Wells’ Risky Loan Strategy Comes to Light
Wells Fargo & Co. for two years has been a banking Wallenda, deftly walking a tightrope while the rest of the industry marveled at the way that it avoided being tripped up by the kind of bad loans hammering other banks.
But Tuesday’s announcement that the San Francisco bank’s problem loans have soared 28% changed that, putting the spotlight on Wells Fargo’s risky lending strategy. The bank disclosed that its huge $3.5-billion portfolio of corporate buyout loans is souring, and some analysts now believe that Wells’ $12 billion in construction and commercial real estate loans may be next.
“You can’t defy gravity for too long,” said James Marks, analyst with banking specialist SNL Securities in Charlottesville, Va.
Wells Fargo’s stock, which had seen a spectacular run-up between February and the start of this month, continued tumbling Wednesday, falling $3.625 to $70.375. It has lost nearly $20, about a fifth of its value, in the past week. A shareholder lawsuit filed Wednesday in U.S. District Court in San Francisco against Wells Fargo and its senior officers termed the drop a “virtual collapse.”
On Tuesday, Wells disclosed that it would set aside $350 million in the second quarter for possible losses on loans.
Wells Fargo’s chief financial officer, Rodney L. Jacobs, told reporters that the bank is trying to be prudent and that its actions reflect the “current state of knowledge about the portfolio and the economy.” The bank’s senior officers told analysts in a conference call Tuesday that they are concerned at lack of liquidity in the real estate market. Wells Fargo declined further comment Wednesday.
The disclosure clearly caught Wall Street off guard. Thomas K. Brown, a banking analyst with Donaldson, Lufkin & Jenrette, said he was at the bank three weeks ago for his regular quarterly visit and picked up no hint of the problem. Brown said he has since concluded that the bank’s disclosure was prompted by a disagreement with regulators over the health of its corporate loans during a special regulatory review.
The debate over Wells’ strategy is not new. Critics, including short sellers who borrow the bank’s shares to bet that the stock will fall, have argued two main points:
* Wells is highly leveraged, meaning it has loaned out a lot of money.
* It is too heavily concentrated in risky real estate and corporate buyout loans. Wells has roughly $17 billion worth of loans in the riskiest categories, five times its $3.4 billion in equity. Those are considered among the highest proportions in the industry.
The bank’s critics argue that real estate recessions, such as the one the nation is now in, take no prisoners. In a highly critical article last November, the respected Grant’s Interest Rate Observer publication asked, “If real estate is an international banking virus, why should Wells Fargo be immune to it?”
The nation’s commercial real estate markets--such things as office buildings, shopping centers, industrial parks and housing tracts--were overbuilt in the 1980s, with one in four offices empty in some cities.
California’s commercial real estate market is one of the softest, especially Los Angeles, Orange County and San Diego. Earlier this month, the Federal Deposit Insurance Corp. moved California into its “warning area” because problem loans, mostly for commercial real estate, exceeded 4% of assets for the first time.
“I can’t believe that any management can be farsighted enough to dodge this particular bullet. How good can management be?” Grant’s editor James Grant asked.
Still, Wells Fargo’s supporters maintain that it is the best in the business at determining the riskiness of prospective borrowers and at monitoring the financial health of customers. They believe that the reaction to this week’s news is unfair, noting that borrowers are still making payments on many of the loans considered problems.
“I think it is a knee-jerk reaction. I’ve spent a lot of time analyzing Wells’ management, and I give them more credit,” analyst Brown said.
Wells Fargo was one of the biggest lenders to corporate buyouts, which earned the bank huge fees in the 1980s. But several Wells Fargo borrowers--Revco, Insilco and West Point-Pepperell--have been troubled.
Competitors have long noted that Wells Fargo keeps a larger chunk of a loan than other banks active in the area, such as Security Pacific and Bankers Trust. Those banks tend to “sell” parts of a loan to other institutions to reduce their exposure.
The problem with corporate buyout loans--called “highly leveraged transactions” in banking jargon--has raised concerns that other banks may be forced to face up to acquisition-related problem loans. Ronald I. Mandle, a banking analyst with the Wall Street firm Sanford C. Bernstein & Co., said he expects to see an increase in problem buyout loans at other banks, but not as big as what Wells Fargo disclosed.
Until it started tumbling, Wells Fargo’s stock had been soaring on the bullish news that investor Warren E. Buffett owns 9.7% of the stock and is seeking regulatory permission to own as much as 22% because of his faith in management.
In addition, the stock has risen on the prospect early this year of a possible merger with Security Pacific. Analysts and investors said, however, that the Wells announcement drove yet another nail into the coffin of those rumors.
