Listening to David Einhorn's testimony on the Financial Crisis Inquiry Commission, I was shocked to hear a statement Einhorn made about Wells Fargo. While he was discussing his short position in MBIA he listed the major subprime players in 2006, and the largest originator was Wells Fargo. Even the interviewer had to have him repeat that vexing statement. Wells Fargo has generally been considered the shining spot in the mortgage business during the housing boom. I previously wrote an article describing Wells and its disciplined lending. Wells was indeed listed as the top subprime originator by Insider Mortgage Finance in February 2007. Just one month later the company fell to 9th place on the list.

It turns out Wells was using a different method to gauge its subprime presence. Wells generates revenue from originating mortgage loans, but they also make money servicing them by collecting fees. The company may hold the loan and service it, or the loan may be held by other investors and Wells just services it by collecting monthly payments and performing other duties on behalf of the investor. This was the case in their subprime exposure.

Wells apparently included these servicing rights for subprime loans in late 2005 to February 2007. They didn’t hold the actual loan and thus would not be exposed to any write-downs should the mortgagor default on the loan. At worst, this stream of revenue would evaporate if the home went into foreclosure. As I wrote earlier, Wells claimed to have left the subprime market in 2003, but that appears to be tongue-in-cheek.

In an interview with John Stumpf in 2007, the CEO acknowledged the subprime portfolio making up 10% of its $1.4 trillion portfolio. He would also admit to various teaser loans where low introductory rates were followed by high long-term rates. Again these types of subprime loans were just over 1.5% of its total portfolio. It was not a significant exposure, but Wells may deserve a slightly less flattering image than they’ve been receiving.

Disclosure: Long WFC

Josh Zachariah

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