Wachovia's 'Poorly Timed' Deals Put Dividend at Risk

Ken Thompson is in denial. In his 2007 letter to shareholders, the Wachovia (WB) CEO admits only (and “with the benefit of hindsight”) to poor timing in his May 2006 acquisition of Golden West Financial. Never mind that most analysts and investors knew at announcement that this expensive, top-of-the-market misadventure would destroy value.

The company’s market cap now stands at $59.6 billion – down 38% since the deal was announced and despite 19% more outstanding shares in order to pay for Golden West and, more recently, A.G. Edwards. Thompson’s grudging nod aside, he has yet to shoulder responsibility for having so poorly assessed the deal’s earnings dilution and geographic and product risks, which have in turn so materially worsened the market’s view of Wachovia’s credit quality relative to peers.

Still, Thompson crows that Wachovia earned $6.3 billion in net income in 2007, despite $4.3 billion in valuation losses and credit reserve build. Even so, net income was 19% less than the company earned in 2006, and as noted, spans a much larger share count. Worse for investors, earnings this year are likely to decline another 20%, to about $5.0 billion, as residential mortgage and auto lending credit costs balloon further, and the company is forced to take more asset writedowns on everything from subprime CDOs to leveraged loans. All this implies earnings of about $2.50 per share (compared to a $3.41 consensus estimate) and a forward earnings multiple of 11.8 times.

The yield on the common stock, meanwhile, stands at 9.2%. Is that sustainable? I say no. This year’s dividend will cost about $5.0 billion—roughly what I expect the company will earn in 2008 after $433 million in preferred dividends. As it is, Wachovia has twice repaired to capital markets since December to raise a total of $5.8 billion in preferred equity. Recent acquisitions (not just Golden West, but also SouthTrust, and Westcorp, and A.G. Edwards) are not accreting to earnings. Meanwhile, Fed Chairman Bernanke is “encouraging” banks to raise capital, cut dividends, restrict share repurchases, and even forgive mortgage debt.

In the midst of all this, Ken Thompson has positioned Wachovia at the center of several adverse credit and market trends. Damage to mortgage markets is especially acute and long lasting. Wachovia needs to be rebuilding its capital, not paying it out to shareholders. In my opinion, a common dividend cut is likely in the year’s second half.

Comments

[jack kreg:]

Keep on bashing the stock, I want to buy at lower prices, using the shovel.

2008 Mar 07 12:10 PM

[Cincy Trans...:]

If the stock goes any lower, I'll have to use the certificates to soak up the oil that splatters on my garage floor when I change the oil in my AMC gremlin.

2008 Mar 07 03:50 PM

[TN hick:]

put time?

say can i buy a call on the future value of the Gremlin? :)

2008 Mar 08 10:12 AM

[jimsep:]

The dividend will be cut before the second half of the year.

2008 Mar 09 11:45 AM

[ballsschweaty:]

I predict a dividend cut in April and bankruptcy in early 2009. Enjoy!

2008 Mar 09 11:53 AM

[johnthebear:]

So when does it end?

2008 Mar 09 01:09 PM

[claudio.lan...:]

so, with the continuing purchases by insiders with their own money even as late as thursday, do you think these executives have money to burn? Perhaps they know something you don't. Bankruptcy by early 09 would be in that case bankruptcy for citi, WM, and others. I think you need a reality check. Here is a rumor I heard WB was in talks to buy WM ...and execs were meeting frantically as late as last week.

2008 Mar 09 02:02 PM

[Cincy Trans...:]

My dead cat Fluffy has more bounce than this stock;
Can you spell f-r-e-e f-a-l-l ?

2008 Mar 10 10:02 AM

[Cincy Trans...:]

Plus I'm a dumbass ... I can't even spell my pseudonym

2008 Mar 10 10:06 AM

[Joe Rodney:]

If you listened to the 4th Quarter 2007 year end conference call presentation you heard Management say: "In 2008, [we are] confident that Wachovia will generate sufficient cash earnings to cover dividend payments, build credit reserves, invest in our businesses, support balance sheet growth and improve capital ratios."

Many people out there have a tendency to paint every company in an industry with the same broad brush without drilling down into the details. The fact of the matter is that as of Year end 2007, WB was in much better shape than the rest of the subprime mortgage industry and many other banks in general. Its tier 1 capital adequacy stood at 7.2% and it total capital adequacy ratio stood at 11.5%, which are both well in excess of minimum requirements and even "desirable" levels. This means that WB "has sufficient capital in relation to risk sensitive assets to absorb any risk rises in the near term."

Nonetheless, increased write offs in Q1 can be expected as the economy continues to falter. Will this result in a dividend cut? I don't think so. Yes, earnings will be weak, and the dividend payout ratio for 2008 will be high. But a dividend cut will crater the stock and will cause investors to abandon ship. I don't think WB will want this to happen.

2008 Mar 10 06:29 PM

[Norman Lepo...:]

The insider buying is important!

2008 Mar 11 02:59 PM

[johnb221:]

I worked for A.G. Edwards for 25 years ad very disappointed that Bob Babgy would sell them out as soon as he eliminated Ben Edwards. Ben was a good man and also disappointed by the sell-out, but Edwards will no doubt add another billion in revenues to WB... I think the dividend is safe, but I wouldn't buy back into financials until late May (and then I would prefer RJF).

2008 Mar 12 07:50 PM