Federal Reserve Board
Since much of this discussion has to do with interest rates, let us take a quick look at the change in rates over the past two years. 2006 and 2007 saw relatively steady interest rates. In January of 2006 the rate for federal funds was 4. 29 percent, and rose to 5. 24 percent by the end of the year. In 2007 the rate in January was 5. 25 percent, peaked at 5. 26 percent in February, March, and July, and then fell to 4. 24 percent by the end of the year.
These fluctuations of around one point per year (22% change in 2006 and 19% change in 2007) are small compared to the 1.16 point increase from 1. 00 to 2. 16 percent in 2004 (116% increase) and the subsequent 1. 88 point increase in 2005 (82% increase) (FRB). These numbers should provide us with at least a glimpse of banking profits and practices during increasing, steady, and decreasing interest rates periods as we look at Wells Fargo. Wells Fargo ended 2007 with 382. 195 billion dollars in outstanding loans, up twenty percent from 2006’s 319. 116 billion. Consumer loans make up 221. 913 billion of this, which is mostly real estate loans.
However, the bank grew their commercial loans more than their consumer loans in 2007 (ten percent compared to three percent). This means they are growing their loans steadily, but more so in the currently less risky commercial market. Interestingly though, when looking at the twenty percent rise in their loans, they increased their allowance for loan losses forty-one percent, twice that of their actual loans increase. One could only assume that this is an attempt to protect against heavier than normal losses from the year before, probably stemming from the sub-prime loan problems.
Interestingly enough, the total loan charge-offs increased forty percent, so the increase in reserves was well forecast. And the actual percentage of total loans that the allowances for loan losses represents has increased as well, although by only a couple tenths of a percent (Wells Fargo). This seems totally in-line with the bank’s realization that default rates were on the rise. Continuing on to look at how the bank’s loan losses and provisions for such affect their actual income, we come to the massive change in their provisions for credit losses.
On the income statement, the provisions for credit losses under net interest income have increased a whopping 260 percent. With only a nine percent increase in actual net interest income, this caused a thirty-three percent decrease in net interest income. 2007 ended with 4. 449 billion dollars in total loan charge-offs, up almost forty percent from the year before’s 3. 179 billion. The consumer loans made up the biggest part of this, totaling seventy-nine percent of the total charge-offs.
The solidifies previous notions about the consumer loan sector being a high-risk/high-loss business right now. Loan recoveries were down slightly from the year before at at 910 million, down from 925; further proof the the market did not get better in 2007 as many hope it would but most forecast it wouldn’t. Total loan charge-offs as a percent of average loans increased two-tenths of a percent, which is just about the same as the increase of allowances for loan losses compared to total loans (Wells Fargo). This is another number that must have been well forecast.
After analyzing Wells Fargo’s financial information, we can see that the quality of their assets has definitely decrease since 2006. This has to do mainly with the instability of their consumer real-estate loans, which while they did not increase them very much in 2007, still made up the majority of their loan losses. On the whole their nonperforming loans increased 35 percent from 0. 52% to 0. 70%. It seem that this increase in consumer loan loss (and likewise risk) put the halt on much of Wells Fargo’s growth.
Their average loans only increased twelve percent, while their reserves, charge-offs, and net charge-offs as a percent of average total loans increased by around three times that. The affect of the mortgage crisis caused by sub-prime loans is clear in Wells Fargo’s inability to properly grow in 2007. Much of their efforts were spent simply trying to offset the damages from the consumer sector loan losses. Well Fargo is probably one of the most heavily hit banks from this, being the number one retail mortgage originator and mortgage services in the country (Wells Fargo).
The degradation of consumer real-estate loan risk clearly hurt the bank. Because of their large holdings of this type of loan, they have seen a serious decrease in the quality of their assets.
Wells Fargo. “Wells Fargo Home Page”. WellsFargo. Com. 2008. Feburary 27, 2008. <http://www. wellsfargo. com> FRB “FRB: Federal Reserve Statistical Release H. 15 – Historical Data. ” Federal Reserve Board Home Page. 27 Feb 2008. Federal Reserve Board. 27 Feb 2008 <http://www. federalreserve. gov/releases/h15/data. htm#top>.