Second-quarter earnings hits of the sort Wells Fargo & Co. is taking on its venture capital portfolio may not be the last, but analysts expect any losses by the handful of banks with large direct investing activities to be less dramatic.
Thats in part because other banks have been taking smaller, steadier losses, and also because they dont have the same large outsized positions and concentration that Wells had, said Henry C. Dickson, an analyst at Lehman Brothers.
Wells is a standout in size, said Kate Blecher of Sandler ONeill & Partners. Most of Wells Fargos $1.05 billion charge from private equity writedowns came from its stake in two stocks whose value has plunged in the last few quarters after having posted strong gains.
Several other banks with large venture capital portfolios, including Bank of America Corp., record the value of their public securities on a quarterly basis and hence may avoid big charges. FleetBoston Financial Group accounts for its securities, as does Wells, but it has been more aggressive, writing down $132 million in losses in the first quarter. Its publicly held portfolio, at $200 million, is also much smaller than Wells, which is $1.6 billion.
Still, poor-performing equity investments clearly will take a bite out of industry profits in the second quarter, and beyond.
Late Wednesday, San Francisco-based Wells Fargo said second-quarter results would include a $1.13 billion charge, the bulk of which was blamed on lower market values of stock holdings in the companys venture capital portfolio. Earlier that day, J.P. Morgan Chase & Co. warned investors that cash gains from investments would not be sufficient to offset writedowns in privately held investments. Morgan Chases disclosure could also affect second-quarter results, and led Merrill Lynch & Co. banking analyst Judah S. Kraushaar to lower his 2001 forecast by 10 cents a share, to $3.30 a share.
Bank One chief executive Jamie Dimon told investors this week that his companys direct investing portfolio would earn about $25 million a quarter the rest of this year, or half of what is normally expected. And finally, at a investors conference in New York Thursday, Bank of America chief financial officer James Hance said the Charlotte, N.C.-based company would have trouble meeting annual revenue growth goals of 7% to 9% this year, in part because of smaller equity investment gains. (See article above.)
Only a handful of banking companies have large direct investment portfolios, and most mark the value of their portfolios to market each quarter. Wells and FleetBoston include the value of the investments on the income statement when there is a material event.
For this reason, Putnam Lovell Securities analyst James Mitchell says he does not expect other banks with venture capital arms to have charges as a result of a drop in the value of these securities, like the one Wells Fargo revealed. I wouldnt be surprised if FleetBoston had $50 million to $100 million in writedowns, but it wont be $1 billion, he said.
In the fourth quarter of 1999 and first quarter of 2000, two companies in the portfolio of Wells Fargo subsidiary Norwest Venture Partners were acquired by publicly traded companies. When Wells recorded the value of its new stock in those companies, the venture capital gains were tremendous $721 million in the fourth quarter and $885 million in the first and a big boost to earnings.
Unlike standard practice at other banks, Wells Fargos subsequent earnings reports did not reflect a fall in the value of these securities. Instead, using available for sale accounting, Wells Fargo could wait until the stocks the two biggest are in Cisco Corp. and Redback Networks were worth far less than the original value before recording it on the income statement.
Ross Kari, Wells Fargos chief financial officer, said that the companys internal policy is to mark-to-market the securities if the stock is 20% below its original level for more than six months. For instance, as a result of an investment in privately held Siara Systems, which Redback bought in March 2000, the bank had 3.5 million shares in the company. The stock was initially valued at roughly $160 a share but is now trading at $15. We could have made the case to treat it earlier, but we stuck by our policy, Mr. Kari said in an interview Thursday.
Mr. Kari, who has announced he will step down from his position once a successor is found, said, We have been gradually selling out of these holdings.
J.P. Morgan Securities analyst Catherine Murray lowered her second-quarter earnings per share estimate to minus 1 cent from 69 cents for Wells Fargo, while Merrill Lynchs Sandra Flannigan lowered her second-quarter estimate to 3 cents from 70 cents.
Wells is somewhat of an outlier given its sizable publicly traded equity portfolio relative to others, coupled with the fact that they were not employing mark-to-market accounting (and writing down the assets as tech stocks were falling) and took noncash gains at the peak of the Nasdaq, said Lori Appelbaum, an analyst at Goldman Sachs.
Mr. Mitchell at Putnam Lovell said Fleet has been more aggressive in selling down its public positions, and he did not expect a charge in the next quarter. A FleetBoston spokesman did not return a call. In the first quarter, FleetBoston wrote down $132 million in venture capital losses.
Lehmans Mr. Dickson said that he does not expect Citicorp, which also has a large venture capital portfolio, to be at risk for a big writedown because it does not have the concentration in a few big public positions that Wells Fargo does. A lot depends on the individual portfolios, he said.
Still, that did not prevent these bank stocks from losing ground Thursday. Wells Fargo and J.P. Morgan Chase were the two biggest losers, Wells dropping 0.4% and Morgan Chase 2.3%. Noting the pressure lower private equity revenues are putting on earnings, Bank of America dropped 0.2% and Citigroup 0.8%.
The potential for the type of large losses predicted by Wells spurred the Federal Reserve Board to propose an across-the-board 50% capital charge on merchant banking investments when it wrote rules implementing the Gramm-Leach-Bliley Act last year. Industry protests persuaded the central bank to replace the 50% requirement with a sliding scale that considers the size of the banks investment relative to its Tier 1 capital, and tops out at a 25% capital charge.
The final rule is still being prepared, and both sides are likely to find justification for their original positions in the losses at Wells and Chase Morgan.
There is a group within the Fed that has been concerned about various large financial holding companies exposure to venture capital investments, said former Fed attorney Satish M. Kini, now a partner with the law firm of Wilmer, Cutler & Pickering. Those folks will look at those losses and say, We told you so.
At the same time, he said, The industry push-back will be, These losses show that we are able to manage our risks that our internal models work. Observers such as Karen Shaw Petrou, managing partner of Federal Financial Analytics, said the two banks losses will have little or no effect on the final capital rule. The role of capital historically is to absorb unexpected losses, Ms. Petrou said. These losses have been expected over the past six months, and it is quite clear that both Chase and Wells have the ability to absorb them out of operating income, which is the way this is supposed to work.
Rob Garver contributed to this story from Washington.
