Bloomberg opinion columnist Jonathan Weil has a talent for navigating balance sheets of often complex financial firms. In his latest piece, he writes about Wells Fargo (WFC), the bank who rejected the idea that it needed TARP funds in the first place, yet has to date neglected to repay the government for the loan. It is an interesting point as many investors, including a big one out of Omaha, have bought the stock of Wells Fargo because it held the mantle of conservative management among the too big to fail set. Whether it is because of worse than expected loans made by Wachovia or their exposure to the real estate market particularly in California, the bank has not been among the first group to repay the TARP. The Wachovia acquisition came with a large amount of loan guarantees from the government, so WFC lessened their risk where possible.
As Weil explains, the reason for the delay in repayment of government funding is plainly obvious when you start digging just a bit in the balance sheet. Quite simply they haven’t got a significant capital cushion to pay back the TARP in a way that leaves them adequately capitalized for any future weakness.
Wells had about $37.4 billion of tangible common equity as of Sept. 30, by my math. Yet even that number is frothy, because it doesn’t take into account the fair-market values for most of the bank’s financial assets and liabilities, which the company discloses in the footnotes to its quarterly reports.
Factor in those adjustments, and Wells’s tangible common equity falls to $14.3 billion, or just 1.2 percent of the bank’s tangible assets. The main reason for the difference is that Wells said its loans as of Sept. 30 were worth $22.1 billion less than the carrying amount it showed on its balance sheet.
How can Wells repay its TARP money, when its capital cushion on a fair-value basis remains so thin? A Wells spokeswoman, Mary Eshet, responded to that question by saying: “We will work closely with our regulators to determine the appropriate time to repay TARP while maintaining strong capital levels.”
She added that “our capital position is improving,” which is true, even using the bank’s fair-value numbers. So far this year, Wells has raised $8.6 billion in a common-stock offering, reported a $4.9 billion increase in retained earnings, and slashed its common dividend. — Bloomberg.com 11/18/2009
This is probably not news to anyone who follows Wells Fargo closely, but it does demonstrate that there is still quite a bit of risk in many financial stocks. The last few years have left many of them much worse for wear and still vulnerable to any downturn in the market. Not to mention that the relaxing of mark to market accounting rules has made their financial statements that much more difficult to decode.
Famed banking analyst Meredith Whitney has turned bearish and recently said that most banks are “grossly overvalued.” She has become more bearish of late because she believes that the markets are pricing in a stronger 2010 than will actually happen. In general, we tend to agree with her that the market has viewed the next few quarters with probably too much optimism for what we are seeing in the so-called real economy. However, when it comes to Wells Fargo, we have a Fairly Valued rating on the stock for a long term investor. Although, as Weil points out, the company may need to raise capital in order to be able to comfortably repay the TARP loans which would clearly be considered unfriendly to current shareholders.