In the days leading up to Wells Fargo & Co.'s fourth-quarter earnings report, many observers were hoping for clarity on issues ranging from credit quality to the company's interest in tackling a major acquisition.
On the credit-quality issue, the San Francisco company confirmed Wednesday what many expected: The weakness that has been evident in home equity is now showing up in other consumer lines, including credit cards and auto loans. And one factor looming large over the company's M&A prospects is a general view that broad consumer trends in the United States are unlikely to improve soon.
Howard Atkins, the $575 billion-asset company's chief financial officer, said that as it looks to offset weaker developing consumer trends, it would continue to expand its insurance operation — it bought 16 agencies last year — and pursue retail bank deals in areas it considers to be growth markets, similar to its Tuesday agreement to buy the $1.7 billion-asset United Bancorp in Jackson, Wyo. It made two similar bank deals in the second half of 2007.
"Those are exactly the types of deals we'd like to continue doing," Mr. Atkins said in an interview.
In the category of deals for which Wells has less enthusiasm, count the legions of financial services companies struggling with broken mortgage lending operations. In the interview, Mr. Atkins said that Wells would not try something like Bank of America Corp.'s recently announced deal for Countrywide Financial Corp.
"What we're interested in is very different than the type of fixer-up transactions that other big banks are doing," he said. The company's name has been linked with the big Seattle thrift, Washington Mutual Inc., in recent days; Mr. Atkins declined to comment on that rumor specifically. Wamu has also declined, in connection with the rumor, to comment on its willingness to do a deal.
During the fourth quarter, the company's net income fell 36% from a year earlier, to $1.36 billion, or 41 cents per share, matching the average of analysts' estimates. Wells blamed the decline primarily on a preannounced $1.4 billion reserve for home equity losses.
Wells executives said Wednesday that they expect further credit losses this year, driven in large part by a housing market they say has yet to hit bottom.
But they also emphasized that the company is well-capitalized and diversified.
Mr. Atkins noted that in the last quarter Wells' revenue rose 8%, to $10.2 billion, from the year earlier; average loans jumped 20%, to $374.4 billion; and average core deposits grew 11%, to $314.8 billion. "We are in better position than most big banks in the country," he said.
However, though Wells has limited direct exposure to subprime mortgages and touts its lending practices as conservative, it has been hit harder than most of its peers in home equity lending, particularly in California, where home prices are plummeting.
"We did not fully appreciate the severity of the residential real estate downturn and its impact on our home equity portfolio," chief credit officer Mike Loughlin said in Wells' earnings report Wednesday.
Goldman Sachs analyst Lori B. Appelbaum said in a note Wednesday that home equity losses remain a vulnerability for Wells, especially in California, a state "we view as currently in recession."
But the company also said that commercial chargeoffs had risen by 62%, to $202 million, from the third quarter, largely due to small-business owners' defaults on unsecured lines of credit, which are similar to credit cards. Separately, credit card chargeoffs increased 27%, to $223 million, in the same period. And chargeoffs for other revolving credit and installment loans, largely in the auto finance portfolio, grew 14%, to $421 million.
The company had warned last month that it would boost reserves by $1.4 billion to deal with home equity deterioration. But Wells' total provision for loan losses tripled, to $2.6 billion, from the third quarter. Nonperforming loans rose 18 basis points, to 0.7% of total loans. The net interest margin fell 31 basis points, to 4.62%.
Observers said the setbacks at Wells may be harbingers of deepening credit woes in the financial sector. "The deterioration in consumer credit and the chargeoffs were higher than we thought they'd be, and now they are talking about credit losses being higher in '08," R. Scott Siefers, an analyst at Sandler O'Neill & Partners LP, said in an interview Wednesday. "That's meaningful. Wells is as good a gauge as anybody, given both their size and their geographic presence."
At the heart of recession concern, of course, is consumer spending, which accounts for about two-thirds of economic activity. With unemployment reaching a six-year high of 5% in December and retail sales falling 0.4% that month, economists are increasingly concerned that the national economy is tottering on the verge of recession.
"If there is a recession and people start to lose their jobs, there will be more problems with credit cards and auto loans — the loans that the typical consumer will struggle to service," Jay Bryson, a senior economist at Wachovia Corp., said in an interview Wednesday. "But in a national recession, the problem will be everyone's, not just Well Fargo's."
"Where credit goes will largely be a function of the economy," Wells' Mr. Atkins said.
But he also said Wells is on solid footing in terms of capital, with a Tier 1 leverage ratio of 6.8%, and he said the company continues to diversify, which should limit trouble areas' impact. The company expects to ramp up retail bank accounts by selling insurance products to existing customers, he said, and pushing for new customers via deals such as the one in Wyoming announced this week. He also said he expects that, with favorable interest rates, mortgage refinancing activity will pick up this year.
"Even in tough economic times, there is always more business to do with your customers," he said.
