Wells Fargo should give up TARP fight
The bank should quit insisting it will earn its way out from under TARP. Raise money through an offering and move on.
By Lauren Tara LaCapra, TheStreet
There's a taboo question that isn't often asked when it comes to Wells Fargo (WFC) and its repayment to the Troubled Asset Relief Program: Investors don't seem to care a whole lot about dilution, so why does Wells' management?
Wells Fargo has been a bit headstrong when it comes to the bailout program. Executives have insisted they didn't need the money, that the public stress test was "asinine," that the bank will repay the funds "as soon as practical" but only while proving Wells Fargo's grit as a core-earnings machine. Any repayment will be in a "shareholder-friendly manner," implying that any capital raised will be kept to a minimum, if it's performed at all.
The attitude appeared commendable at first. Wells blew away the expectations of regulators, investors and even its own internal estimates for core capital generation during the first couple of quarters. It was as though Wells was standing up for the industry, whose morale was beaten down after posting huge losses, being doubted by the government and the market.
Now it just smacks as kind of silly.
The bank may well be able to generate the $25 billion in capital it needs to repay to the government -- eventually. But it will take a whole lot longer, and require billions more in dividend payments along the way. Many analysts and observers believe that TARP is a paperweight on bank stocks right now, and paying it back will remove some of the government's power in bank operations, along with the uncertainty it brings. The market seems to want TARP paybacks now.
Wells Fargo's stock more than tripled from a low point of $7.80 in early March to close out the second quarter at $24.26. It has continued to climb, but at a much more moderate pace, hitting a recent high of $31.53 in mid-October, but slumping down to $26.03 as of Tuesday's close. Paying back TARP might be the jolt that Wells Fargo's stock needs, even if the price is held back initially by the size of the capital raise required.
Wells is quite good at generating earnings, but it also has a big book of bad loans that are eating away at that capital. Its Tier 1 ratios are among the lowest for big bank competitors like Bank of America (BAC), JPMorgan Chase (JPM), U.S. Bancorp (USB) and others.
Wells Fargo's key metric, risk-adjusted Tier 1 common capital, stood at 5.18% on Sept. 30. While earning $7.6 billion in net income, apart from preferred dividend payments, Wells has only brought the metric up 2.08 percentage points since the end of 2008. Wells would need to move it another 3.32 points higher to reach the level that Bank of America will have after its mammoth $45 billion TARP repayment -- also the level that one can assume regulators may be requiring.
Using a simple ratio, it would take another $12 billion in earnings, and perhaps more than a year's worth of time, to reach that 8.5% benchmark. Then Wells would need to raise enough additional capital to keep the metric that high after repaying its $25 billion in TARP, along with however much the related warrants cost. There's also a $5 billion Wachovia-related debt it will need to pay Prudential Financial (PRU) at the beginning of 2010.
It would be a lot simpler, and far less time consuming, if Wells would simply reach out to the market for funding. Investors appear happy to oblige.
Bank of America has received nearly $33 billion from the market by issuing new stock this year, not to mention the capital raises completed in 2008. It is seeking approval to expand its float past the current 10 billion-limit on outstanding shares because of how much new stock it has issued. Yet demand was still strong, with investors snapping up $1.29 billion more than Bank of America was seeking in its most recent capital raise.
Investors have been eager to latch onto other bank stock in their recent offerings as well, including banks that raised capital to exit TARP, like Morgan Stanley (MS) and Goldman Sachs (GS); smaller regional banks like PNC (PNC) and Fifth Third (FITB); and even troubled financial firms like E*Trade Financial (ETFC). The market has been eagerly buzzing about a Citigroup offering to repay TARP, even though the bank is 40% government-owned and has a long ways to go in its turnaround before it can be considered a strong, independent bank again.
Investors may have concerns about Wells' loan book or its capital levels, but few doubt its core financial strength or earnings power. Its most-recent stock offering that sought $6 billion in fresh funds was well received and "heavily oversubscribed," according to CFO Howard Atkins, and ended up raising $8.6 billion in capital.
A Wells Fargo spokeswoman said the bank had nothing further to add to the comments made by CEO John Stumpf about raising capital at a conference Tuesday. Stumpf has repeatedly insisted that management will "earn our way out" of the crisis, and that TARP will be repaid in a "shareholder-friendly manner" with minimal dilution. He seems to be missing the point.
The government has required every other bank exiting TARP to raise capital in the market, and there's no indication that it will make an exception for Wells. Furthermore, it appears that investors would jump at a chance to buy more Wells Fargo stock -- but only if it helps remove the TARP burden. Why not just get it over with?
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John Stumpf acknowledges that growth has been slow, but he says he's still optimistic.
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