Wells Fargo Poised to Rebound After Writedowns

Wells Fargo's aggressive writedown of bad assets allows it to benefit from the massive government effort to unburden bank balance sheets.
Publish date:

Updated from Tuesday, March 24

Wells Fargo's

(WFC) - Get Report

aggressive writedown of bad assets acquired in its deal for


may have better positioned the bank to take advantage of the massive government initiative to unburden bank balance sheets.


Public-Private Investment Partnership

, the Obama administration's plan to finance up to $1 trillion worth of distressed-debt deals, intends to kick-start the credit markets, drive up prices, and allow banks to start lending more aggressively again.

Regardless of how successful the government's plan is, Wells Fargo's decision to significantly reduce exposure to troubled housing debt and its minimal exposure to credit-card and auto debt -- which are expected to drive the next wave of consumer defaults -- set it apart from its peers. The company is better positioned to move forward in a tough economic environment, with a leg up to book bigger profits ahead if credit-market conditions improve, according to some experts.

Bart Narter, senior vice president of banking at the analyst and consulting group Celent says Wells stands out from the herd in terms of risk management and timely, strong-fisted writedowns.

"They're not getting any more of a windfall than other banks, they're just going to see it reflected in their financials more because they wrote it down more aggressively," Narter says. "If Wells marked

bad loans down to 40 cents on the dollar, and Citi marked it down to 60, and the government buys it at 70, Citi will only make $10 on that, but Wells will make $30. I think it's a good strategy -- you kind of say, 'Times are tough, we're going to acknowledge that and write them down, and if markets improve, then we can benefit from that.'"

Wells posted a fourth-quarter loss of $11.2 billion, mostly related to $42.6 billion in writedowns, charge-offs and reserves against Wachovia's high-risk loan portfolio, as well as $9.6 billion in losses on its securities portfolio. All told, Wells reduced Wachovia assets by $115.2 billion, or 17%, since the acquisition, mostly in the fourth quarter.

Wells has $58.8 billion worth of Wachovia loan exposure remaining after what it terms "de-risking" the portfolio -- implying that the company held onto only the best of the worst assets.

By comparison,


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had exposure to $111.6 billion worth of what it terms "key-risk categories," like subprime and Alt-A mortgages, derivatives, commercial real-estate, private equity and highly leveraged deals, at the close of 2008.

JPMorgan Chase

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held $88.5 billion worth of impaired consumer loans from its Washington Mutual acquisition, predicting as much as $36 billion in potential losses to come from WaMu's home-loan portfolio alone.

Bank of America

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held exposure to $55 billion in risky credit-default swaps, residential-mortgage and commercial real-estate debt and bank investment securities from Merrill Lynch's toxic portfolio.

A lackadaisical attitude among banking giants about writing down bad debt is nothing new, Narter says in a December report.

While banks with more than $10 billion in assets faced a much higher portion of loans going bad, their loss provisions were remarkably delayed. The ratio of charge-offs to credit provisions is an inverse pyramid to the size of the institution -- that is, until the end of 2007, when losses were undeniable.

"They have demonstrated inferior risk management for years; yet they have felt that they can provision less for it relative to smaller banks," Narter says in the report.

Narter predicts Wells will benefit more in earnings power once the economy and markets improve. NAB Research analyst Nancy Bush echoed the thought in a note upgrading Wells to buy from hold on March 11.

"We're just now beginning to appreciate the strength of that accounting treatment in bad times, as it allows for the maximum writedown on assets that might go bad in the months to come," Bush writes. "(And, BTW, if they don't go bad -- Wells gets to recoup the upside over the next few years. Why is that so hard to understand?)"

Of the 19 analysts who cover Wells, only three rate it a sell with eight rating it a buy and eight a hold. DBRS analysts say that despite headwinds, Wells "has continued to report solid operating revenues, strong core deposit and loan growth, and positive operating leverage, which differentiates Wells Fargo from many of its bank peers." DBRS predicts that further loan losses will be "manageable" for Wells, and that the company is "well positioned" to ride out the economic funk.

Warren Buffett, the Oracle of Omaha whose

Berkshire Hathaway

owns more than 7% of Wells Fargo, also predicted recently that the San Francisco-based company will emerge "better than ever" from the financial crisis and that its "prospects three years out have been better than ever."

But while some sense a buying opportunity, investors at large don't seem to be convinced. Indeed, Moody's slashed ratings on Wells' debt and lowered its preferred rating into junk territory on Wednesday, citing concerns that "capital ratios could come under pressure in the short term."

Wells shares have fallen 47% since the end of 2008. By comparison, the

KBW Bank Index

, which factors in 24 major banks, has dropped a less dramatic 35%. JPMorgan is down 17%, BofA 49% and Citi 56%, as of Tuesday's close. Wells shares closed up 5.9% to $16.41 on Wednesday.

Of course, all bank shares have been volatile this year, and with Citi and Bofa trading in the single-digits few

long-term investors

are pleased. Those two firms required $20 billion more in government assistance than their peers to grapple with bad debt, receiving $45 billion in Treasury funds, versus $25 billion for Wells and JPMorgan and $10 billion for

Goldman Sachs

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Morgan Stanley

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The CEO of each firms has pledged to


TARP dollars as quickly as possible to get out from under the government's wing. Reports surfaced Tuesday that Goldman's

Lloyd Blankfein

is pushing to repay funds sometime this year, while Bank of America's

Ken Lewis

has predicted its TARP money will be repaid in 2010. Lewis said he should have taken fewer dollars for the Merrill deal, while Blankfein, Wells' John Stumpf and JPMorgan's Jamie Dimon have asserted that they didn't need the money in the first place, but accepted funds to please regulators and help stabilize the financial markets.

Wells declined to comment on whether it wrote down assets aggressively to gain in quarters ahead as market conditions improve, but the firm did strike a positive note on the

Public Private Investment Program

outlined by the Obama administration on Monday.

"Wells Fargo supports any plan by the Treasury that helps financial institutions efficiently sell troubled assets while still providing an investment return to the U.S. taxpayer," spokeswoman Julia Tunis Bernard said in an emailed statement. "It's premature to comment further on our own plans since we have yet to see all the details of the Treasury's proposal."

CFO Howard Atkins characterized Wachovia's loan portfolio as "heavily de-risked" during a financial services conference on Feb. 4 and explained the motivation behind the major mark-downs during Wells' earnings call on Jan. 28.

"While some of these actions adversely impacted fourth-quarter earnings," Atkins acknowledged, "this de-risking will reduce the likelihood of losses in the future, improving the level and consistency of our performance going forward."