Paulson's gambit

Wells Fargo Can Hack Its Writedowns - Can Citi and JPMorgan?

Comment: There is some foul language in this link!

Excerpts:

On the Paulson agreement:

If the banks agree to Paulson's gambit, bank shareholders and loan investors will take a bath, credit available for housing will disappear, and a least one in three subprime borrowers will eventually default anyway. The editorial yesterday in the New York Times supporting the Paulson proposal is dead wrong: Loan modification does not help struggling subprime borrowers, only the politicians of both parties who prey upon them. Loan modification a la Paulson hurts investors, financial institutions and the US economy.

On Wells Fargo:


WFC ended the third quarter of this year with an ROA of 1.58% and ROE of over 15%, both figures are annualized and both a full standard deviation above peer. Run rate defaults were 80bp (annualized) through September 30, 2007, but WFC announced last week that it will write off 300bp or 3% of total loans which the bank considers problematic. That will take gross loan and lease defaults for the full year up to about 400bp or 4%, more than 2x the maximum probable loss from lending estimated by the IRA Bank Monitor or just inside the upper range for a "B" bond equivalent rating for the bank's portfolio.

The decision by WFC to immediately write down loans equal to 3x the expected defaults for all of 2007 may seem like bad news, but we view it as a sign of strength. Unlike the the big players in structured finance such as C, JPMorgan Chase (NYSE:JPM) and Merrill Lynch (NYSE:MER), WFC does not have much of a trading or capital markets operation.

The majority of WFC's Economic Capital needs stems from the investment book, followed by trading and then lending activities. The 0.8:1 ratio of Economic Capital to Tier One Risk Based Capital for the bank at the end of Q3 compared with just 0.5:1 for Q2, a more than 50% change in a single quarter. The increase comes from a big jump in WFC's securities portfolio.

Unlike many of its larger peers, WFC seems to have the capital and the earnings power to navigate its way through the coming credit risk storm.