime exposure, and it made me feel pretty terrific:

The subprime loans that we made -- there are about $25 billion on our balance sheet -- were made in a subsidiary company called Wells Fargo Financial. This is a very different kind of subprime loan. It's a debt-consolidation product. The customer already owns her home, but she might have a lot of credit card debt, a debt on an auto, a debt with a hospital. We would consolidate all that debt and put it on her house. That's the kind of subprime loans we put on the books. In fact, those loans are performing very, very well -- well above the industry average because they are fully underwritten, there's no broker involved, full appraisals, full income verification.

Does anyone believe that besides me?

If they do, then the negatives switch to the terrible Wachovia loans. Just awful, right? The pick-and-pay outrage, the ticking time bomb. Those loans are going to wreck Wells Fargo's capital, no?

Here's Stumpf again:

We typically have the highest capital ratios in the industry. The reason that we have less Tier 1 common capital is because we wrote off nearly $40 billion in loans when we bought Wachovia to put the losses behind us. We have great earnings power. We will earn that capital back quickly.

Lying again? Well, consider that Bob Steel, the discredited CEO of Wachovia but still at least somewhat worthy of judging the situation, figured that there were only about a fraction of bad loans within the bank. In fact, this $40 billion figure presumes gigantic losses, much bigger than I think possible unless unemployment goes well above where it is right now and housing continues to decline through 40% reductions.

For the longest time, any number about housing had been too positive, but that kind of writedown may encompass even the most negative projections if we have house price stabilization, as I believe we have. In a house price stabilization situation, the risks of the walk-away and the risks of foreclosure diminish rapidly because there's no reward to jumping to a rental, particularly if you refinance. Of course, again, unemployment is a wild card, which is why it is so important to monitor.

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