Wells Fargo & Co. has sparred — sometimes in public — with the government over bailout issues, but to achieve the company's goals, it might want to make nice.
The bank's first order of business comes Wednesday, when it will report second-quarter financial results. If the profit and revenue numbers are strong — and analysts are betting they will be — Wells can then use the earnings to bolster capital, if the government approves. However, the government's cooperation is a wild card, observers say.
At issue is Wells' plan to avoid another common stock offering. In May, regulators ordered the San Francisco company to add $13.7 billion of capital, per the outcome of government stress tests. Though in the past the $1.3 trillion-asset Wells studiously avoided moves that could dilute shareholders, it had no choice after the stress tests and raised $8.6 billion through a common stock offering.
Wells planned early on to make up the $5.1 billion gap by getting credit from regulators for the difference between the stress test's financial assumptions for the company's second and third quarters, and the company's actual results.
Regulators have said if banking firms expected revenue higher than what regulators had assumed for the two quarters, the firms could count only 5% of that projected excess toward the amount they sought to raise in the capital plans they submitted in June. Banks can devote a higher percentage from revenues toward their capital shortfalls once they've actually earned the money, but it is unclear exactly how much higher the government will let them go.
The consensus among analysts on Wells' second-quarter earnings is 34 cents a share, down from 53 cents a year earlier because of many of the same one-time items other banking companies have seen, higher loan-loss provisions and deposit insurance costs among them. But analysts also predict pretax, pre-provision net revenue between $7.6 billion and $10 billion, similar to the previous quarter's $9.2 billion.
"We think Wells could report a blowout quarter on the revenue side," said Anthony Polini, an analyst with Raymond James & Associates. "They should have double-digit revenue growth from both fee income and spread income from wider spreads and balance sheet growth."
Will that be enough to impress regulators? Joe Morford, an analyst at Royal Bank of Canada's RBC Capital Markets, says it would demonstrate to regulators that Wells is well on its way to covering the capital shortfall from within. But others are not so sure it will be an easy sell.
Wells has had a tricky relationship with regulators over the past year. In the fall, its executives were among the industry's most outspoken in saying they did not need the aid; they eventually accepted $25 billion from the Troubled Asset Relief Program, saying it was for the good of the overall financial system. In March, Wells Chairman Richard Kovacevich called the stress tests "asinine."
Still, Wells has not announced any plans to repay the $25 billion as it works its way through credit quality issues inherited from last year's acquisition of Wachovia Corp. of Charlotte.
Wells and Federal Reserve Board officials declined to comment for this story.
Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. Inc., said there has been some speculation that Wells would announce another stock offering after it posted its results.
"But Wells has always been reluctant to raise capital — they had to raise it in May because they had a gun to their head — so I think they'll try to post as big a number as they possibly can" to limit future capital raises, Miller said.
Most observers are in close agreement on expectations for Wells' second-quarter numbers.
In particular, it should benefit from margin expansion and from continued strong growth in mortgage banking, Polini said.
In the first quarter, Wells generated more than $2.5 billion in revenues from its mortgage activities, both refinancings and new originations. Though that kind of performance may not be sustainable in the long term, Polini said that Wells will likely post a similar number — or higher — for the second quarter because mortgage activity likely did not taper off significantly.
Wells could also write up the value of its mortgage servicing rights, which would flow through its income stream, boosting its bottom line.
In the first quarter, Wells was more conservative and wrote down the value of its servicing rights to reflect the expectation of higher prepayments from refinancings due to lower mortgage rates. But now that mortgage rates are rising again, Wells will likely write up the value of its servicing rights, and analysts will be looking to see how much the write-up will offset the amount that Wells had hedged against the value of its servicing rights through interest rate swaps and other methods.
Wells could also benefit from the expected cost savings from its Wachovia acquisition last year, and from additional cuts identified within its $2 billion expense-reduction program announced in March, said Jason Goldberg, a Barclays Capital analyst.
The deadline for meeting the capital shortfall for all the banks that failed the stress tests is Nov. 8. While Wells' revenues might taper off in the second half of the year, particularly as mortgage refinancings decline, the company might still be able to make enough money in the third quarter to earn its way of out its capital shortfall, Miller said. The trick, of course, is convincing regulators that that route is sufficient.
Aside from revenues, all of the analysts expect Wells' credit quality — like many other banks — to have deteriorated in the second quarter, particularly in its home equity, commercial real estate, auto and credit card portfolios.