enters 2009 nearly twice the size it was last year, after closing its $12.7 billion acquisition of
on New Year's Eve.
The California-based bank's stellar recent track record, however, could be challenged by the addition of its East Coast counterpart. Wells shares currently trade at a premium to others in the financial space, thanks to the bank's conservative lending culture and strong price-to-earnings ratio. But while Wachovia offers a nice path to growth by expanding Wells Fargo's retail footprint in large markets like Florida, Virginia and New Jersey, it also brings a lot of baggage in the form of its troublesome mortgage portfolio.
Both Wells and Wachovia have tried to mitigate risk going forward. Ahead of the merger, approved by Wachovia shareholders on Dec. 23 and closed Wednesday, Wachovia took a $23.89 billion loss stemming from an $18.79 billion goodwill impairment charge tied to the Wells deal and a $6.63 billion provision for credit losses. Wells has therefore already incurred some of the damage.
Uncertainties nevertheless remain. Wachovia has not always had a good handle on the performance of its own securities portfolio. In May,
had to restate its first-quarter loss, making it 80% worse than originally reported, after writing down assets related to its life insurance business. Wachovia also ran into legal trouble earlier this year for its dealings in auction-rate securities.
The question for Wells is whether Wachovia's assets will continue to pose unforeseen problems. The main culprit in Wachovia's woes has been an option-adjustable rate mortgage portfolio the bank took on when it acquired mortgage lender Golden West in 2006.
According to Wachovia's third-quarter earnings statement, its exposure to the troublesome "Pick-a-Payment" loans totals $118.7 billion as of Sept. 30. Wells Fargo has said it anticipates about $74 billion in losses and mortgage-related writedowns following the merger. About $39 billion of that should be recognized at the deal's close, and then the remainder is expected to be charged off incrementally over the course of 2009 and 2010, said Credit Suisse analyst Todd Hagerman.
If the housing market continues to deteriorate, however, even that aggressive writedown forecast may prove insufficient. Further declines in home prices would accelerate charge-offs from Wells, yielding an unpleasant surprise for shareholders.
Wells' healthy cash position should offer some cushion. Following the announcement of the Wachovia deal, the company quickly raised $11 billion in a common-stock offering. The $25 billion preferred equity stake the bank sold the federal government through the $700 billion Troubled Assets Relief Program further bolstered its balance sheet.
Although Wells Fargo no longer boasts the highest possible credit ratings, agencies such as Fitch, Standard & Poor's and Moody's continue to rank the company among the top in its industry.
On Friday, Fitch Ratings affirmed Wells Fargo's Issuer Default Rating at AA following the Wachovia deal's close, saying that although the Wells will likely see declines in its asset quality over the near term, it "is well-positioned to absorb the associated credit losses." Fitch also said Wells is highly capable of integrating its acquisitions and that it should rebound from short-term deterioration in its capital ratios.
Meanwhile, Standard & Poor's on Dec. 19 downgraded Wells Fargo's rating, along with those of 10 other large financial institutions. It cited increased risk to the banking industry at large and a worsening economy. S&P's long-term issuer rating is AA. Moody's similarly keeps an Aa1 rating on Wells' long-term debt.
Wells' management is optimistic about its prospects after the Wachovia deal. CEO John Stumpf has said he anticipates $5 billion in annual cost savings in the combined company, and has been enthusiastic about the expanded branch network Wells will now boast. He has also said that the bank's existing deposit base is growing as customers flee failing or troubled institutions, seeking the stability Wells offers, and the company has said that it expects the merger to be accretive within three years.
According to Wells, the combined company creates a bank with $1.42 trillion in assets, $787 billion in deposits, 48 million customers and $259 billion in assets under management. The merger also substantially expands the company's presence in large markets such as Florida, Georgia, North Carolina, Pennsylvania, Virginia, Texas and New Jersey.
Saying that Wells has been "anointed a survivor by the government back-stop," Hagerman wrote that the bank's large profit margin and capacity to expand its balance sheet will offset additional credit erosion.
Furthermore, Wells has an institutional distaste for exotic loans, the company has said that it will let the more adventurous parts of Wachovia's portfolio expire over time. Barclays analyst Jason Goldberg notes that Wells' aversion to the TARP money has been a public matter, and he sees the government funds as "added capital to put to work, but we don't expect that to alter their risk appetite." Barclays provides banking services for Wells Fargo, and a Barclays fund holds Wells shares.
Goldberg isn't alone in his bullish stance on the company. Wells counts Warren Buffett's
among its major institutional holders. Berkshire holds an $11 billion stake that's worth about 7.8% of shares outstanding. Among other big investors,
each own around 3.5%.
The stock also offers an attractive dividend, expected to be $1.36 in the coming year for a yield of 4.6%. Goldberg noted that Wells has been one of the few banks to raise its dividend in the past year, and he said the payout appears safe.
Wells' competition has been hammered over the past year. Shares of
have plummeted about 76%,
Bank of America
has lost 65% and
have tumbled 27%. By contrast, Wells is only down 1.1%.
Thanks in part to the stock's outperformance, Wells shares currently trade at a premium to others in the financial space. The stock sports a price-to-earnings ratio of 16.77 based on 2009 earnings estimates from Thomson Reuters. Rivals JPMorgan Chase and Bank of America trade with P/Es of 12.72 and 6.93, respectively.
Writing in a research note, Credit Suisse analyst Todd Hagerman says that Wells' consistent earnings and strong balance sheet help justify the premium valuation. He also foresees growing market share for the company and the potential for an upside earnings surprise in coming quarters.
The market volatility has contributed to a recent dip Wells' share price. Trading around $29.32, the stock is down 26% from its all-time closing high of $39.41, reached on Sept. 19.
That dip may offer an opportunity for investors who believe the Wachovia acquisition won't yield additional nasty surprises. Should the integration go smoothly, Wells Fargo looks well positioned to continue expanding market share and generating consistent earnings as a newly-minted nationwide banking presence.