Wells Fargo Sham Revealed

In July Wells Fargo Increased Dividend 10 Percent.

"This increase, which reflects the Company's performance and our confidence in its long-term growth, is possible because of our time- tested vision and values, diverse business model and our talented team that collaborates so well as One Wells Fargo to satisfy all our customers' financial needs," said Chief Financial Officer Howard Atkins. "Wells Fargo is one of only a few financial institutions that have continued to increase its annual dividend, which now exceeds $4.5 billion."

Yesterday Wells Fargo raised $2 billion in a bond offering, proving the dividend hike was noting but a sham. Minyanville's Mr. Practical was all over the story today.

Let's tune in to what the ever practical Mr. Practical has to say.

Sham Revealed

Yesterday Wells Fargo (WFC) raised $2 billion in a bond offering. The cost of the capital? 9.75%. When the top rate it can lend at is 6% the only way it can make money on this capital is to lever it.... increase the risk.

I ask you, why would a company that just raised its dividend go out and raise dilutive capital (the cost of the capital will be a drag on earnings)? Since the only reason is to get capital ratios back in line, something a dividend cut might have done, we can clearly see that the dividend raise was a sham to make things look better than they are.

Financial companies are in worse shape, not better, than they were a few months ago. They desperately need to raise capital and anyone buying stocks at these levels is taking a huge risk that they will be caught in the middle of that process.

Risk is high.

Comments

[firstmethod70:]

um... disclosure please.

2008 Sep 04 06:12 PM

[toomuchgas:]

See Bill Gross' comments on CNBC. He won't buy bank debt till the Treasury moves to prop up FNM.

2008 Sep 04 06:44 PM

[whidbey:]

I have some dealings with Wells Fargo which have lead me to feel that the game was getting harder to play. They forced an auction on a fleet of leased trucks rather than sell them reasonably to my clients as slightly less than residuals. The auction resulted in a loss of 25% over the offer price. That is called gambling and losing is it not? Yes something is wrong I agree. If you are right, it is more wrong than I sensed.

2008 Sep 04 06:47 PM

[samadams:]

how come no one is talking about how they changed the way report mortgage losses on their books? they wont be able to hide in mid Oct when they report again--all I can say is watch out below

2008 Sep 04 07:30 PM

[marinsunshine:]

I think fact checking is in order. Who says Wells can only get 6% on there money? They have all sorts of legal methods of higher yields, credit cards, servicing fees, foreign exchange trading, various commercial business lines, etc.,etc.

2008 Sep 04 07:52 PM

[Bapcha's St...:]

seekingalpha.com/artic...

I agree.

2008 Sep 04 08:47 PM

[budtrader:]

I did some fact checking. Wells has issued some floating rate notes as late as August 28th at 3 month LIBOR + 65 basis points, or roughly 3.5% as of today (check the SEC's website). This 9.75% offering was issued by an asset-backed trust of Wells Fargo Financial, so the assets are undoubtedly earning more than 9.75%, as marinsunshine pointed out. The bottom line is that Wells is one of the few banks that hasn't had to do a dilutive equity offering of common shares. Additionally, how many other banks are not only increasing their dividend, but also continuing to buy back shares and make small acquisitions? They are not stupid. They would not do this unless they were confident of their asset quality and adequacy of the capital position.

2008 Sep 04 09:49 PM

[icandoitdon:]

"Additionally, how many other banks are not only increasing their dividend, but also continuing to buy back shares and make small acquisitions? They are not stupid. They would not do this unless they were confident of their asset quality and adequacy of the capital position."

good grief. if there is one think these major banks have proven during the last year and a half it is that they are utterly stupid. every one of these banks is still a short.

2008 Sep 04 10:02 PM

[bloombergju...:]

This is hybrid capital and carries a considerably higher risk premium than senior debt due to equity-like characteristics: perpetual life, ability to defer interest (i.e. dividends), and deep subordination to senior debt. The fact that it is issued from an 'asset-backed trust' is immaterial from an economic perspective; it is purely a legal construct necessary to create the security.
That said, issuance of debt or hybrid debt to support dividends and / or common stock repurchases is nothing new. I would argue that it is to Wells Fargo's credit that it could actually get a hybrid deal - especially one of this magnitude - done in the current environment.

2008 Sep 04 10:34 PM

[Randall Arnold:]

WF appears to me to be the closest thing to a solvent bank out there.

2008 Sep 04 11:55 PM

[sissi:]

Why they didn't let everybody know that they were going to raise the dividens. They did it after some internal big fish purchase more than a million dollars in shares at only $26 and then they raise the dividens knowing that it raise the shares to $30. Isn't this internal ilegal information? Do you know Martha...

2008 Sep 05 12:00 AM

[1 of 4:]

The statement that Wells can only lend at 6.00%, so why are they borrowing at 9.75% really just highlights the author's banking ignorance, though he does touch on the answer: LEVER IT.

As another poster noted, this bond offering has equity-like characteristics including perpetual life, interest deferment and subordination. Undoubtedly this will be treated as Tier 2 capital under BIS regs. The BIS rules set requirements on two categories of bank capital, Tier 1 capital and Total capital. Tier 1 capital is the book value of its stock plus retained earnings. Tier 2 capital is loan-loss reserves plus subordinated debt (subordinated debt is long term debt that, in case of insolvency, is paid off only after depositors and other creditors have been paid. Thus it can be used like equity to provide those creditors some protection against insolvency). Total capital is the sum of Tier 1 and Tier 2 capital. BIS requirements establish a minimum Total Capital of 8%. Technically new loans with a 100% risk weighting are funded with 8% equity plus 92% borrowings in the form of deposits (whether retail, commercial or inter-bank). Assume for the sake of simplicity that the loan is a one year term loan. The cost to fund this loan at the margin is the weighted average cost of the subordinated debt (8% x 9.75%) and the one year LIBOR rate (92% x 3.20%) for a total funding cost of 3.72%. So if they can lend at 6.00% and their funding cost is 3.72%, their interest margin is a respectable 2.28%. Without factoring in staff and other costs, that is a 23.4% return on equity. Wells has been chugging along at 20% return on equity, so it all seems to be in form to me. That this author concluded that Wells was making a capital raise in desperation is scary. Rather, Wells is likely seeing a lot of loan growth opportunities as other banks are on the sidelines repairing their balance sheets after flushing much of their capital away.

2008 Sep 05 02:47 AM

[Ishortyou:]

1 o 4 thank you for the assesment and education.

2008 Sep 05 07:21 AM

[kommando:]

FYI - WFC's recent bond offering is also callable after 5 years, another mitigating factor in risk managment of the potential liability.

2008 Sep 05 11:10 AM

[AMPH:]

I own the WELLS FARGO CAP XIV 8.625% preffered that came out recently. I am interested in this new issue but I am somewhat concerned about why they would need to raise even more money and at such a high rate. If WFC is one of the most solid banks out there, what is Citibank and the other weaker players right now going to have to pay? 11%?

On another note, can we expect to see some type of price adjusted on the WELLS FARGO CAP XIV 8.625% preffered with the new hybrid bond issue?

The new hybird issue is trading around 101.75, I think this is not going to run away and think that a good entry point would be around PAR. Any thoughts on this?

2008 Sep 05 12:10 PM

[The Jackal:]

Mgmt at WFC are a bunch of douchebag assclowns.

2008 Sep 05 12:14 PM

[barcswine:]

Something stinks, and it is not in Denmark !!!!

2008 Sep 05 01:58 PM

[pug:]

Greetings to the author and The Jackal. I'm a retired EVP of a large financial institution (not Wells Fargo). I found the article to show little understanding of banking and that the article's conclusion of a WFC sham is ridiculous. I also found the The Jackal's comments to sophomoric and zero value to an any investor (but hey, go look back at his previous 30+ cerebral comments). I know many of WFC's executives and I have continued to personally invest and believe in them. While other financial institutions have floundered or gone away recently, Wells has quietly and steadily increased marketshare and customer deposits. While other banks have been unable to attract institutional investors, Wells has continued to place loan portfolios. The true return on a Wells Fargo investment will be realized when the economy eventually turns and WFC emerges stronger than ever. By then, however, you will have missed your window of opportunity to buy at a low price. WFC executives have been and still are acting in what I believe to be a conservative and prudent manner and I will continue to invest with them at the appropriate share price. Go ahead and sit out if you so desire. In the meantime, Jackal, continue that incisive financial assessment and thrill us with your intellectual prowess. And to the author, go ahead, call Howard Atkins (CFO) he is the kind of guy that might surprise you by answering if he is available. He might then be able to help you understand a little more...

2008 Sep 05 04:11 PM

[pug:]

By the way, they went up 5.13% today.

2008 Sep 05 04:20 PM

[Recourse Bob:]

As a point of interest, I have thought that the banks may be maintaining their high dividend as a means to discourage short sellers. A short seller must pay the dividends of banks they short to the party to whom they borrowed the shares, even though the short seller does not receive the dividend from the bank. The payment of the dividend by the short seller must come out of their own pocket.

2008 Sep 05 09:55 PM

[poet1:]

1 to 4 - what do you think of SKF at the moment? I'm recently in.

2008 Sep 06 12:35 AM

[WEBISKING:]

If these guys were dooing"dub things" Mr Buffett wold be enlightening them.Dont worry about WFC

2008 Sep 06 05:01 AM

[Skip Olinger:]

Mr. Pug:
Thanks for you comments. According to my calculations, the increase in dividend of $.03 per quater cost the company about $397million per year in additional capital. That is about 0.8% of their total capital. That does not sound like much to me. $397 is about 20% of the $2.0B sub debt they just raised. Therefore, I think the author has a point that they are paying from one pocket and putting it back into another. But if I were running the bank and knew for certain my loan and investment portfolio was in good share I would keep up with the long history of dividend increases. It is not like this was a special dividend or out of line. If you take a look at the 2Q08 cash flow statement you will see that they cut back share repurchases to $500M from $2B in the first 6 mos. That had the effect of leaving $1.5B in equity in the company. So all in all, I just don't see this as being a big deal let alone a sham.

On to another point. I have to admit that I sold WFC a while back at $31. I still hold USB. I just got nervous about WFC having such a big position in home equity loans, car loans and credit cards. I don't think we have seen the end of home price declines in CA nor the bottom of consumer pain. Your comments on the loan quality?

2008 Sep 06 11:14 AM