Did you know that Wells Fargo (WFC) is running the equivalent of a Bank of America (BAC) in Enron-style, off balance sheet vehicles?
It has $2 trillion in off-balance sheet assets, separate from its $1.2 trillion balance sheet, and big chunks of that may come pouring back onto its financials, thanks to new accounting rules set to take effect in January.
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And did you know that in advance of those new rules, Wells says that, out of that $2 trillion warehoused in Enron-like vehicles, it doesn't have to put back onto its balance sheet $1.1 trillion because the US government is guaranteeing these items?
This may come as a surprise to you amidst the news that Wells Fargo is repaying $25 billion in TARP loans. Wells historically has had the weakest capital cushion in the business, a razor-thin $53 billion in Tier 1 capital supporting a $1.2 trillion balance sheet.
Given these sums, and its souring loan portfolio, should Wells pay back TARP? All of these items should make you stop in your tracks if you think Wells Fargo is putting its problems behind it and its stock is a buy right now.
All of the big banks are running separate banking operations off the balance sheet, operations that would double their size. These Doppelganger banks are coming back to haunt the big banks because a lot of these assets are due to come pouring back onto their financials next year.
The four top banks--JPMorgan Chase (JPM), Citigroup (C), Bank of America and Wells Fargo--have a combined $5.2 trillion in off balance sheet assets. That equals about a third of the US economy.
For example, Citi says it expects to take back on $155 billion next year. Bank of America has disclosed it had about $114 billion in off-balance-sheet credit-card debt, with more assets warehoused away from its financials that could come sluicing back on.
Spooky Stuff Submarined in Wells' Footnotes
But watch Wells' logic here. Let's take a walk through its footnotes.
To see this $2 trillion in Wells' off balance sheet assets, take a look at page 31 of its third quarter filing, (add together the QSPE and VIE lines, which stand for qualified special purpose entity and variable interest entity).
On another table explaining some of its off-balance sheet assets, again the size of a Bank America, on page 24 of its supplement to its third quarter earnings, you'll see a footnote where Wells discloses it has $1.1 trillion in residential loan assets shoved off the balance sheet.
Specifically, you'll see a footnote to the table that says: "We have concluded that $1.1 trillion of conforming residential mortgage loans involved in securitizations are not subject to consolidation under FAS 166 and FAS 167.”
FAS 166 and 167 are the rules governing off balance sheet assets.
Another footnote on page 14 of its third quarter SEC filing says about $174.4 billion “represents certain of our residential mortgage loans that are not guaranteed by government-sponsored entities.” And so that sum may come back onto the balance sheet.
So Wells is effectively saying that, ipso facto, because the government—likely Fannie, Freddie and the FHA--insure the majority of the mortgage assets warehoused in these off-balance sheet vehicles, $1.1 trillion, the bank doesn't have to put them back onto their financials or set aside more capital for them.
Meaning that essentially, the bank is not liable for them.
Really? Even though the Financial Accounting Standards Board is saying, not so fast?
You'll also see a footnote in its third quarter report that says Wells is trying to wind down a lot of these off-balance sheet positions in advance of this new rule.
But it says “there is no assurance that we will be able to execute such sales prior to adoption of these accounting standards, although it is our intent to do so.”
There's no telling what off-balance sheet sums Wells is responsible for. The rules accounting for them are notoriously vexing to follow.
Wells Trying to Cut Back its Enron Vehicles
So, should Wells pay back TARP?
Remember, Wells bought Wachovia, which made the disastrous decision at the height of the bubble to buy Golden West Financial, a California thrift that willy nilly approved loans for deadbeats that let these borrowers set their own payment terms, called “pick-a-payment” loans.
Wells also picked up a lot of home equity loan exposure, too. But it's the commercial real estate stuff that might be pretty terrifying.
The bank says it has $135 billion in commercial real estate loans, a ton of which it picked up from Wachovia.
About a third of Wells Fargo's commercial real estate loan book is tied to properties in California or Florida, two states slammed hard by the downturn in real estate.
Overall, Wells Fargo has $57 billion in impaired “pick-a-payment” loans, $43 billion in impaired commercial real estate loans, and $55 billion toxic, level 3 assets, the worst of the lot.
Again, it has the lowest capital cushions in the industry, with just $53 billion in Tier 1 capital, a regulatory item that government officials require it to have to backstop its balance sheet.
Meanwhile, Wells' loan loss reserves have grown to $24.5 billion, double its $11.7 billion in net interest income for the third quarter.
When loan loss reserves start swamping the lifeblood of a bank, it's a troubling sign.