Last Thursday Wells Fargo beat even the most optimistic of forecasts posting first-quarter net income of approximately $3 billion or about 50% higher than the same period last year. Great news right? Except that the quality of the earnings just can’t be trusted. It seems the result had more to do with accounting treatments and a suspiciously low charge-off rate.
As Whitney Tilson pointed out the $3.3 billion in charge offs for the first quarter appears very strange given the $6.1 billion that was reported for the combined Wells Fargo Wachovia entity in the 4th quarter of 2008. Credit quality did not get better in Q1, in fact it continued to deteriorate.
Is it just me or does it appear that the gaming of financial earnings is on for young and old? Could it be that financial institutions, knowing that they will need more capital to absorb the losses coming down the pike, are trying to bump up their share prices in an attempt to raise private capital by reporting earnings that suggest the worst is over?
An interesting report emerged yesterday about the possibility that Wells could face $120 billion in losses under a stress scenario that assumes a 12% unemployment rate, and a recession lasting into the first quarter of 2010, far more realistic than the so-called Treasury stress tests, from Bloomberg:
Wells Fargo May Need $50 Billion in Capital, KBW Says
Wells Fargo & Co., the second- biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.
KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote.
First-quarter net income rose 50 percent to about $3 billion, Wells Fargo said last week in announcing preliminary results that topped the most optimistic Wall Street estimates and sparked a 32 percent jump in the stock. The bank attributed the profit to a surge in mortgage originations and revenue from Wachovia Corp., acquired in December. Full results are scheduled for April 22.
“Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”
Wells Fargo raised its provision for loan losses by $4.6 billion in the quarter, below Cannon’s estimate of $5.4 billion. FBR Capital Markets analyst Paul Miller wrote after the announcement last week that he expected a $6.25 billion increase.
Charge-offs
Net charge-offs were $3.3 billion in the quarter, compared with $2.8 billion in the previous period at Wells Fargo and $3.3 billion at Wachovia. The current numbers are artificially low because consumers received tax refunds and a there was a moratorium on some mortgage defaults, wrote Cannon, who predicts a “re-acceleration” of charge-offs in the second quarter.
There is no turnaround in fortunes at Wells Fargo anytime soon, just some smoke and mirrors earnings tricks for the first quarter. Ignore the headline numbers and the media sheep who repeat them in overly optimistic tones and look at the underlying quality of financial company earnings for a better picture of what is really going on.
