Wells Fargo suffers from weight of Wachovia’s mortgage losses
As the banking industry went from bad to worse in 2007 and 2008, Wells Fargo & Co. looked like a strong man among weaklings, its balance sheet relatively resilient to the mortgage meltdown and economic contraction.
Last fall, the company was so confident about its prospects that when then-Treasury Secretary Henry M. Paulson practically ordered Wells Fargo and eight other giant banks to accept $125 billion in capital infusions from the government, Chairman Richard Kovacevich reportedly pounded the table, insisting that the San Francisco bank didn’t need or want the money.
So why is Wells’ stock down 45% since the start of 2009, compared with 36% for an index of 24 bank stocks?
Industry analysts blame fallout from the company’s agreement last fall to buy wounded Wachovia Corp. in a transaction that closed Dec. 31 -- compounded by an economic downturn that seems to be worsening every day.
“Since the . . . merger was announced, economic deterioration has deepened, raising investor concern, in our view, of the strength of the combined company’s balance sheet,” Keefe, Bruyette & Woods Inc. bank analysts said in a report Monday.
Wall Street will be looking closely today at Wells Fargo’s fourth-quarter financial results, trying to discern whether the combined bank has the earning power to build up capital -- a bank’s cushion against losses -- while offsetting loan losses far greater than those expected when the Wachovia deal was struck in October.
“We are taking a wait-and-see attitude toward the stock until the earnings announcement” today, the Keefe Bruyette analysts wrote.
The shares jumped Tuesday along with other bank stocks, rising 71 cents, or 4.6%, to $16.19. On Dec. 31, they closed at $29.48.
Other analysts didn’t even wait for the fourth-quarter results.
FBR Capital Markets this month cut its estimate of Wells Fargo’s earnings and said $12 was a realistic price for the stock 12 months from now. Noting that banks in general have been reporting horrible fourth-quarter earnings, FBR suggested that a dividend cut was looming at Wells -- though not as large as at Citigroup Inc. and Bank of America Corp., which sliced their quarterly payouts to a penny a share as a condition of receiving a second round of government investment.
Regulators said Wachovia, a powerhouse bank in the East and Southeast, was near collapse in early October when Wells, which is huge west of the Mississippi, agreed to purchase it for $15 billion in stock.
Then the country’s fifth-largest bank, Wells became the fourth-largest after taking over Wachovia, with about $1.4 trillion in combined assets.
For years, many analysts had salivated over such a deal because of the geographic fit and the opportunity to blend Wells’ aggressive sales culture with Wachovia’s tradition of excellent customer service. But the fear of huge losses is darkening the outlook, especially after Merrill Lynch’s $15-billion fourth-quarter loss dimmed the prospects of its emergency acquirer, Bank of America.
Wachovia’s biggest problem has been losses on pay-option adjustable-rate mortgages, or “option ARMs,” inherited through its acquisition of Golden West Financial Corp. of Oakland.
When the Wachovia deal was announced, Wells Fargo estimated that it would write down Wachovia’s $122-billion option ARM portfolio by $32 billion, or 26%. Wells raised the loss estimate to 29% in November, said analyst Joe Morford of RBC Capital Markets.
The question is whether even 29% would be enough of a write-down given the continued decline in home prices and rise in foreclosures. The actual amount written down will be reflected in Wells’ fourth-quarter results.
The turmoil in the economy also means Wells probably will record greater losses on Wachovia’s commercial real estate lending and investment banking businesses than Wells Fargo initially expected, analysts said.
The fourth-quarter results are likely to include further losses on Wells’ own consumer lending, including home-equity loans and prime mortgages, areas that Morford said also plagued Wells’ biggest rival in California, Bank of America.
The bigger the write-downs and other losses, the more damage that will be done to the combined banks’ capital.
A key indicator, Morford said, will be Wells’ ratio of tangible common equity to assets, a capital measure that excludes intangible assets such as goodwill and preferred stock such as that purchased by the Treasury.
“We expect the ratio to be just under 3%, which is uncharacteristically low for a historically strong bank like Wells,” Morford said. “You’d like to see it over 5% and in this kind of market really over 6% or 7%.”
On the bright side, the FBR analysts noted, Wells Fargo expects during the financial crisis to boost revenue, cut costs and increase its share of the banking market.
It’s possible, they said, that Wells will be worth $40 to $60 a share in three years, as some watchers of the company contend.
However, they concluded, “predicting earnings three years from now is next to impossible, given our expectation for further capital raises, increasing regulation and economic uncertainty.”
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