When Wells Fargo reported its Q4 earnings last week, the one topic analysts and investors wanted much more clarity on, was the bank's exposure to oil and gas loans, and much more color on its energy book over concerns that Wells, like most of its peers, was underestimating the severity of the upcoming shale default wave.
And while the company's earnings call indeed reveals that things are deteriorating rapidly in Wells energy book, perhaps an even bigger concern for Wells investors, which just happens to be the largest US mortgage lender, should be what is going on with its mortgage book. The answer: nothing. In fact, at $64 billion in mortgage applications in the quarter, this was not only a major drop from Q3, but also the lowest since the first quarter of 2014.
Needless to say, without significant growth in Wells' mortgage pipeline and originations, there can be no upside to Wells Fargo stock, meanwhile one can kiss the so-called housing recovery goodbye for the final time, because now that the US Treasury is cracking down on criminal and money laundering "all cash" buyers, we fully expect the housing industry to grind to a near halt in the coming 2-3 quarters.
That covers the lack of upside. As for the downside, here are the key parts from Wells' conference call discussing the bank's energy exposure.
First: how big is Wells' loan loss allowance for energy:
We've considered the challenges within the energy sector and our allowance process throughout 2015 and approximately $1.2 billion of the allowance was allocated to our oil and gas portfolio. It's important to note that the entire allowance is available to absorb credit losses inherent in the total loan portfolio.
Then, from the Q&A, how much is Wells' total loan exposure, its fixed income and equity exposure toward energy:
I would use $17 billion as outstandings for energy loans. And for securities, I would use, call it, $2.5 billion which is the sum of AFS securities and non-marketable securities.
In other words, a 7% loan loss reserve toward energy, perhaps the highest on all of Wall Street.
Then, here is the breakdown by services:
We're focused on the whole thing. Half of those customers - half of those balances represent E&P companies, upstream companies. A quarter of them represent oilfield services companies, and a quarter of them represent pipelines and storage and other midstream activity. And it excludes what I would describe as investment grade sort of diversified larger cap companies where we don't view the credit exposure as quite the same.
But the punchline in the problem category was the following exchange with Mike Mayo:
<Q - Mike L. Mayo>: What percent of the $17 billion is not investment grade?
<A - John R. Shrewsberry>: I would say most of it. Most of it.
<Q - Mike L. Mayo>: So most of the $17 billion is non-investment grade.
<A - John R. Shrewsberry>: Correct.
To summarize: $17 billion in oil and energy exposure, which has a $1.2 billion, or 7%, loss reserve assigned to it already, and which is made up "mostly" of junk bonds.
In retrospect we can see why the Dallas Fed told banks to stop marking assets to market.
Source: Wells Fargo Q4, 2015 Conference Call