America's most fraudulent bank reported earnings that were much better then expected.
The Wall Street Whore machine was quickly on top of it.
*Great Results!
*Kicking On All Cylinders!
*Great Execution!
*Raising Estimates!
*Raising Price Target
*Buy! Buy! Buy!
From this stock futures and Wells common rose on the day earnings were announced.
But was it all good for Wells?
Are they killing it softly?
Kicking on all Cylinders?
In Short. NO!
Wells Fargo, the broader markets, and other banks were enjoying a decent day until late in the day an analyst who had come on CNBC earlier in the morning praising Wells suddenly downgraded it unleashing a late day sell off.
There was a lot of chatter about credit write downs and mortgage servicing rights or MSR's earlier in the week involving many banks including Wells Fargo. The earnings release clearly documented where Wells was making money. It wasn't in trading, commercial banking, private banking, investments, or even lending, it was all due to MSR hedging.
Lets get one thing straight. This has been a very good quarter for bank earnings. Goldman Sachs, Morgan Stanley, JP Morgan, Wells Fargo, US Bancorp,and most European Banks as one would expect are profiting from record low interest rates.
The broader question is for larger banks, have they taken enough losses? Are they properly reserved for future losses? Are the credit write downs continuing? Forget the fact that they are slowing, going from $10B to 8$ is no relief. The smaller banks are in serious trouble as they are significantly hedged to the broader economy via commercial real estate and construction loans. GS and MS should do better as they are more leveraged to sales and trading. But these stocks have risen so far that there is little room for valuation expansion.
Back to the disgrace that Wells Fargo is.
Wells Fargo posted a cosmetically pleasing to the eye profit of $3.2B, or double the loot from the same quarter last year, and in the process beating estimates.
Like I said, analysts were falling over themselves praising Wells for the results even though the results were all due to MSR Hedging. As the day went along, people really started to look at the report a little more in detail. Many tarted to complain that the bank's entire profit for the quarter came from a $3.6B profit on a hedging transaction. The bank's core operation's, meanwhile, produced results that ranged from mediocre to downright poor.
The analyst that came out with the sell rec late in the day was the same one waving the pom poms earlier on CNBC.
You cant make this stuff up.
The best part of the piece is at the end when CNBC anchor Becky Quick thanks Bove for speaking eloquently about the results so quickly after they were announced.
Yes America. We thank you for speaking eloquently and screwing us up at the same time. Its really par for the course when you had a dolt like Bush for President for 8 years. We now praise people who can actually complete sentences regardless of its total relevance and logic. This is the Obama Presidency in a nutshell.
I digress. Back to the disgrace.
The analyst Dick X Bove actually confessed that he didn't read the Wells earnings report before he got on air. Was it just CNBC trying to peddle more Wall Street smut to retail investors? Bove called Wells a "Standout" bank and that Wells has its loan losses "Under Control." Later in the day when he was actually doing his job, he reversed course and downgraded the piece of crap stating that the banks earnings were in fact "Pretty Poor" and mortgage hedging and unsustainable tax cuts inflated earnings. All of this was quite evident right off the bat in the morning, all people had to do was read the earnings report.
Bove continued to say:
"Wells Fargo reported earnings of $0.56 per share for the third quarter. This was well above my estimate of $0.41 per share and in line with second quarter results. The earnings forecast for 2009 has been increased to $2.08 per share from $1.94 per share. The estimates for 2010 and 2011 remain unchanged at $1.93 per share and $2.67 per share, respectively. The target price on the stock is being maintained at $25 per share. The rating is reduced to Sell."
Furthermore.
•While the quarterly number was higher than the expected, the increase seems to be due to two factors. The servicing fees on mortgages (MSR) jumped by $1.1 billion or $0.15 per share, and the tax rate fell by 2.2% adding another $0.02 per share to earnings.
•The volatility in the mortgage servicing fee is impossible to explain. In the past five quarters this fee has moved around as follows: $525 million, negative $40 million, $843 million, $753 million, and $1.9 billion. Mortgage rates in these five quarters have been as follows: 6.31%, 5.87%, 5.06%, 5.03%, and 5.15%. These rates would argue for a constant decline in the value of mortgage servicing until the third quarter this year.
•This is not what is depicted in the Wells Fargo numbers. The reason is that Wells hedges its servicing portfolio. These hedges are very large. For example in the second quarter, the bank lost $1.3 billion on its MSR hedges. In the third quarter, it made $3.6 billion on these hedges. The swing from quarter to quarter was $4.9 billion. The earnings per share impact was $0.68 per share. This is more money than the bank earned, overall, including the hedge profit, in the third quarter.
•The remaining businesses of the bank were very mixed in the quarter. Most disturbing is that loan losses seem to be accelerating on the negative side.
•Despite the fact that this is the most compelling earnings event in each quarter, the bank never spends much more than 5 seconds discussing it. It is an unsustainable profit but MSR hedges keep coming through for the company when it needs to bolster earnings.
This is the best point. Wells doesn't spend much time discussing MSR hedging. Why? Simply, they don't understand it themselves, and they only care if they are in their favor, so its like Gays In The Military - Don't Ask Don't Tell. Why go into the fact that the only reason you guys are in business is to make loans, but you are not making loans because loans are not in demand. The only reason you guys have not blown up the company is because of financial engineering that has for once worked. Broken clocks work at least twice a day. Wells sucks at commercial banking, consumer banking, and investments at the moment, but the blind squirrels at their mortgage hedging desk had a god quarter. They simply cant say that.
But lets go back to the MSR question. These next few points are right from Wells 10Q from their corporate website.
The Company originates, funds and services mortgage loans. These activities subject the Company to a number of risks, including credit, liquidity and interest rate risks. The Company manages credit and liquidity risk by selling or securitizing most of the loans it originates. Changes in interest rates, however, may have a potentially large impact on mortgage banking income in any calendar quarter and over time. The Company manages both the risk to net income over time from all sources as well as the risk to an immediate reduction in the fair value of its mortgage servicing rights. The Company relies on mortgage loans held on its balance sheet and derivative instruments to maintain these risks within Corporate ALCO parameters.
At September 30, 2003, the Company had mortgage servicing rights (MSRs) of $5.8 billion, net of a valuation allowance of $1.8 billion. The Company’s MSRs were valued at 1.03% of mortgage loans serviced for others at September 30, 2003, up from .92% at December 31, 2002 and .89% at September 30, 2002. The increase in MSRs was predominantly due to the growth in the servicing portfolio resulting from originations and purchases.
The value of the MSRs is influenced by prepayment speed assumptions affecting the duration of the mortgage loans to which the MSRs relate. Changes in long-term interest rates affect these prepayment speed assumptions. For example, a decrease in long-term rates would accelerate prepayment speed assumptions as borrowers refinance their existing mortgage loans and decrease the value of the MSRs. In contrast, prepayment speed assumptions would tend to slow in a rising interest rate environment and increase the value of the MSRs.
The Company mitigates mortgage banking interest rate risk in two ways. First, a significant portion of the MSRs are hedged against a change in interest rates with derivative contracts. The principal source of risk in this hedging process is the risk that changes in the value of the hedging contracts may not match changes in the value of the hedged portion of the MSRs for any given change in long-term interest rates.
Second, a portion of the potential reduction in the value of the MSRs for a given decline in interest rates is offset by estimated increases in origination and servicing fees over time from new mortgage activity or refinancing associated with that decline in interest rates. In a scenario of much lower long-term interest rates, the decline in the value of the MSRs and its impact on net income would be immediate whereas the additional fee income accrues over time.
Under GAAP, impairment of the MSRs, due to a decrease in long-term rates or other reasons, is reflected as a charge to earnings through an increase to the valuation allowance.
In scenarios of sustained increases in long-term interest rates, origination fees may eventually decline as refinancing activity slows. In such higher interest rate scenarios the duration of the servicing portfolio may extend. In such circumstances, periodic amortization of servicing costs may be reduced, and some or all of the valuation allowance may be released.
Its all there in black and white. They are basically telling you that they originate loans that have a number of risks including credit, liquidity and Interest Rate risk. That is why they securitize all that is holy under the sun. They manage the MSR risk with even more complex derivatives.
So in effect what these shysters are saying is that a decrease in interest rates as we have seen should lower net income right away as the loss in revenue flows through the income statement. Yet, this did not happen this quarter and his rarely consistent this year. The question then on everyone's mind is why? The answer is that Derivative Hedging is the business that Wells Fargo is in. They are not in the business of lending. Not in the Asset Management Business. Retail brokerage AG Edwards and Wachovia are all fronts for a giant hedging book. In short temporary gains from the hedging contracts have more than offset the more permanent loss in MSR income. But for how long? What about continued credit losses? RMBS Losses? CMBS losses? HELOC Losses? ARM losses? Option ARM losses? Off Balance Sheet exposure that needs to brought back onto Wells balance sheet? Wells Fargo will be making a kings ransom on mortgage refinancing, but these fees accrue over time. Please be advised that most existing home sales are distressed sales, that the $8K Tax Credit has spurred home sales across the country. Some say these sales would have happened anyway without the credit, to which I say Hogwash!
Net Net
What will happen with these massive MSR derivative hedges is very much unclear. What is clear is that these inflated MSR values this quarter will have to be written down and that will be a drag to income later on. So, when Investors wake up from their stupor and you strip out the hedges, the earnings level at Wells is misleadingly and shockingly fraudulently high.
The more troubling thing about this is that these hedges are actually marked to market and because there are no actively traded contracts for comparison, there are no reliable marks to mark to market them to. This is where they also lie and say "See We Are Marking To Market." Its just there is no market to compare.
In fact they are mark to make believe. Wells is not the only scam bank doing this. BOFA, JPM, and the largest mortgage service companies all practice and benefit from this.
This next nugget is from digging up regulatory filings. Did I tell you that Google Search is great?
"The four banks wrote up the value of their MSRs by about $11 billion in the second quarter, according to regulatory filings. Mortgage rates climbed by 0.35 percentage point in that period, according to Freddie Mac."
"The four banks control 56 percent of the market for the contracts, according to Inside Mortgage Finance, a Bethesda, Maryland-based newsletter that has covered the industry since 1984. Service agents collect payments from borrowers and pass them on to mortgage lenders or investors, less fees. They also keep records, manage escrow accounts and contact delinquent debtors."
"Under U.S. accounting rules in place since 1995, banks should report the value of mortgage-servicing rights on a fair- market basis, or roughly what they would fetch in a sale. A bank must record a loss whenever it sells MSRs for a price below where they’re marked on the books."
"Because there’s no active trading in the contracts, there are no reliable prices to gauge whether banks are valuing the rights accurately, analysts said"
"Bank of America held the largest amount of MSRs as of Sept. 30, with $17.5 billion. JP Morgan had $13.6 billion, while Wells Fargo owned $14.5 billion and Citigroup $6.2 billion."
This is just a look at the tip of the iceberg at Wells Fargo.
MSR Hedging is just one skeleton in their closets.
I posted this a month ago about a potential CDS nightmare:
tradersutra.blogspot.com/2009/09/wells-fargo-just-keeps-shenanigans.html
And this about their OBS/SIV exposure:
tradersutra.blogspot.com/2009/06/mortgage-pain-ahead.html
And this about non performing assets.
tradersutra.blogspot.com/2009/07/more-on-wells-non-performing-assets.html
The only way Wells survives is if the general investment public keeps believing in the lies that Wells executives spew out. The only way this company survives is if Congress legislates accounting fraud across the board in America. That really is the only way any of the banks survive at the end of the day.
They have already done that to some extent with FASB rollbacks.
tradersutra.blogspot.com/2009/07/back-to-fasb-repercussions.html
tradersutra.blogspot.com/2009/08/frb-balance-sheet-and-credit-crisis-2.html
tradersutra.blogspot.com/2009/03/more-mark-to-market-non-sense.html
But FASB is no longer laughing.
tradersutra.blogspot.com/2009/07/congress-is-jokebut-fasb-not-laughing.html
Its just a matter of time before we have the eventual caving in of the entire shadow banking system, a system that was saved by TARP and near low rates.
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