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rd80 (99.10)

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May 06, 2009 – Comments (9) | RELATED TICKERS: WFC

If you’ve been following my blogs or picks, you probably know I’ve been a cautious bull on Wells Fargo (WFC), one of my original CAPS picks from Feb 2007 and a core part of my portfolio pretty much since I started investing in individual stocks.

Today I ended my WFC green thumb.  With the news leaks that they would need $15 billion as a result of the stress test and the sharp run up in price, I decided to capture the points and accuracy – surprisingly a bank, the nation’s second largest mortgage originator, beat the S&P by 15 points over the past 2+ years.

Going into the stress test, I believed WFC either wouldn’t need to raise capital or it would be a manageable amount.  The $15 billion leaked to the media nearly certainly requires a share offering and/or converting some of the government preferred to common.  Part of my premise for owning Wells was that they would be able to buy back the TARP shares out of earnings and reinstate the full dividend.  I can’t see that happening anytime soon if they need to squirrel away as much capital as possible.

What I don’t understand is why WFC (and BAC) rallied so strongly today on news they would need to raise capital.  In BAC’s case, earlier leaks indicated they needed $10 billion; this morning’s news reports $34 billion and the stock screams up????

I have no clue what’s going on in the market with the banks.  This news should have sent WFC and BAC share prices crumbling, but WFC rallies 15% and BAC 17%??  The only explanation I can think of is some major market makers were expecting bigger capital requirements to come out of the stress tests.

I also sold some more of my WFC today.  I kept some just to see how far this craziness will run, but am down to about a third of what I had before earnings a week ago.  A couple more days like today and Mr. Market can have my remaining shares too.

I still like the company and think the long term prospects are great, but I don’t see the basis for a 35+ % run in one week.  Holding the stock as a core position with a highly probable capital raise coming and/or a possible government preferred conversion with unknown terms is more risk than I care to take.  To date, a good rule of thumb has been to sell any bank that needed to raise capital – virtually all that issued stock went on to trade well below the offering price.  If/when the share price pulls back and/or the capital raise picture is a little clearer, I’ll consider buying it back.  If it doesn’t pull back, there are other stocks out there.

Any theories to explain strength in banks that need to raise money?  Anyone buying banks in this run up?  If so, which ones and can you share your reasoning?

Fool on!

Russ

9 Comments – Post Your Own

#1) On May 06, 2009 at 11:09 PM, devoish (98.73) wrote:

Maybe the real results do not match the leaked ones? Maybe the people who have reviewed the results have told their friends accurate information?

Maybe I am paranoid and think the markets are manipulated, and will be until the "experts" with experience in investment banking are removed from Government?

I don't know.

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#2) On May 06, 2009 at 11:23 PM, russiangambit (29.94) wrote:

> Maybe I am paranoid and think the markets are manipulated, and will be until the "experts" with experience in investment banking are removed from Government?

Good one. LOL.

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#3) On May 06, 2009 at 11:29 PM, russiangambit (29.94) wrote:

May be SEC should look into this. I liked QualityPicks post about needing a downtick rule to protect  long-only investors from their own folly.

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#4) On May 06, 2009 at 11:42 PM, StopLaughing (< 20) wrote:

By converting government perferred into common the banks are getting "free" money without the cost of raising it. It does dilute common but that is offset by not having to pay the preferred dividend and not having to buy back the preferred in the future. There is a big difference between converting government preferred and raising new capital in the current market. Both dilute capital but the dilution was already priced into the market.

The "smart" money (inside info) already knew the formula for the stress tests and could compute the needed capital. They also knew that the preferred would be converted.

On more major reason for the bank stocks to go up is political. Obama just bet the future of the Dem Party on making money on those bank stocks. Do you really think he is going to hand the Reps an issue like that. He has to make money for the tax payers now on the banks or the Reps will rip him.  He just took the risk out of those bank stocks. He can't afford to have them down and losing money in the next election. 

 

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#5) On May 07, 2009 at 12:40 AM, kmcgorry (< 20) wrote:

> By converting government perferred into common the banks are getting "free" money without the cost of raising it. It does dilute common but that is offset by not having to pay the preferred dividend and not having to buy back the preferred in the future.

>>

 While I'm sure that's a (small) relief to the board, it doesn't address the core issue.  Bank equities have become a short-game ponzi with no underlying value.

 "Need to raise capital" is just the latest euphemism for an insolvent business. We are now witnessing the slow nationalization of our banking system.

 Should the government prove a profit on a handful of government-run businesses would only bolster a case for socialism and permanent corporate welfare.  If anything, Congress will be demanding disincentives for public funding.

Right now, job #1 for any official (public or private) is to persuade everyone that there's nothing to see here, before they look behind the magician's desk more closely and see that our entire economy is founded only on the willing suspension of disbelief.

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#6) On May 07, 2009 at 12:55 PM, rd80 (99.10) wrote:

devoish - I'm with you on firing the 'experts.'  Can we fire the tax cheats too? 

russiangambit - SEC look into it?  If Devo's right, they're in on it.

StopLaughing - The 'convert preferred to common' strategy is one of the key proofs that this whole excercise is purely political.  Since that doesn't raise any new cash, the only thing it does to help the bank survive is replace the preferred dividend with a lower common dividend, a slight cash flow improvement.  Otherwise, it does nothing to improve the bank's ability to survive or loan money. 

One other concern for common holders besides just the dilution from a preferred conversion is having the government as one of the biggest shareholders.  Politicians' primary interest isn't profitability, it's getting elected and retaining or retaking power.  Without getting into a discussion of the pros and cons of running a business with top priority of social good vs profitability vs political power tool, the point is the government's priorities as a shareholder usually won't align with those of private shareholders.

Thanks for the comments.

 

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#7) On May 08, 2009 at 8:16 PM, rd80 (99.10) wrote:

Glad I didn't sell all my WFC.

Bought a little back early this morning.  After listening to their conference call last night and seeing how well the offering went,  it seemed like the plan to raise capital is sound.  

Sell some at $25.70, buy it back at $24.60, ride it to $28... If I could figure out how to do that on a regular basis, I'd retire.

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#8) On May 08, 2009 at 8:21 PM, automaticaev (33.88) wrote:

why wells?

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#9) On May 08, 2009 at 9:32 PM, rd80 (99.10) wrote:

Several things I like about Wells
    They're going to own the mortgage market soon
    Wachovia is short term pain, but with the tax breaks it's going to look like they stole it in a few years.
     Best net interest margin in the business. 
     Very strong market response to the secondary and a good plan to cover the rest, i.e. I don't see much risk of needing to bring the gov't in as a common shareholder - that was my biggest concern from the stress test results.
     The big write downs they took on Wachovia's assets probably put their balance sheet in the best shape of any of the big banks.

There are a number of risks as well, even after my buy back this morning my Wells share count is down from pre-earnings levels.
     They may need to raise more capital to meet the stress test TCE level.
     Still lots of loans that will need to be written down
     I don't see them buying back the gov't preferred in the near future.
     Who knows what the gov't will do next.

I want a big, diversified financial in the portfolio.  I think BAC is going to have trouble raising $34B without serious shareholder dilution.  C is way outside my risk tolerance level, note that last quarter, even with near zero fed rates they still lost money. JPM is probably in better shape than WFC, but I think Wells has more growth opportunities as they expand their footprint.

FWIW, at $28, I'm more inclined to take my profit and run than I am to buy more. 

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