Wells Fargo: Higher Loan Defaults Ahead

From Bloomberg, Wells Fargo expects higher defaults ahead:

Wells Fargo & Co., the nation’s biggest home lender, expects unpaid loans to increase, adding to signs that the U.S. real-estate crunch will squeeze bank profits the rest of this year.

Wells Fargo wasn’t accruing interest on $15.8 billion of loans as of June 30, or 1.9 percent of the total, Chief Executive Officer John Stumpf said at an investor conference today in New York. So far, Wells Fargo has taken $7.3 billion of the $41 billion in loan losses predicted when it acquired Wachovia Corp. last year, and costs tied to the takeover are likely to be less than the estimated $7.9 billion, he said.

So loans worth about 10% of Wells Fargo's market capitalization are essentially dead weight. Add to that about 5/6th of estimated losses yet to be realized, and you have a situation where earnings are likely to surprise on the downside in future quarters.

“We have forgiven over $1.8 billion in principal balances,” Stumpf said. “The loan modification efforts we’re making should help reduce the future losses."

That's a huge assumption. Tell me what sectors, besides the government sector, job growth is coming from. In the end, loan modifications are a doomed last ditch effort to save bank earnings.

The bank’s risk from its $127 billion in commercial real estate is mitigated by experienced executives and better market conditions than during previous recessions, Stumpf said. “We’re not dealing with an outsized, overbuilt market,” he said.

This is a hard statement to comment on. What previous recessions are we talking about? The current 40% decline in commercial real estate prices is a direct result over overcapacity. Even the S&L crisis only brought commercial real estate prices down about 25%. The only way for this market to recover is for the problems in excess capacity, unemployment, and the consumer to be addressed. Otherwise, good luck picking a bottom in commercial real estate.