Monday, October 20, 2008
Wells Fargo Number Fudging
Wells Fargo announced *better than expected* earnings the other day of 49 cents per share. I contend and have been contending that they are full-fledged liars, that they are using sleight-of-hand accounting. Here's what the WSJ wrote about their *earnings*:
Wells allowed a key measure of reserve strength to drop considerably. If it had held that measure at its second-quarter level, Wells's third-quarter earnings would have been half the 49 cents per share it reported Wednesday.
At a time when bad loans are expected to continue rising, it makes sense to compare a bank's loan-loss reserve with past-due loans. Many of those won't return to health and will lead to a loss.
In the third quarter, Wells's $7.87 billion reserve was 1.57 times as big as its $5 billion in past-due loans.
That's down from 1.81 times in the second quarter.
Maintaining that ratio at 1.81 times in the third quarter would have taken an extra $1.18 billion out of earnings.
After tax, that would work out to 24 cents a share.
Wells's defenders might argue that some loan portfolios are not deteriorating as fast as they had been, allowing the bank to ease up a bit on this reserve measure. But that's a bold step in a faltering economy.
Even after getting $25 billion under the government's financial-rescue plan, Wells still wants to raise another $20 billion of capital on its own to support its planned purchase of Wachovia.
If bad loans snap higher, it will need it.
There you go. Into the teeth of this financial crisis Wells Fargo is reducing its loss reserves. Obviously they have so much discretion with this number (and most others) that they can manufacture whatever bottom line they feel like.
Even if you accept Wells' accounting shenanigans, multiply 48 cents per share time four to arrive at $2 in annual EPS. With the stock currently trading $34 per share, that implies a PE ratio of 17. With the *leveraged* bank model exploding, banks, particularly large ones ought, IMO, to be trading closer to 10 multiples (on earnings).
Now if you don't accept their accounting and/or have a very bearish outlook on the economy, consider the *revised* 24 cents figure. Multiplied by four gives $1 in annual EPS; and a 10 multiple would push it down towards, duh, $10 a share.
John Maudlin wrote the other day that today's markets have *new rules*; he advised to "throw out" all your old metrics. That's some sagacious advice - particularly concerning Wells Fargo which obviously has the *in* with Big Government and its agents. This $25 billion they just got, with few strings attached, and structured to limit share dilution is rather huge. I still don't know what to make of it - except that it raises the point ($24?) where I'd start to cover my short position.
And, of course, Wells Fargo is hardly the only bank out there fudging their numbers via low loan loss reserves. Today, from Briefing.com,
Friedman Billings discusses current results on banks; notes credit and asset quality on investors minds:
Friedman Billings says 50 banks out of 287 total banks and thrifts with assets greater than $1 bln have reported earning. For 3Q08, investors still really have one thing on their minds: asset quality. NPAs rose a median 24 bps to 1.5% of loans, while charge-offs continued accelerating, up 8 bps to 0.48%. Reserves are up only slightly to 1.4% of loans, which continues to disappoint, as firm would like to see reserves building in line with NCOs, at the very least, in this uncertain environment. If this trend continues, firm would expect to see an outsized jump in reserves at some point in the coming quarters as cos build their reserves to more acceptable levels if credit losses continue to accelerate. Firm continues to believe that many cos in the industry are overvalued relative to risk, and firm's concerns surrounding the economic outlook in the Northeast are quickly rising given the financial sector upheaval in recent months. The primary positive has so far been the cost of deposits, which have declined at a higher rate than the yields on loans.
UPDATE - Looks like everyone is all over Wells Fargo today. The NYPost ran an article: The Pretenders - Analysts Say Wells Fargo Sugarcoats Balance Sheet and put up this nice graphic: