Editor's note: This article was originally published May 12.
Investors who are buying up
shares these days are arguably making one of the riskier gambles in big bank stocks, though the payoff looms large if they are correct.
Wells executives believe the government's stress test finding -- namely, that the bank needed to raise $13.7 billion in additional capital -- were far afield from reality.
According to Wells, regulators did not take into consideration just how far the company wrote down Wachovia's assets, and they severely underestimated Wells' ability to generate revenue. The company is encountering strong mortgage business, "booming" deposits, wide interest margins and investment-banking opportunities, all with a vastly shrunken dividend. Plus, Wells says, cost savings and synergies at Wachovia that were better than initially expected.
"The Fed's results differ considerably from our results ... and that was under a stress scenario," CEO John Stumpf asserted in a conference call on May 8 to discuss an equity offering in which Wells raised $2.6 billion more than the $6 billion that had been first targeted. "We feel very confident in our numbers. We've had a 20-year record here at Wells Fargo and if there's one thing we do know, it's revenue."
In short, says Stumpf, much of the capital Wells is required to produce will be "additive, if you will."
The boastful attitude of Stumpf and other managers like Chairman Dick Kovacevich, who called the stress tests "asinine," and CFO Howard Atkins, who has touted Wells Fargo's operational successes in a confident, but data-centric manner, have solidified confidence in the firm, which first appeared after an earth-shattering
Positive analyst notes supported those initial gains, as did surprisingly strong results from other major banks like
Bank of America
. Increasing signs of life in the left-for-dead economy and stress-test requirements that are less dilutive than some investors had feared have propelled Wells further, along with the rest of the market.
All told, Wells' share price has more than tripled from a recent low of $7.80 in early March to close at $25.70 on Tuesday due to these bullish factors. Shares traded above $28 last week. The sentiment allowed the San Francisco-based bank to raise $8.6 billion in fresh funds last week through an oversubscribed common stock offering to fill in the mandated capital hole.
Shares were priced at $22 apiece -- a 22% discount to a stock that is now trading near $28. But it's worth remembering that only a month ago, Wells was trading around $15, and that past performance is no guarantee of future results.
In a simple presentation when announcing its plan to raise $6 billion in a stock offering, Wells estimated it will generate another $7.7 billion through pretax, pre-provision earnings, accounting adjustments on deferred taxes and intangible assets, and stock issuance through its employee-benefit plan. If those strategies don't provide enough of a capital buffer, Wells plans to monetize other assets and liabilities, like converting nearly $4 billion in convertible preferred stock it gained through the Wachovia acquisition.
Wells took pains to note that during the first quarter, when stress-testing was already underway, the bank exceeded examiners' pretax, pre-provision revenue estimate by $2 billion. Stumpf predicted similar results in the current and upcoming quarters, saying "we're already halfway through the second quarter" and "have a pretty good view of what the second quarter is going to look like."
Management also effectively pledged to not harm existing shareholders beyond the 9% dilution that will occur from last week's offering, with Kovacevich saying "we don't think it makes any sense to dilute our stockholders beyond what someone else is requiring us to do."
Wells also wrote down Wachovia assets by $1 billion more than initially assumed, has reduced exposure to less-risky loans and investment securities, cut merger-related costs, experienced better revenue synergies with Wachovia, and retained better deposits and interest margins at those branches than initially anticipated. Wells believes the firm will save $5 billion a year once the integration is complete.
Still, upcoming results hinge largely on a shaky economy that is struggling to regain its footing. A mortgage-refinancing boom strengthened earnings during the first quarter, but delinquencies, defaults and foreclosures are still on the rise, as home prices continue to slump. A wave of foreclosures is also looming in the distance, once major banks lift a voluntary moratorium put in place at the start of the year.
Even if housing is no longer the biggest loss-driver, credit-card debt and commercial loans are the next daggers ripping through bank balance sheets. Furthermore, while job cuts have moderated, unemployment is still on the rise, and expected to continue that upswing for some time.
Since Wells plans to generate the remaining $5.1 billion in mandated capital internally over the next six months, all of those factors will weigh heavily on its goal. Sandler O'Neill analyst R. Scott Siefers noted that the strategy is "fairly aggressive" and "a bit riskier than we would have guessed." It is also unlike any of the other nine banks that must raise $61 billion in additional capital by Nov. 9. Their plans mostly rely on stock offerings, preferred-to-common equity swaps and asset sales.
Nonetheless, says Siefers, "our initial impression is that, if anyone can generate the several billion dollars of excess capital internally, it is
The biggest risk, says Lawrence Kaplan, a former senior lawyer at the Office of Thrift Supervision, is whether management's promises will be fulfilled.
If economic conditions deteriorate further than expected, a stock that has had an impressive run-up in the past couple of months poses an increasing risk to investors. Wells is now trading at less than two times tangible book value, according to a Citigroup analysis.
If Wells is forced to come back to the market or the government with hat in hand, management's assurances will likely fall on deaf ears.
"The harder position will be down the road if they need more
capital, to come back and say, 'Oops, we were wrong,'" says Kaplan. "Because at that point, burn me once, shame on you. Burn me twice, I'm a fool."