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Is Wells Operating Below The FDIC Statutory Minimum 3.0% Tier 1 Capital To Total Assets Ratio Courtesy Of A Few Accounting Gimmicks?

Courtesy of Tyler Durden

With Geoffrey Batt

Each quarter, following the release of assorted 10-K’s and Q’s, one of the most interesting pieces of detective work in the world of financials occurs when one, hopefully armed with a lot of free time, pores through the hundreds of pages of financial arcana and outright magic and cow manure, better known as Wells Fargo’s financials (blessed by such grizzled and conflicted wizards as Warren Buffett). The investigative work is usually driven by the desire to uncover just where the trampling of accounting rules, and collusion between the management team, accountants, lawyers and regulators (FDIC and otherwise) occurs. In this specific case, the results demonstrate that adjusting for some rather egregious accounting “frivolities”, Wells Fargo may well be under the 3.0% FDIC Tier 1 ratio minimum for “strong” bank holding companies. This would imply that the publicly reported Tier 1 ratio of 6.46% is more than double what the bank deserves, and a pure construct of some accountant’s imagination rather than anything even remotely indicative of the truth.

Before we dig in, a friendly reminder from the incompetent regulators at the FDIC:

The Board has established a minimum ratio of Tier 1 capital to total assets of 3.0 percent for strong bank holding companies (rated composite “1″ under the BOPEC rating system of bank holding companies), and for bank holding companies that have implemented the Board’s risk-based capital measure for market risk as set forth in appendices A and E of this part. For all other bank holding companies, the minimum ratio of Tier 1 capital to total assets is 4.0 percent. Banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Moreover, higher capital ratios may be required for any bank holding company if warranted by its particular circumstances or risk profile. In all cases, bank holding companies should hold capital commensurate with the level and nature of the risks, including the volume and severity of problem loans, to which they are exposed.

One can make the argument that with recent revelations that Wells Fargo is allegedly overtly cooking its books, at least as pertains to the “value” and benefit of its MSR hedges, the bank’s Tier 1 should have a materially higher threshold than 3.0%. But we’ll let that slide for the time being.

Digging into Wells’ 10-K, we uncover that according to the management team, the firm’s Tier 1 common equity to total risk-weighted assets ratio is 6.46%.

Life would be grand if only this were true.

As we have exposed on many occasions in the past, one of the key fudgings that occurs in the financials’ books is the major discrepancy between a bank’s designated carrying amount of assets (loans) and their estimated fair value, which all financials are now required to disclose. As the chart below demonstrates, between 2008 and 2009 Wells Fargo, unlike its peers JPM and BofA, has seen this delta increase substantially, from $14.2 billion to $26.4 billion. In essence, the firm acknowledges that the fair value of its loans is $26.4 lower than where it marks them for bookkeeping purposes. Obviously, the implication is that this adjustment amount should also be used in determining the true Tier 1 equity value. So adjustment number 1 – Fair Value to Carrying Amount Delta of ($26.40 billion.

Next, looking at the first table above, we can see that Wells provides an adjustment for intangible assets of $37.7 billion in the Tier 1 equity waterfall analysis. This is odd, because looking at the firm’s balance sheet, we can see that the intangibles on Wells books are slightly greater, at $41.9 billion, which should include the MSR value, whose fleeting basis has been discussed previously (and likely shouldn’t have any value whatsoever due to crazy pill accounting), yet which for all Tier 1 calculation purposes should be excluded. To wit:

Mortgage-servicing rights are intangible assets that consist of rights to receive fees from third parties in exchange for doing things like collecting and forwarding monthly payments from homeowners. Unlike other intangibles, such as goodwill or trademarks, companies have the option under the accounting rules of marking them at their fair market values on a quarterly basis, and then running the changes in value through their earnings. [We urge readers to go through the following post for an in depth analysis of MSRs and how WFC loves to fudge these]

So adjustment number 2: the $4.2 billion delta between the $37.7 billion presented in the Tier 1 calculation table above, and the $41.9 billion as demonstrated.

Lastly: deferred assets. Why Wells is taking a deferred tax asset benefit is beyond us. After all, the only time a company should have a reason to adjust for this number is when it believes it will make enough profit to take advantage of the “asset.” Will that ever be the case with Wells Fargo? Hardly, especially if one were to assume that WFC would ever mark its portfolio to its true basis. According to WM Lab, Wells is not provisioning nearly enough for its delinquent loans. 28% of the bank’s loan book is in 1-4 family first liens and has a 17.39% 30 day delinquency rate. JP Morgan has $42.2 billion in 30 day delinquencies and has a loan loss allowance of $31.5 billion, or a delinquency allowance ratio of 1.34. Wells, however, has $59.1 billion in 30 Day + delinq. and a loan loss allowance of just $22.8 billion, for a delinquency ratio of 2.59; this is quite scary. Aside from broader implications about the bank’s viability, it should render any discussion moot about whether or not WFC’s accountants have any right to take advantage of a deferred tax asset. And since we are far less conflicted and will not make any money from Wells from this report, this will bne our third adjustment: i.e. $5.3 billion.

Combining the three, we present a bridge between the Tier 1 equity as reported and Tier 1 equity as adjusted below.

By now it should be clear where we are headed. If one were to use the adjusted Tier 1 equity we have thus derived after three minor adjustments, and use it to calculate the firm’s Tier 1 Ratio, which has a $1,013.6 billion of total risk-weighted assets in the denominator, we go from a perfectly acceptable 6.46% to a FDIC verboten 2.91%!

This is shown graphically below

Is Warren Buffett’s favorite bank currently operating at below the statutory minimum capital requirement? We believe so, and if various GAAP-allowed book cooking techniques were to be stripped out, the bank would not only have a sub 3.0% Tier 1 ratio, but its leverage instead of being in the low double digits, would be probably north of 30x. In essence, Wells is using the same leverage as a deposit-based lending operation as Goldman and other investment banks used as hedge funds during the peak of the credit bubble.

You have been warned.

Link to Wells Fargo financial supplement for all your paperweight needs.


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