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Wells Fargo Sham Revealed

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.