The day of reckoning has arrived for Wells Fargo (WFC), and the immediate future looks grim for the company.
I've written numerous columns over the past several years aboutWells Fargoextending its dominance of the residential mortgage business. I've also written about the risks the company faces by focusing almost exclusively on this sector, if housing suffers an extended setback.
As I write this column in the afternoon of Tuesday, Oct. 14, Wells Fargo's stock price is off by 2.15%. To put this in perspective, the other three money centers are all up or close to even on the day. Bank of America (BAC) is up by about 0.7%, Citigroup (C) is up by 2.6%, and JPMorgan Chase (JPM) is down by .22%.
I would usually address this situation in my quarterly bank call report commentary, but the third-quarter reports won't be available for another month, so I'm addressing the issue here.
The reason for the discrepancy between the performance of Wells Fargo and the other three money centers today is that speculators, traders, and investors are realizing simultaneously that the housing sector is in trouble. That means that the mortgage business is in trouble.
This comes as no surprise to anyone who's been reading my columns on the housing sector this year, as I've repeatedly advised selling the builders and explained why. I'll provide my quarterly review of housing in another month as well, but the negative trajectory this year remains intact, and I expect the stock prices of the builders to decline much further.
In 2008, Wells Fargo had become much larger than the executive management team can handle when it purchased Wachovia, which had previously merged with First Union in 2001 and purchased Golden West Financial in 2006.
Golden West Financial was the repository of the toxic deferred interest and negatively amortizing loans that brought down Wachovia, shortly after it acquired Golden West and forced it to be purchased by one of the remaining money centers. Wells Fargo ultimately won that bid.
The toxic Golden West mortgages are still on the Wells Fargo books, and the company has shown little interest in restructuring them. This issue has been masked by the post-crisis increase in housing activity enabled by the lowering of the Fed funds rate, which resulted in mortgage rates declining to all-time record lows.
Instead of allowing the mortgage division to capitalize on this and run itself, allowing management to focus on other Wachovia assets, Wells Fargo did the opposite. Under the leadership of John Stumpf, management focused on the mortgage division. It was overkill and unnecessary, but it was the sector that Stumpf and his managers were most familiar with.
It didn't help that the banking industry was seemingly unaware of the risks taken by these management decisions, with the American Banker publication naming Stumpf banker of the year in 2013.
This type of accolades should always be viewed cautiously, or even as warning signs. In this case it reminds me of the accolades that were heaped upon the co-CEO's of Golden West Financial during the 1990's and early 2000s. The company had been named the most admired financial firm in the country for about 15 years straight by Fortune and Forbes.
Just a few years later, the value of the mortgages that Golden West had originated, carried, and sold to Wachovia would crater and bring that company down.
The current management decisions at Wells Fargo show no signs of changing. The housing sector had begun to face major headwinds since last year, when treasury yields and mortgage rates had spiked. The company began to expand its loan offerings in the non-qualified mortgage (non-QM) market, which I discussed in a column.
In short, non-QM mortgages are predominantly jumbo mortgages. They are loans with balances above the loans that are eligible to be sold through Fannie Mae or Freddie Mac, and are packaged into mortgage backed securities.
As I have outlined in another column, the housing sector most at risk of a correction now is the high end.
Both growth speculators and investors should note that Wells Fargo's business model had been aided by monetary policy, which has become a drag in the economy, and Wells Fargo has a management team that is incapable of meeting the challenge.
At the time of publication, Arnold has no positions in any securities mentioned.