Wells Fargo: Good bank or bad bank?
Ongoing worries about loans it inherited from Wachovia and capital questions leave Wall Street divided about the health of the West Coast banking giant.
NEW YORK (CNNMoney.com) -- Is all well with Wells Fargo?
Few other questions have nagged at bank investors more these days than the health of the San Francisco-based lender.
There are, of course, the ongoing concerns about the adjustable-rate mortgages and other questionable loans the company absorbed as part of last year's acquisition of Wachovia.
At the same time, many company observers have been puzzled about why Wells has yet to return the $25 billion in bailout money it reluctantly accepted last fall.
That uncertainty has left many on Wall Street divided about the company. The stock is up just 9% over the past four months, lagging the performance of many other big banks.
And of the two dozen analysts that cover the bank, nine rate the stock a "buy," nine have it labeled a "hold" and six consider it worth selling altogether.
Devotees point out that the firm's strong management team and the impressive revenue growth the company has enjoyed in spite of the recession make it one of the best bets in banking. Last quarter, Wells Fargo reported record revenues of $22.5 billion, helped in large part by origination of new mortgages.
"One of the keys for us is Wells' proven ability to grow revenue quarter in, quarter out," said banking analyst Joe Morford of RBC Capital Markets.
Detractors, however, have argued that Wells' latest results, particularly within its mortgage business, are unsustainable.
And there have been criticisms that the increase in Wells' loan loss reserves have not kept pace with its credit problems in recent months, especially as it remains exposed to troubled housing markets like California.
The firm's total number of non-performing assets, or loans that are not collecting interest or principal payments, for example, surged 45%, or $5.7 billion, in the second quarter from the previous three months. During that same period, however, Wells' loan loss reserves, grew at just 3%, or by $700 million.
With roughly $23.5 billion in reserves, it would appear that the company has an adequate capital cushion to handle further deterioration across its loan portfolio. But that's hardly certain.
Some analysts wonder if Wells could absorb another large writeoff tied to the loans it inherited from Wachovia without aggressively replenishing its reserves.
One of the biggest trouble spots of the Wachovia purchase were its option ARM portfolio of loans made under the Pick-a-Pay brand, a group of loans that allowed customers to pay less than the full interest payment on new mortgages.
So far, Wells has already significantly written down that portfolio, but with many of those loans due to reset in the coming years, those initial projections could prove too rosy.
"They did write down a good portion of that product," said Al Villalon, a senior research analyst with First American Funds, an investment firm which owns shares of Wells Fargo. "We are hoping that there is nothing beyond that."
In addition to having questions about its loan portfolio, many investors have also been focusing on the company's plans to pay back the $25 billion in bailout money it received last fall under the government's Troubled Asset Relief Program, or TARP.
Last week, Wells Fargo CEO John Stumpf said in an interview that his firm intended to pay back TARP money "shortly", adding that it would be done in a "shareholder-friendly way." Investors interpreted that comment to mean that the bank did not intend to issue new shares.
Instead, Wells has been retaining its profits to cover the repayment. If the company maintains its current earnings pace, some analysts anticipate Wells could return taxpayer aid as early as next year.
Such a tactic would certainly please existing investors in the company, including large stakeholders such as Warren Buffett, whose firm Berkshire Hathaway became Wells' largest individual shareholder when it acquired 304 million shares in early 2008.
But some analysts question why Wells would forgo raising money publicly at a time when peers experienced little deterioration in their stock price -- if any -- after issuing new stock.
There is also the question of whether regulators think Wells is healthy enough to pay back the money. Several other big financial firms, including JPMorgan Chase (JPM, Fortune 500) and American Express (AXP, Fortune 500), returned taxpayer aid only after raising money publicly. Neither of them were required to raise new capital as a result of the government's bank stress tests earlier this year.
Compare that to Wells Fargo, which was ordered to raise $13.7 billion following the stress tests. Paying the entire $25 billion at once would harm Wells' capital levels, or ability to absorb future losses, noted one analyst, who was not authorized to speak with the media.
The analyst noted that if Wells repaid the TARP money in full, its Tier 1 capital ratio, a key measure looked at by analysts and investors, would fall below 8%. That level is viewed as unhealthy by regulators.
Of course, other issues loom for Wells, including concerns about souring commercial real estate mortgages becoming the next shoe to drop for banks. In the years leading up to the crisis, Wachovia had become a major commercial real estate lender.
But for many analysts, the short-term challenges hardly outweigh the longer-term growth opportunities for Wells Fargo once things turn around.
At the same time, the company has been positioning itself to branch out beyond the bread-and-butter business of making loans. This summer, Wells executives indicated they were looking to rely more heavily than on the securities business it acquired as part of the Wachovia deal than originally thought.
And Wells' problems may all be relative. Wells did report a big Wachovia-relegated loss in the fourth quarter. But other than that, the bank has consistently generated better-than-expected profits during the recession. The same can't be said for many of its peers.