Is Wells Fargo $50 Billion Short?

Despite Wells Fargo's (NYSE: WFC  ) rosy earnings pre-release last Friday, which sent shares popping like a champagne cork, the California lender's shareholders may be in for a nasty hangover. While it's clear that the banking environment was hugely favorable in the first quarter, Wells' balance sheet could still reveal enormous toxic exposures -- to the tune of $120 billion in potential losses, according to one analyst.

What's $50 billion between friends?
On Monday, KBW (NYSE: KBW  ) , an investment bank focused on the financial services industry, published a note stating that Wells Fargo will require an extra $50 billion in common equity if it is to repay the TARP investment and achieve a reasonable capital cushion.

The analyst's $120 billion loss estimate is based on an economic scenario that looks pretty severe, but far from implausible, with the economic downturn lasting through the first quarter of 2010, and unemployment peaking at 12%. Under those conditions, the KBW analyst estimates that Wells will need $50 billion in order to achieve a tangible common equity ratio of 4.5% by the end of 2010 (after repayment of the government's $25 billion TARP investment).

Wells Fargo isn't top of this table
As the following table shows, Wells has a ways to go before it meets that bar -- and catches up to the upper echelon of its peers:

Bank

Tangible Common Equity Ratio (on Dec. 31, 2008, unless otherwise noted)

Goldman Sachs (NYSE: GS  )

4.6%* (Mar. 27, 2009)

US Bancorp (NYSE: USB  )

4.5%

Morgan Stanley (NYSE: MS  )

3.3%* (Nov. 30, 2008)

Wells Fargo (NYSE: WFC  )

>3.1% (Mar. 31, 2009)

Citigroup (NYSE: C  )

3.0%**

Bank of America (NYSE: BAC  )

2.8%

Source: Standard & Poor's Capital IQ.
*Estimated. **Prior to the common shares/preferred stock exchange.

Shareholders: Buckle up!
Faithful readers will be aware that I have had concerns about Wells Fargo for some time. At the end of January, I suggested that the bank had yet to fully recognize losses in its loan portfolio. I continue to think that is the case; consequently, shareholders (a group I'm part of) should expect significant volatility in results (and share price) over the coming year. I'll be eagerly anticipating the details of the company's full first quarter earnings release on April 22nd -- they'll definitely merit investors' careful consideration.

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Alex Dumortier, CFA has a beneficial interest in Wells Fargo, but not in any of the other companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 15, 2009, at 5:26 PM, keahou wrote:

    WFC must have exposure to the subprime re-set mortgages that are just beginning to come in for the reset. These are the ones that have a teaser rate and have a negative amortization which is added to the principal each month. This make the new monthly payment jump to astounding figures.

    Holders may have counted on a refi before the 3 yr reset. We all know what those chances are today. These mortgages are likely to have a much higher default rate than previous subprime loans.

  • Report this Comment On April 16, 2009, at 2:26 AM, kenthedem wrote:

    I would suggest that Wells NOT payoff the Tarp $25 billion until it's due several years from now. It's relatively cheap money 5% as opposed to the effects on stockholders of a capital raise (which all the shorts are betting on).

    No let's keep the Tarp and use the effect of the reduced dividend, increased earnings, and the runoff of unprofitable assets, or asset sales, to continue to improve tangible equity.

    I suspect a lot of the Wells naysayers have short positions which now show hugh losses after the preannounced earnings the day before Good Friday, which for them was not such a good Friday!

  • Report this Comment On April 16, 2009, at 1:30 PM, mikecart1 wrote:

    Wells Fargo is going down and they aren't the only one.

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