Wells Fargo Profits: Smoke and Mirrors?

I didn’t comment on this last week when the numbers were reported, but the euphoria surrounding Wells Fargo’s first quarter earnings reports seems a little naive. Short that stock.

Having sat in on very similar discussions myself many years ago I can imagine to pressure at Wells to publish good earnings. After all the administration is finally close to summoning up the courage to get tougher on the big banks, the results of the stress tests are being accumulated, and it would therefore be a ‘jolly good thing’ were wells Fargo to step up with a dramatic display of earnings rebound. Remember to that Wells CEO is one of the more outspoken critics of government interference in his activities, which presumably he thinks has been superlative notwithstanding his need for TARP cash.

So color me a little cynical over these figures.

Especially when they include a derisory loan loss reserve figure and ludicrous write-offs of bad loans.

Banks set up reserves against potential loan losses all the time. It is a normal cost of doing business. In a bad economy it is prudent to increase the loan loss reserve dramatically so that future losses are already accounted for. In effect the loan loss reserve provides a cushion so that loan losses don’t have to be written off directly against capital. It is testimony to the awful credit quality that the big banks allowed to develop in their loan portfolios that their loss reserves were overwhelmed by the surge in bad loans last year. Of course it didn’t help that some of them never set aside as much as they should into their reserves – they ‘under-provided’ for losses as a way of pumping up reported earnings.

And who was the most aggressive ‘under-provider’?

Wells Fargo.

And they’re at it again in the first quarter.

The reason their earnings appear so good is that they wrote off a paltry $3.3 billion of loans and set aside a mere $4.6 billion into the reserve. Both numbers are staggeringly aggressive. They can only be justified if the rotten portfolio that Wells acquired along with Wachovia Bank last year has suddenly undergone a miraculous return to health, and all those mortgages that are about to re-price at much higher rates [up from their introductory teaser rates] will sail into the future serenely untouched by the recession and unemployment rates.

Only the screaming heads on cable TV could possibly fall for this nonsense. In fact CNBC went nuts touting Wells Fargo’s profits as a sign of an imminent economic recovery. That alone should give a serious investor cause for alarm.

My conclusion: those profits are fiction. They are window dressing of the first order and anyone relying on them as a basis for investing in Wells stock needs to get help fast.

Here’s a like minded comment from HousingWire.com: A Game of Credit Cost Smoke and Mirrors at Wells Fargo? : HousingWire || financial news for the mortgage market

Smoke and mirrors indeed.