Wells Fargo: Risks Outweigh the Benefits

The balance of risk remains highly skewed towards the negative, with further asset write-downs, earnings revisions, and dividend contractions to come. We are initiating coverage on Wells Fargo (WFC) with a SELL rating.

INVESTMENT THESIS

• Until home prices stabilize, Wells Fargo expects higher losses in its home mortgage portfolio. We expect further deterioration in Wells Fargo's balance sheet and earnings.
• Wells Fargo trades at a significant premium to its peers. We expect Wells Fargo's price-to-book multiple to revert towards the group's average and historical lows in comparable eras.
• Wells Fargo has the lowest Tier 1 capital ratio of its comparison group, thanks in part to its huge acquisition of Wachovia. We are skeptical of the reliability of future dividend payments.
• Good things come in threes, except Level 3 assets, which grew by 50% to $34.7 billion from the first quarter to third quarter of 2008. We expect both further growth and further losses related to these suspect assets.

RISKS

• Wells Fargo has utilized this turbulent time period to gain market share and position itself for the eventual economic recovery better than its peers.
• Both fiscal and monetary policy are squarely focused on solving (or at least minimizing) the effects of the financial crisis. With governments around the world throwing trillions at this problem, short positions in this sector will continue to face headline and/or intervention risk.

SUMMARY

Wells Fargo & Company has long focused on building relationships, both with consumers and businesses. With an emphasis on customer loyalty and its customers' well being (a.k.a. cross selling multiple products and making each customer more profitable), Wells Fargo did not become entrenched with toxic assets from pick-a-pay loans and the like as did many other financial institutions. Nevertheless, the credit crisis affected all banks last year, resulting in increased write-downs, the building of credit reserves, and the raising of capital. Regarding Wells Fargo specifically, it reported a net loss of $2.5 billion in the fourth quarter of 2008, including $6.9 billion of credit losses, securities write-downs, the building of credit reserves, and almost $300 million of Madoff-related charges. The quarterly loss, however, was overshadowed by Wells Fargo's purchase of Wachovia Corp. and the resulting $36 billion in fund raising that followed.

Wells Fargo's Level 3 assets are growing, while its Tier 1 capital ratio is decreasing and well below that of its peers. In order to maintain sufficient capital, and maintain the lofty common and preferred dividend payments, we believe Wells Fargo will need to raise even more capital. We believe WFC is likely to cut the common dividend. We initiate coverage with a SELL rating.

Disclosure: Short WFC.

Comments

[oceansmike:]

they should stop Short trading on Financials and reinstate the Uptick rule,sorry butty you naked shorts are going to cause a massive failure in the market place,,no long term invester will ever touch these stocks ,you will be responsible for the banks total failure,,,look at history ,,,why did you not predict this happening,,instead now we are stuck with all these short trader pundits that talk a stock lower for Hedge funds (naked Shorts)

Mar 05 07:34 AM

[oldmaninPA:]

A brilliant call with the stock already near its multi-year low. Where was this call when the stock was trading around $30.

Mar 05 08:00 AM

[adiposity:]

I would retitle your article: 'Shorting WFC is dumb because Risks Outweigh the Benefits'
The risk/reward on your short is not even close to in your favor. That's a crowded trade and should be very painful at some point. WFC is trading at 2x its current pre-tax pre-provision income without including any potential earnings from Wachovia. No one can predict when, but it is inevitable that WFC will start to move up substantially when things improve, even just slightly. This thing is priced for armageddon.

Mar 05 10:02 AM

[Donald Johnson:]

Good piece. Should help keep people from jumping in until Moody's comes out with new credit ratings and the stock forms some kind of bottom. Timing is everything, and WFC is a falling knife.

Mar 05 02:47 PM

[Irene:]

We, Wall Street, stock holders, banks and the government, would all be so much better off if you people (pundits) would just stop talking!! After a while it becomes a self fulfilling prophesy. Gloom and doom!! Would you be happier then! Go on vacation, write about something else. If you try really hard you may find something to bring you some happiness - but I don't count on it!! Bad news seems to have the ability of forming a smoke screen, making it more difficult to find any good news - TRY HARDER!!

Mar 05 04:12 PM

[listen to me:]

oh by the way WE'RE SHORT THIS STOCK

Mar 05 04:20 PM

[Skeptical Ben:]

I get it. They want to short WFC, so let's get some Seeking Alpha readers to join us. Who is Singular Research? Probably him and his wife. WFC was an awesomely managed bank until they gambled on Wachovia, they figured they'd never be able to get all those east coast branches on the cheap again. I think they'll survive. I'm long with re-invested dividends.

Mar 05 07:46 PM

[dare16:]

During bad time, short should not be allowed, it could make economy even worse. Majority would suffer.

Mar 06 04:49 AM

[pockyclips ...:]

Let's use some common sense. Since Wells Fargo is a major player in three out of the four worse housing markets, this shouldn't come as any surprise. Even
without the Wachovia boat anchor, WFC was going to take a major hit.

Mar 06 08:44 AM

[rich c:]

Well THANK GOD for this post !!! I can finally sell my WFC and sleep better. What should I do with my C and BAC???

Just now 'initiating coverage' (on WFC)? Isn't that a bit like saying, "I've been asleep the past 18 months but figured I should go ahead and have an opinion." Jeez. Why bother, friend?

I just think it's great that folks stick their neck out and write for this site. But hopefully you guys didn't spend a lot of time thinking about this one??

Mar 06 03:06 PM

[User 371798:]

These people who for whatever reasons constantly bash good companies
will only win if we let them. Every investor should do their own
homework before investing in a company or a mutual fund. There are
fantastic opportunities in the market today, opportunities that will
make people wealthy. Don't let the fear mongers prevent you from
sharing in that opportunity.

Mar 07 10:28 PM