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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