Careful mortgage lending practices helped the San Francisco bank avoid the problems plaguing large rivals such as Bank of America and Citigroup
Some of America's premier commercial banks, from Bank of America (BAC) to JPMorgan Chase (JPM), are still digging out from the 2007-2009 financial crisis, facing fat settlements and legal fees to resolve claims related to their mortgage portfolios that could yet cost billions of dollars. Not so Wells Fargo (WFC), the fourth-largest U.S. lender by assets, which is viewed by analysts as one of the commercial banks best positioned to sprint ahead.
Wells reported $12.4 billion in 2010 net income, beating 2009's number and placing it second in profits among the nation's largest commercial banks behind JPMorgan Chase. The San Francisco-based company moved into the top spot in mortgage lending in 2009, and held it last year, originating $386 billion in home loans as its main competitor, Bank of America, devoted more resources to working out troubled mortgages. "Wells is in a uniquely strong position to continue to outperform its peers," says Andrew Marquardt, an analyst at Evercore Partners (EVR) in New York. "They have weathered the storm far better than most."
Prodded by lawmakers, government-controlled mortgage companies Fannie Mae (FNMA) and Freddie Mac (FMCC) have pressed banks to buy back loans that were based on faulty data about homes and borrowers. Bank of America, JPMorgan Chase, and Ally Financial have settled in an effort to limit their liability. Bank of America paid $2.8 billion in December to end some repurchase demands.
At Wells, Chief Financial Officer Howard I. Atkins says the bank won't seek settlements with Fannie Mae or Freddie Mac over faulty home loans because, thanks to the stricter standards, its exposure is so small. "It doesn't make sense for us to pay up to get rid of the remaining small amount of problems we have," he says. The company bought back $1.36 billion in loans in 2010 and trimmed its reserves for future repurchases to $1.29 billion.
By contrast, Bank of America said the cost to settle demands from private investors alone could grow to as much as $7 billion to $10 billion. The Charlotte (N.C.)-based lender reported a $1.24 billion loss for the fourth quarter on costs to end mortgage disputes, while JPMorgan put aside $1.5 billion in litigation reserves to cover similar expenses.
Consider this odd tribute to the relative quality of Wells Fargo's underwriting: According to the Securities and Exchange Commission, Paulson & Co., the New York hedge fund, helped Goldman Sachs (GS) choose bonds tied to shaky mortgages to bundle into a security that later led Goldman to a $550 million settlement with the SEC. In its lawsuit against Goldman Sachs, the SEC cited e-mails saying Paulson rejected Wells Fargo's subprime mortgage bonds. Why? Because the bank "was generally perceived as one of the higher-quality subprime loan originators."
Still, Wells Fargo and its chief executive, John Stumpf, haven't avoided all issues tied to soured mortgages. When it bought Wachovia in 2008, Wells Fargo inherited a portfolio of option-ARMs (mortgages that let borrowers defer some payments), which have some of the industry's highest default rates. Wells Fargo still has about $90 billion in unpaid principal on that portfolio. The lender set aside more than $26 billion at the time to soak up losses on those loans and hasn't yet exhausted the cushion. And the bank said in October that, much like rivals, it would submit supplemental affidavits to courts in about 55,000 foreclosure cases after finding some didn't adhere to requirements.
The strength of its mortgage operations means Wells can exploit new opportunities in areas such as lending to midsize businesses, Marquardt says. Wells Fargo has 2,400 employees who focus on businesses that have $10 million to $500 million in revenue. It plans to increase that workforce by more than 10 percent this year, according to Perry Pelos, the executive in charge of the unit.
Pelos says that Wells Fargo's 187 commercial banking branches across the U.S. will distinguish it from larger rivals with fewer offices. Wells Fargo will also get a leg up by allowing local salespeople to make credit decisions and by offering a wider variety of loan products than smaller rivals, he says. "I've been in the commercial banking business for 25 years, and this is the biggest opportunity I've ever seen," Pelos says. "Shame on us if we don't take advantage of it."
The expansion sets up a clash with rivals that have also targeted commercial lending as an area for growth. U.S. Bancorp (USB) and PNC Financial Services Group (PNC) are among many that have said recently they're putting more resources into commercial lending.
And lending is likely to remain sluggish as companies with near-record amounts of cash hold off borrowing, according to Paul J. Miller Jr., a former examiner for the Philadelphia Federal Reserve Bank and analyst at FBR Capital Markets (FBCM). Until companies draw down their cash, he says, they won't need bank loans.
Even in such an environment, Wells Fargo's ability to avoid some of the major mortgage troubles slowing rivals gives it an edge, says D. Anthony Plath, a finance professor at the University of North Carolina at Charlotte's Belk College of Business: "That's why Wells can pursue strategic initiatives whereas Bank of America is essentially fighting fires."
The bottom line: Wells Fargo avoided many of the mortgage problems plaguing its rivals, leaving it in a strong position to expand its commercial lending.