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Wells Fargo (NYSE: WFC ) recently joined JPMorgan Chase (NYSE: JPM ) , State Street (NYSE: STT ) , Goldman Sachs (NYSE: GS ) , Bank of America (NYSE: BAC ) , and others by repurchasing its TARP preferred stock from the government. Investors should ask: So what? Is the stock now a better investment?
To recap, Wells Fargo raised $12.25 billion by selling 490 million new shares. That represents a little more than 10% dilution to existing shareholders. That money, along with cash on hand, was used to repurchase $25 billion of TARP preferred stock.
Cash flow and earnings impact
Wells Fargo was paying $1.25 billion per year in dividends on that preferred stock. That cash is now available for other purposes. Wells Fargo's common stock pays an annual dividend of $0.20 per share, so those new shares represent an expense of about $100 million per year. Net cash flow from the deal is $1.15 billion per year, or $0.22 per diluted share.
It was estimated that Wells Fargo would earn $1.83 per share in 2010. The dilution from the additional shares brings that down to $1.66 per share. Add the $0.22 above, and the total comes to $1.88 per share. That's a slight gain even after the dilution (and being conservative by dinging the earnings for incremental dividends), assuming analyst estimates are close.
Balance sheet
On the asset side of the balance sheet, the bank raised $12.25 billion and paid out $25 billion, for a net cash reduction of $12.75 billion. Wells Fargo was carrying the TARP preferred stock at a touch more than $23 billion. How about that -- mark-to-market on a bank's balance sheet!
The decreases in assets and liabilities net out to a $10.3 billion increase in book value. Even after the dilution, that works out to a slight increase in book value per share.
Summary
The reduction in payouts more than cancels the dilution in earnings. Similarly, the percentage increase in book value is about the same as the dilution, leaving book value per share with a slight increase. Based on those two parameters, I'd say the CEO kept his promise to repay TARP "in a shareholder friendly way."
Pulling out the ol' crystal ball, it's reasonable to expect that Wells Fargo will increase its dividend and start a share buyback program when large loan-loss provisions are no longer a staple of quarterly earnings reports. The capital raise/preferred buyback puts a damper on future dividend hikes, because the increase will need to be spread over more shares.
In addition, the reduction in cash does leave the bank with less capital to make loans, acquisitions, or other investments that might increase shareholder value.
Changes from the TARP repurchase are minor, and the net result for investors is essentially no change in Wells Fargo's prospects. The wait for normalized bank earnings is still uncertain, and the TARP payback does nothing to change that.
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Report this Comment On December 30, 2009, at 4:17 PM, ron153 wrote:
The author needs to take some accounting classes. The dilution from Wells Fargo's stock issuance is about 3.5%, nowhere near the 10% he states.
Wells Fargo is the largest position in my personal and client portfolios.
Ron Beasley
www.rwbi.net
Report this Comment On December 30, 2009, at 5:22 PM, rd80 wrote:
Double checking the math.
Float before the offering was 4.7 billion shares.
Wells sold 490 million shares in the capital raise.
That would be a little over 10%.
Report this Comment On December 30, 2009, at 6:40 PM, ron153 wrote:
That's not how it works.
Report this Comment On December 30, 2009, at 6:43 PM, ron153 wrote:
That's not how it works. I suggest you call the company's investor relations department, they will be glad to walk you through the calculation. And if you don't believe this, check Morningstar - they estimate the dilution at 3%.
Ron
Report this Comment On December 31, 2009, at 7:46 AM, richandre wrote:
Wells capital raise was approximately $12.2 billion. Wells is now able to purchase in cash the remaining $5 billion Prudential stake in Wachovia Brokerage. So that alone reduces the dilutive effect of the capital raise. The dilution is limited to the extent that they can increase earnings per share with the capital that has been raised. 10% dilution assumes that they will be no better off from an eanrings standpoint with $12.2 billion in added capital.
Report this Comment On December 31, 2009, at 11:47 AM, DrRoberts1 wrote:
The title of this article is just plain odd. Over the past year Wells Fargo has made great strides in assimilating Wachovia as well as cleansing its books of the toxic assets that came along with the deal and has beaten estimates for the first three quarters by wide margins. As Mr. Krull should know, WFC never wanted nor felt it needed a TARP injection in the first place. One is not quite sure just how many "squares" are involved in Mr. Krull's analysis but postulating that WFC is currently occupying square one seems downright silly.
Report this Comment On December 31, 2009, at 6:16 PM, rd80 wrote:
@DrRoberts1 - The title to this article was changed by TMF's editors. Your other comments are some of the reasons WFC is in my portfolio as noted in the disclosure statement at the end of the article.
@ron153 - Thanks for the accounting lesson :)
@richandre - This piece just looked at the capital raise and TARP payback. As noted in the article, my calculations show the combined impact of those two events is a decrease in cash on the balance sheet, a slight increase in EPS and a slight increase in book value per share.
Thanks for the comments and Happy New Year.
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