Updated from Tuesday, April 14The bulls and the bears have come to a crossroads after a huge rally in Wells Fargo ( WFC) stock last week. Since then, significant questions have been raised about its preliminary report of record first-quarter earnings and whether the company will raise equity . Until the company discloses more details about where, exactly, the expected $3 billion profit came from, whether it's sustainable, and whether Wells will have to dilute shareholders to shore up capital levels, the market seems to be taking a wait-and-see approach. The San Francisco-based bank attributed the expected results to mark-ups on a heavily written-down portfolio of bad Wachovia assets, as well as new mortgage business, healthier capital markets and "strength in our traditional banking businesses." The market was blown away by Wells' report, sending its shares up over 30% to close Thursday's session at $19.61. The fat profits -- which, at 55 cents per share, were more than double the average estimate -- left some analysts awestruck, but others smelled a rat creeping around in the wide differential. As a result, investors have been pressing to know details of purchase-accounting adjustments performed when Wells acquired Wachovia, which would give some sense of how much pain may be left ahead, or whether gains from those sharp writedowns last quarter will hold water. The question takes on special importance, due to a foreclosure moratorium proposed by the Obama administration and agreed to by Wells, Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C), Morgan Stanley ( MS), Fannie Mae ( FNM) and Freddie Mac ( FRE).
Halting foreclosures during the first quarter helped boost results because banks weren't forced to completely write off those assets. However, the moratorium won't last forever, and as credit conditions remain under stress -- especially in Wells' key West Coast markets -- some predict further pain ahead.
net charge-off level seems a valid question," writes Sandler O'Neill analyst R. Scott Siefers. Siefers -- who sits among the sideliners with a hold rating -- goes on to question "how much of this quarter's earning strength will come from mortgage banking ... and how much of it will be sustainable in future quarters ... Finally, we would be curious to know exactly how the net interest margin was able to come in so far ahead of our expectations." Others noted that even if Wells' results were not solely supported by "artificial" gains from accounting shifts, a worsening economy bodes poorly for future results. Indeed, when asked on CNBC whether he would attribute results more to improving credit conditions, or the Wachovia mark-ups, CFO Howard Atkins confirmed it was the latter. He and other bank executives, like BofA CEO Ken Lewis, have recently warned against assuming that better results imply better consumer banking conditions.
"We still hold our view that banks will not bottom until nonperforming assets growth decelerates," Goldman Sachs analyst Richard Ramsden writes above charts showing higher delinquencies and defaults for credit-card debt, leveraged loans, and both commercial and residential mortgages. "All data we track points to NPA acceleration in 1Q09."
The potential for some kind of equity raise is even stronger as confidence in the firm has risen dramatically. Wells shares have more than doubled from a recent low of $7.80 just over a month ago to close at $18.27 on Tuesday. The stock was flat Wednesday morning. Amid all the hype, Wells is keeping mum until results are officially reported next Wednesday. "It's our practice not to comment on analyst reports or speculation," Wells spokeswoman Janis Smith Appleton said in response to questions about capital needs and how various line items affected results. "And we are not commenting in more detail about Q109 earnings beyond our April 9, 2009 press release. The company will report its financial results on April 22, 2009."
are announced." However, few dispute that the firm has a strong franchise that stands to be ultimately enhanced by the Wachovia acquisition once its capital issues are contained and the economic headwinds die down. Its fundamentals may provide an opportunity for long-term investors who prefer to follow the lead of Berkshire Hathaway ( BRK-A) CEO Warren Buffet, who lifted his stake in Wells last year and asserted that its earnings potential a few years down the line is "better than ever." Rochdale Research analyst Richard Bove touted himself as one of those bulls in a report on Sunday, initiating Wells with a buy rating. He acknowledged that the firm has "an over-extended balance sheet and a need for additional capital," but predicts Wells will "earn its way out of its current dilemma." " I f one focuses on the earnings projected two years out, either by this comment or the consensus," Bove writes, "this is a very cheap stock."