adiposity

Time to Call Out Wells Fargo's Balance Sheet

Why do those that short banks completely ignore operating cash flow or earnings? Looking at the balance sheet in a vacuum without operating cash flow is a huge flaw in your analysis. If I charge off a loan by $100 but earn $100 in cash from other business, what happens to my balance sheet? ABSOLUTELY NOTHING. WFC is currently producing $39 billion annually in pre-provision pre-tax income (PPPI), a.k.a. cash, that it will use to offset future losses. Using your pessimistic loss numbers that would leave $25 billion to raise ($87 [pessimistic losses] - $23 [current reserve] - $39 [PPPI]), assuming all losses occur in one year. If the losses occur over two years, WFC doesn't need to raise any capital as that $39 billion or some number in its vicinity is recurring. On a $1.3 trillion balance sheet, PPPI is more likely to grow over the next couple of years as WFC resets the cost of Wachovia's liabilities and fee and spread income improves due to the recovery. Which timing scenario is more likely? Why do you ignore actual cash coming in the door and choose to only look at a static balance sheet? This ignores business reality. As a result, your analysis is completely flawed.

Tangible Common Equity: How Much Is Enough?

Just a quick point on your comparison to 1995. In my opinion, it's quite misleading. Throughout the early 90s, banks were reeling from losses stemming from a real estate bubble and a fairly deep recession. Throughout this period, they cut their dividends to rebuild capital. By 1995, they had repaired their balance sheets. So in effect you are comparing very different points in the credit cycle. Also, as a result of an accounting change, goodwill is no longer amortized. For certain banks, I think this focus on tangible common equity (i.e. liquidation value) is very foolish. Why are we completely ignoring the income statement? And loan loss reserves? In the case of WFC, you need to write off 40 billion (20 billion loss reserve plus 20 billion in pre-tax pre-provision income) before the company loses a penny going forward and such losses have any effect on the balance sheet. This amounts to about 5% of loans even after the Wachovia pick a pay loan write downs upon the consummation of the merger, which assumed a 20% default rate.

Wells Fargo: Risks Outweigh the Benefits

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.

Yes, Financial Companies Can Be Analyzed

I agree with Tom' Brown's message, but his statement regarding the timing of the Buffett purchase of WFC is not accurate. Buffett bought 5/6 of his initial holdings of WFC in 1990, the remaining 1/6 he bought in 1989. (See 1990 Shareholder letter under Marketable Securities).