Sunday, September 20, 2009

Is Wells Fargo Making AIG’s Suicidal Mistake?

John Carney has a whopper of a story that suggests Wells Fargo may have the same kind of exposure to risk, specifically, Collateral Call Risk, that caused AIG all its problems. Carney writes:
It was not bond defaults that killed AIG, after all. It was collateral calls.Recall that AIG also thought that it was exercising the utmost caution, hiring a Wharton/Yale professor to build "risk models," and AIG was confident that many of the bonds on which it wrote insurance would never default. And AIG was right—many of those bonds didn’t default and still haven’t. But that wasn’t enough to save AIG.What AIG's risk models missed was the possibility that AIG would have to post additional collateral in the event of a decline in the value or ratings of bonds that had yet to default....

Is it possible that even after AIG, Wells Fargo could make the same stupid mistake? Could they really have overlooked Collateral Call risk? At this point, given the widespread idiocy in the banking sector, anything's possible.
We’re not sure Wells Fargo has overlooked this risk. We’re not even sure that the company has this risk—their annual report discussion isn’t detailed enough for us to tell. But neither, we expect, was AIG's.

We’re told that the right to demand more collateral is completely standard in such credit default swaps, so it is likely that Wells does have Collateral Call Risk. Which is what makes it alarming that we haven’t seen evidence that they have taken this risk into account.In fact, when Wells Fargo does discuss its exposure to the credit default swaps, it sounds frighteningly like AIG, assuring us that the likelihood of the repurchase obligations being triggered is remote and that the residual value of the underlying bonds hedges the risk. But it says nothing about collateral risk.
Sounds to me like Carney has it nailed down.

The further problem with this exposure is that there are no numbers available from WFC that make it possible to judge the size of such risk. Francine McKenna follows up on Carney's story with these points:

When I read that (Carney's story), I saw eerie parallels with New Century, all the more so because of the auditor connection – both Wells Fargo and Wachovia and New Century (now in Chapter 11) are audited by KPMG. New Century was not too transparent either and, as a result, many people, including some very sophisticated investors were caught with their pants down. KPMG is accused in a $1 billion dollar lawsuit of not just being incompetent, but of aiding, abetting, and covering up New Century’s fraudulent loan loss reserve calculations just so they could keep their lucrative client happy and viable...So where are those numbers? Where is the number that correlates to the $8.4 billion dollar exposure that brought down New Century? Wells Fargo saw an almost 300% increase from 2007 to 2008 in delinquencies and 200% increase in charge offs from commercial loans and a 300% increase in delinquencies and 350% increase in charge offs on residential loans they still hold. Can anyone say with certainty that we won’t see FNMA and FHLMC come back and force some repurchases on Wells Fargo for lax underwriting standards?...The lack of disclosure of this issue here mirrors the lack of disclosure in New Century and perhaps in other KPMG clients such at Citigroup, Countrywide ( now inside Bank of America) and others. How do I know there could be a pattern? Because the inspections of KPMG by the PCAOB, their regulator, tell us they have been called on auditing deficiencies just like this.
If investors understand what this may mean, WFC may not have a pretty trading day Monday.

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