Term Paper on "Fargo (NYSE: Wfc)"

Term Paper 15 pages (4604 words) Sources: 1+ Style: APA

[EXCERPT] . . . .

Fargo (NYSE: WFC), following the completion of its purchase of Wachovia, is now the fourth-largest U.S. bank by assets, with the largest branch network (Reuters, 2009). The company was founded in 1852 by Henry Wells and William Fargo as both a banking concern and a delivery concern (the forerunner of an armored car business). The bank opened in San Francisco during that city's gold rush. At one point, they ran the western leg of the Pony Express. The company spread across the West on the basis of their transport business, first by stagecoach and later by railroad. By the early 1900s their offices were increasingly shifting towards the banking business (Wells Fargo History.com, 2009).

In 1918 the Federal government took over the express business and left the company as a bank only. The years following World War Two were the prime expansion years, with Wells Fargo able to grow rapidly from its strong market position in northern California. It introduced credit card service, and continued with a steady stream of mergers. The company did not begin to make acquisitions outside of California in earnest until the 1990s. Wells Fargo has stuck to its banking roots the entire time, focusing on the retail segment. After the Wachovia purchase, the company has a national presence and has extended into Canada as well through Wells Fargo Financial. In retail banking, they operate in 39 states.

3) Wells Fargo purchased Wachovia as of January 1, 2009. The deal was announced in October, 2008. Wachovia had held a significant amount of bad mortgage debt and was forced into finding a buyer by federal regulators. Wachovia had courted Citibank, but that bank's bid was smaller than the one that Wells Fargo put in. The Wells Fargo bid came in at $12.7 billion.

The major consideration in this merger for Wells Fargo was whether or not it had properly assessed the risks in Wachovia's assets. A significant portion of Wachovia's toxic assets had come from its purchase in 2006 of Golden West Financial. Corp. Wells Fargo believes it will have to write down $71.4 billion of Wachovia's $482.4 billion loan portfolio. The deal makes Wells Fargo the #4 retail bank in the U.S. based on assets (Reuters, 2009).

In other news, Wells Fargo raised $8.6 billion in capital through an issue of common stock this month. The government had mandated that Wells Fargo and several other banks much increase their capital in the wake of the government's "stress test." The banks were ordered to raise the capital, or risk having the federal government take out ownership stakes. This would give the government a degree of control over the banks that the bank managers would find uncomfortable. There would be changes, for example, at the senior management level. As a consequence, Wells Fargo was one of the first banks to raise the additional capital that was mandated (Fineman, 2009).

They raised the capital through a share issues, selling 392 million shares at $22 per share, giving them $8.6 billion in cash. Wells Fargo's current position is relatively weak. They are facing losses for the next two years of $86.1 billion. Shares in Wells Fargo have declined 16% so far this year and the company was forced to cut its dividend by 85%. The federal government informed Wells Fargo that it needed to raise a total of $13.7 billion. After the issue, prices of Wells Fargo shares closed up 14% to $28.18.

4) Profitability ratios measure the degree to which the company converts its revenues into profits. The higher the ratio, the more of the banks' revenues it retains after all expenses are calculated. In the banking industry, the gross margin is not calculated. From MSN Moneycentral, the pre-tax margin at Wells Fargo is 9.3. This compares with the industry average of 10.7. Competitor Bank of America has a pre-tax margin of 8.8. Wells Fargo's performance with respect to pre-tax margin is therefore reasonable compared with its rival, and still within the context of the industry as a whole. Indeed, the five-year average pre-tax margin at Wells Fargo is 27.7% compared with an industry average of 27% and Bank of America's 32.1%. We can see therefore that the major banks tend to vary in a range around the industry average. Wells Fargo outperforms the industry slightly over the medium-term but there will be year-over-year variability.

The other key measure of profitability is the net margin. This reflects not only the bank's ability to drive profit after operating expenses, but its ability to manage its tax burden. Last year, Wells Fargo had a net margin of 7.2%; Bank of America had a net margin of 7.7%. The industry average last year was 9.7%. This shows that both of these major banks suffered tougher years than the industry as a whole last year. The five-year average net margin for Wells Fargo is 18.8%. For Bank of America this is 22%. The industry average five-year net margin is 19.7%. This shows that Wells Fargo was not only less profitable last year than Bank of America and the industry but has also been less profitable over the medium-term. The company's ability to control its tax burden is inferior to that of the industry and major competitor Bank of America. It should be noted, however, that for the company to have been profitable at all last year is a testament to its conservative culture. Wells Fargo had little exposure to toxic assets. After purchasing Wachovia, however, Wells Fargo acquired a substantial amount of toxic assets and is expected to suffer significant writedowns on these assets and receive assistance from TARP.

5) The asset utilization ratios indicate the company's ability to generate profits from its asset base. In the banking industry, firms first compete to acquire assets (deposits) and then they compete to generate income from those assets (loans). To some extent, the revenue that can be generated from assets is dictated by the Federal Reserve, which sets basic interest rates and reserve requirements. However, the bank's cost structure and the type of investments they make with their assets will also dictate their asset utilization.

As such, the traditional asset utilization ratios -- receivables turnover, asset turnover and inventory turnover -- are worthless in the banking industry and are not calculated. Return on assets, however, is calculated, because it reflects directly the bank's ability to generate profits from its assets. At Wells Fargo, last year's return on assets was 0.4%. For Bank of America, it was 0.3%. The industry average is 0.4%. This indicates that Wells Fargo's asset utilization was on par with the industry while Bank of America underperformed.

The five-year average return on assets for Wells Fargo is 1.2%, versus 1.0% at Bank of America. The industry's five-year average is 0.9%. This indicates that both of these firms historically outperform the industry. Wells Fargo in particular outperforms the industry by a third, indicating dramatically superior performance to most of the other major banks. Bank of America roughly performs in line with industry averages, give or take a percentage point on either side.

6) The banking industry does not view liquidity in the same way that other industries do. The standard liquidity ratios -- current ratio, quick ratio and cash ratio -- measure the ability of firms to cover their short-term obligations. At banks, liquidity is guided by reserve requirements as set out by the Federal Reserve. Banks are compelled to hold a portion of their deposits in order to maintain liquidity. Additionally, the federal government provides a measure of liquidity to the banks through the Federal Deposit Insurance Corporation (FDIC), which guarantees depositor's balances up to $100,000. There is also the Temporary Liquidity Guarantee Program (TLGP), of which Wells Fargo is a member. Thus, bank liquidity is a tricky thing to measure and the three standard liquidity metrics are not normally used.

Discussions of liquidity at banks refer primarily to the role as financial intermediaries. The banks are used by the Federal Reserve to create liquidity in the financial system. Banks manage their own liquidity on a constant basis, by lending to one another or with the Federal Reserve banks. Banks take into consideration the structure of their liabilities. The recent equity issue was a response to government demands that Wells Fargo improve its capital. The company has long been prepared to use debt issues where needed to improve liquidity (2008 Wells Fargo Annual Report, p.72), but this time more financing was required. Provided that Wells Fargo raises the required capital, their liquidity needs will be considered met by federal regulators.

Bank of America is in a similar position. They are preparing to sell 1.25 billion shares of common stock in order to meet federally-mandated liquidity requirements (Fineman, 2009).

7) As with liquidity, debt utilization is a difficult issue to assess with banks. As asset at a bank is a mortgage or loan; a liability is a deposit. The way banks work is that they require liabilities in order to generate… READ MORE

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