Wells Fargo: Doing What It Takes to Succeed

By Steve Murray

One of the most surprising outcomes from the government’s “stress test” release comes from a bank that many thought was adequately capitalized to weather further deterioration in the markets. Among the 9 banks which the government will be forcing to raise new capital to cushion their equity position is Wells Fargo (WFC). Wells Fargo has been one of the few large-cap banks that was extremely conservative during the banking boom. Now it is being asked to raise an additional $13.7 billion, when management feels the bank's current capital position is fine.

During the banking boom, Wells Fargo avoided tactics used by other banks to raise its bottom line. Since it was founded in 1852, the bank has proven itself to be one of the most (if not the most) conservative banking institutions. It does not like to be classified as a typical Wall Street bank, because that is not how it operates. Rather than trading with its own book, or profiting off of huge fees from investment banking businesses, it prides itself by operating as banks used to. Wells Fargo makes a majority of its money by old fashion lending (which is hard to say for many other banking institutions).

John Stumpf, CEO of Wells Fargo, took over Dick Kovacevich’s job last year. During the height of the credit crisis, Kovacevich was quick to shoot down short sellers and fought against the media which classified Wells Fargo as just another large-cap bank that has been destroyed by toxic assets and poor lending standards. He has also publicly stated that the government’s decision to conduct a “stress test” and publicly release the data is “asinine” as the government conducts stress tests every day.

Struggles with Wachovia

With the recent acquisition of Wachovia (WB) last year, regulators are worried that write-downs from its books will severely affect Wells Fargo. Wachovia’s acquisition of Golden West Financial (a large sub-prime lender) led to the downfall of the prestigious bank. About 2 weeks after the announcement of Wachovia’s acquisition came the government’s TARP injections to U.S. banks. Kovacevich reluctantly accepted the money because he wanted regulators to pass the deal.

In an interview with Fortune, Kovacevich reluctantly explained: “You want to do what your country and your regulators want…” When the Wachovia deal was officially closed for $12.5 billion (almost $3 billion less than the original offer), Wells wrote down $37 billion of a Wachovia loan portfolio worth $94 billion. Many analysts were expecting this write-down to be significantly larger than $37 billion, and bashed the stock with downgrades.

"Unprecedented times"

The downgrades were warranted as Wells' TCE, or tangible common equity (a measure of a bank’s capital cushion), fell to 2.7%. This was below the industry standard and expectation of 3%, which many consider the bare minimum to operate healthily. Wells Fargo was able to raise $12.6 billion, more money than any non-IPO on record, to buy Wachovia. Many felt this was a sign of things to come for the bank, as it had targeted to raise as much as $20 billion in the issuance. Since then, Wells followed suit by unexpectedly cutting its dividend by 85%.

Defending the move, Stumpf said: “We’re going through unprecedented times, and more capital is better than less capital.” This cut did not ease investor’s concerns about the bank, which continued to trade down with the rest of the banking world. Since October, the bank has been able to raise $43 billion ($25 billion in TARP, $13 billion in private fundraising, and $5 billion in cost savings from the dividend cut), which is $23 billion more than management said it would need. Fed officials disagree though with the results of the “stress test”.

Out of the $13.7 billion, which Wells will need to raise, a large portion of the estimated write-downs come from first lien mortgages ($86.1 billion), second lien mortgages ($32.4 billion) and commercial & industrial loans ($14.7 billion). Analysts are extremely concerned with a $355 billion pool of commercial mortgages, and a $137 billion pool of credit derivatives. These assets were not added to Wells' books after the merger, but rather kept off-balance sheet through “Special Purpose Entities” or SPE. If these were added to its books, some analysts believe that Wells would need over $20 billion in additional capital.

Growth areas

Wells Fargo focuses on gaining customers, and making their lives better. Cross-selling products has been at the forefront of Wells Fargo’s success. Whether it be credit cards to mortgages for consumers, or even treasury-management and insurance for businesses, its primary focus has been increasing the number of products it sells per customer. Over the past 10 years, Wells Fargo has successfully increased the average number of products for retail customers from 3 to almost 6.

Growth has also skyrocketed for business customers too, as they now average almost 8 products per customer. Growth has not been hindered by the current financial crisis though. Both retail and business customers have been flocking to Wells to give them what they desire: Security. This business model has served the bank well from both retail consumers and businesses, because the more products they have with Wells, the less likely they will move their businesses to a competitor.

These segments have proved investors and analysts wrong about its business strength during this banking crisis. Wells Fargo pre-announced first quarter earnings results of $3 billion, which sent shares up over 30% that day as the results were more than twice what analysts were expecting.

What needs to be done

It is critical to Wells Fargo’s future success to complete these three necessary steps: 1. Continue operating as they have since the bank's inception, with conservative standards; 2. Raise enough money to cover the stress test results and to payback TARP; and 3. Successfully complete one of the largest bank mergers in history. The latter of the three is already ahead of schedule. The hardest step will be to distinguish themselves from the rest of the pack as an extremely conservative banking institution. This will allow them to raise enough capital to get them back on track.

Comments

[greedcanbgood:]

Your article reads like a PSA for Wells Fargo. Wells Fargo, though admittedly well run, has had its fair share of credit losses as a percentage of its portfolio. While not explicitly indicative of the aggressive and often borderline unethical lending practices of many others it does imply some measure of irresponsibility. The mere fact that it wasn’t an investment bank allows it to better absorb those losses and not have them compounded.

You do a disservice by not brining up at least two other VERY well run banks, BB&T and USB, both of whom have performed admirably in the midst of this burst bubble. Other than quoting an interview with its leadership, I’d sure like to see some more analytics and comparative data to support your commercial.

May 18 04:45 PM

[Vafer:]

"commercial?" seems like a lot of facts to me.
could actually add a lot more. eg. buffet, record earnings, the positive conf.call after the dilutive announcements.

"disservice?" the article is about wells fargo. not usb, not bb&t.

" While not explicitly indicative of the aggressive and often borderline unethical lending practices of many others it does imply some measure of irresponsibility."
What-are-you-talking about? it doesn't imply that at all.

On May 18 04:45 PM greedcanbgood wrote:

> Your article reads like a PSA for Wells Fargo. Wells Fargo, though
> admittedly well run, has had its fair share of credit losses as a
> percentage of its portfolio. While not explicitly indicative of
> the aggressive and often borderline unethical lending practices of
> many others it does imply some measure of irresponsibility. The
> mere fact that it wasn’t an investment bank allows it to better absorb
> those losses and not have them compounded.
>
> You do a disservice by not brining up at least two other VERY well
> run banks, BB&T and USB, both of whom have performed admirably
> in the midst of this burst bubble. Other than quoting an interview
> with its leadership, I’d sure like to see some more analytics and
> comparative data to support your commercial.

May 18 07:35 PM

[Radiohead:]

The funniest part about any analysis of any of these banks is people's willingness to disregard the fact that Wells Fargo, to name one, is leveraged to their eyeballs when compared to their tangible common equity. A quick back of the envelope calculation from their 4Q08 report shows approx. $29B in TCE, with total assets weighing in at over $1.3T. So you're telling me that you or anyone should be comfortable with a bank that can only withstand around 2.2% losses on its portfolio?? Are you insane? Do we not understand that employment is not going up anytime soon, and commercial RE is going to implode, not to mention credit cards? Seriously explain to me how defaults on Wells' loan portfolio is going to keep that equity in tact. IT WON'T HAPPEN. Disputing this is arguing from a stance that doesn't understand the true extent of how screwed our banks are. It should come as no surprise that a bloated bank like WFC needs to raise capital. They all do.

May 19 02:56 AM

[Radiohead:]

Also, your assertion that WFC is interested in attracting customers and "making their lives better," is hilarious. Sounds like you got that out of some marketing brochure. At $1.3T in assets, they are not some small community bank that knows your name when you walk in the door. The level of corporate bloat is likely tremendous. Since I have no direct knowledge of this, I won't make exclamatory statements stating such, but neither should you. Oh yeah, have you ever been a Wells Fargo customer? Ever talked with someone who is? My experience has been egregiously high fees, no matter what you are doing and extremely average customer service. When I went to close my account with them, they said they would have to charge me a fee to close my account. Turns out my experience was not dissimilar from many others.

The more I read articles from Bullish Bankers, the more I wonder if you guys just sit around and congratulate each other about your titles as opposed to doing some real thinking outside of the educations you are all STILL getting. You've got to question any advice from a bunch of guys who have no real world experience outside of preparing copies for some Hedge Funds.... But I suppose you would lead everyone to believe that you were instrumental in upper-level management decisions.

May 19 03:11 AM

[buoy:]

WFC has made my life better!

May 19 09:25 AM

[BSexposer:]

Radiohead = great band, TERRIBLE analyzer of banks. Dude, you really don't get it, do you. TCE is a MEANINGLESS metric - for some insane reason the dopey regulators have bought into the TCE mania hook, line and sinker. WHO CARES what the TCE is???? What matters is Tier 1 capital and earnings power. And WFC has plenty of each. Their dividend cut will add $5B/year in capital. And with their capital raise they will have over 4% TCE by November, if that makes you sleep better at night. WFC is the LAST BANK the regulators should be worried about. Seriously, you have a lot to learn about commercial banking, bro.

May 19 10:50 AM

[BSexposer:]

"My experience has been egregiously high fees, no matter what you are doing and extremely average customer service. When I went to close my account with them, they said they would have to charge me a fee to close my account. Turns out my experience was not dissimilar from many others."

Do you really believe that JPM or Citi or BofA is any different?!!?! Get real, fool. You are clearly clueless.

May 19 10:51 AM

[Ishortyou:]

the only thing that is going to recover the economy is the correction in the excess of housing invetories. BANKS will have to stop lending money to homebuilders and people that plan new home starts of their own, HOMEBUILDERS will have to stop building new homes and clear their excess of unsold inventories, COUNTIES will have to stop issuing building permits, MEDIA JOURNALISTS have to emphisize the importance of clearing these inventories, POLITICIANS will have to put a moratorium on new house starts, POPULATION in general will have to aggree to this strategy if they want to see their retirement funds appreciate again.

May 19 12:24 PM

[BerkeleyBob:]

I agree the initial post read like a puff piece. I am a WF customer, not shareholder. One unmentioned reason for taking a pass on a long position in WF stock is its considerable exposure to HELOCs, which they have aggressively marketed. I don't know how they are accounted for in a balance sheet sense, but a large number are due in 2012. Will California property values remain depressed for that long? Maybe. The FASB is apparently looking at tightening up "off the books" SPE's. It is a shame, what happened to Golden West but in its present form, both it and Wachovia will be very difficult to digest. Clearly, WF did not mark down its acquired loan portfolios sufficiently.

May 19 12:29 PM

[Radiohead:]

I'll just finally agree with a previous comment, that WFC is highly levered to California, and with their Wachovia acquisition, they are highly levered to Option-Arms. Based on recent recasts of ARMS in general, the time-bomb is set to go off between now and 2012.

Also, TCE isn't the end all be all of metrics when analyzing a bank, I realize that. I am just throwing it out there that WFC has next to nothing for common equity holders. The possibility that WFC will have to further dilute common shareholders is high with the kind of common equity they have. God forbid we enter into a period worse than the "stress tests" provided for, which based on current unemployment stats is worse than the regulators had planned for in 2010.... Good luck getting that to rise. Also, you've got to understand that California is screwed royally. There economy is going to lock up in a major way, should the state employees not agree to some major concessions, and/or state programs are cut...

We aren't out of the woods yet with regards to banks. That is all I am saying.

Jun 16 05:57 PM

[rpbarbati:]

Well, all that is fine and dandy, but it doesn't even matter to W.F. how they are trading or what they are investing in, because they have found the money tree right in their own back yard.

Fees, Fees, Fees, Late Fees, Overlimit fees, overdraft fees, etc., etc. That's right - if they need to raise 20 billion, 10 billion of it is going to come directly out of their customers accounts. And I do mean directly, and I do mean with out warning or notice or remorse. They just ate my entire last paycheck in 2 days, having charged me over 650 dollars in overdraft charges. They used overdraft protection from my credit card to put that card over its limit (35.00) repeatedly, and then proceeded to nail my checking account for $400 dollars over a 2 day period for my having overdrafted by less than a $100. Their customer service idiot argued with me trying to make me see that these were legitimate charges, my account was overdrawn. Yeah, of course it is legitimate to make a 400% profit in 2 DAYS. If Obama rolls out regulations for the big banks without limiting their ability to crush us all with outrageous fees, then we are all completely scr___ed - or at least those of us who can least afford to be scr____ed are going to be scr____ed! I closed all my accounts with them, and have moved to America First credit union.

Jul 06 02:38 PM