What a wild begining to September.
Not only was Cerberus forced to come out and make a formal statement denying rumours of an impending default of one of its funds, Wells Fargo also came out to deny rumours that it was preparing a secondary offering to raise money to repay the Tarp.
Wells Fargo’s chief executive, John Stumpf, told Bloomberg Television shortly before yesterday’s market close that the bank planned to pay back $25 billion from the Tarp but it would do so out of organic earnings without an additional stock offering.
“We will pay it back, but we’re going to pay it back in a shareholder-friendly way,” he said. “We are now earning capital so quickly, organically, we don’t want to dilute our existing shareholders.”
If you are keeping score, the rumours yesterday were actually half-right: Wells Fargo is looking to pay back the Tarp. It just isn’t going to do it in the way people were whispering about yesterday. And that repayment will be costly to shareholders, at least in the short term. Any earnings redirected toward the government will deprive shareholders of that money.
Wells has been one of the Gang of Three megabanks–in addition to Citi and Bank of America–that hasn’t yet repaid the Tarp after the stress tests. Wells was one of the companies that arguably failed the stress tests, although officially no banks “failed.” It was just told that it “passed” as long as it could raise $13.7 billion to fill the capital hole in its balance sheet.
Can Wells really spin off enough profit to fill the capital hole and pay back $25 billion out of earnings? And can it really do this “shortly?”
The bank has already raised at least $7.5 billion by selling equity. And it says it generated more than enough revenue to fill that $13.7 billion capital hole. In addition to the $25 billion of Tarp equity, the Tarp warrants held by the government are worth around $1.33 billion according to Linus Wilson. So Wells needs something like $26 billion to meet its capital requirements and pay back the Tarp in full. (These estimates are very rough.)
In April the bank said it earned $3 billion in quarterly profits, its best results in 157 years. Wells also cut its dividend drastically, allowing the bank to conserve cash. In July it said it made $2.75 billion and kept the dividend low. If Wells were to continue that kind of outstanding performance–low dividends plus big earnings, something shareholders will hate–Wells might be able to pay off the Tarp somewhere in the middle of next year. But many analysts are sceptical of those results and predict Wells will stumble in the near future.
At the heart of the debate over earnings at Wells is whether the bank is being reckless by not provisioning for enough losses. If losses outpace the bank’s estimates, it could find that the capital hole is even bigger than expected. One analyst back in April estimated that the bank might actually face a capital hole twice the size of that estimated in the stress tests, meaning Wells would need something like $45 billion to repay the Tarp. That’s more than than three more years of profits with tiny dividends to shareholders.
What’s more, the cheap money from the Federal Reserve and lack of competition in several lending categories that have given the large banks licence to mint money may not last. As the economy recovers, the Fed will curtail aid programs and raise interest rates. Competition in lending will return. Those giant earnings from this year may become a thing of the past.
Then again, Wells has surprised critics all through this year. Those betting against its stock since the rally began in March have suffered painfully. (Although the stock is still down year-to-date by around 11%.) So maybe the current quarter is looking like the best one yet. Is this what Stumpf was signalling in his talk with Bloomberg yesterday?