01—Abstract
Summary
Summary of the 10-K filed February 27, 2009. Cited figures are marked; the original filing is the authoritative source.
Wells Fargo's 10-K for fiscal 2008, filed February 27, 2009, shows a company transformed by its December 31, 2008 acquisition of Wachovia, which was valued at $12.5 billiona to Wachovia shareholders and created a $1.3 trillion-asset franchise, the fourth-largest U.S. bank holding company by assets.
Reported 2008 results were sharply weaker: net income fell 67% to $2.66 billionb ($0.70 diluted EPS) from $8.06 billion ($2.38) in 2007, driven by an $8.14 billion pre-tax credit reserve build, a provision for credit losses of $15.98 billion (up from $4.94 billion), and $2.01 billion of other-than-temporary impairment. Revenue nonetheless grew 6% to a record $41.9 billion, net interest margin rose to 4.83%, and noninterest expense declined 1%. Balance sheet strength was reinforced by a $25 billion U.S. Treasury preferred stock investment under TARP, which lifted Tier 1 capital and supported a Tier 1 risk-based capital ratio of 7.84% and total RBC of 11.83%, both above regulatory minimums.
Nonaccrual loans rose to $6.80 billionc (0.79% of loans) from $2.68 billion, and the allowance for credit losses reached $21.7 billion, about 3.2 times nonaccrual loans. Wachovia's Pick-a-Pay option ARM portfolio and home equity exposure, particularly in California, Florida and Arizona, remain the principal credit risks going forward. For investors, the key tensions are the reported earnings decline and dividend constraints versus the scale and franchise benefits of the merger.
Dividends are restricted while TARP preferred stock is outstanding: any increase above the $0.34d quarterly common dividend and any common repurchases require Treasury consent until October 2011. The filing also flags integration risk, possible further Wachovia loan losses as purchase accounting is finalized, and pending litigation including Citigroup's claim seeking $20 billion in compensatory and $40 billion in punitive damages related to the merger.
02—Key points
Key Highlights
- Wachovia acquisition closed December 31, 2008: valued at $12.5 billion, issuing 422.7 million shares, adding $707 billion of Wachovia assets at fair value and about $8.8 billion of goodwill; the combined company had $1.3 trillion in assets, $865 billion in loans and $781 billion in deposits.
- 2008 net income fell 67% to $2.66 billion ($0.70 diluted EPS) from $8.06 billion ($2.38), reflecting an $8.14 billion pre-tax credit reserve build and $2.01 billion of other-than-temporary impairment charges.
- Revenue rose 6% to a record $41.9 billion, with net interest income up 20% to $25.4 billion (taxable-equivalent) and the net interest margin widening to 4.83% from 4.74%.
- Credit deterioration was significant: net charge-offs reached $7.84 billion (1.97% of average loans, up from 1.03%), nonaccrual loans rose to $6.80 billion, and the allowance for credit losses reached $21.7 billion (2.51% of total loans).
- TARP participation: $25 billion of Series D preferred stock issued to the U.S. Treasury on October 28, 2008, with a warrant for 110.3 million common shares at $34.01; common dividend increases and buybacks require Treasury consent until October 2011.
- Capital ratios remained above well-capitalized thresholds at year-end 2008: Tier 1 RBC 7.84%, total RBC 11.83%, and Tier 1 leverage 14.52% for the Parent; the common equity to assets ratio fell to 5.21% from 8.28%.
- Significant legal exposure from merger-related and Wachovia matters, including the Citigroup lawsuit seeking $20 billion in compensatory and $40 billion in punitive damages, plus auction rate securities, Adelphia, and interchange litigation.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2008filed February 27, 2009Financial Statements
FY2008 against FY2007
| Line item | FY2008FY2007 | Change |
|---|---|---|
| Interest Expense | $9.76B$14.20B | −31.3% |
| Net Income | $2.65B$8.06B | −67.0% |
| EPS (Basic) | $0.70$2.41 | −71.0% |
| EPS (Diluted) | $0.70$2.38 | −70.6% |
| Shares Outstanding (Basic) | 3.38B3.35B | +0.9% |
| Shares Outstanding (Diluted) | 3.39B3.38B | +0.3% |
05—Questions
Frequently Asked Questions
Why did Wells Fargo's 2008 earnings decline so sharply compared with 2007?
Net income fell to $2.66 billion from $8.06 billion, largely because of an $8.14 billion pre-tax credit reserve build (including $3.9 billion to conform loss-emergence methodologies with Wachovia), higher net charge-offs, and $2.01 billion of other-than-temporary impairment on securities. Revenue still grew 6%, and expenses fell 1%, so the decline was driven mainly by credit costs.
Does the Wachovia acquisition affect 2008 results?
Only marginally. The deal closed on the last day of 2008, so Wachovia's operating results are not included in the 2008 income statement or average balances. Its assets and liabilities appear on the year-end balance sheet at fair value, which is why total assets jumped to $1.31 trillion from $575 billion. Future results will reflect Wachovia, and the purchase accounting adjustments will affect net interest income beginning in 2009.
What restrictions does the TARP investment place on shareholders?
Until October 28, 2011, unless the preferred stock is redeemed or transferred, the company needs Treasury consent to increase its $0.34 quarterly common dividend or to repurchase common or other equity securities, except in limited circumstances such as benefit plans consistent with past practice. Dividends on common stock are also prohibited until accrued preferred dividends are paid. The Treasury's warrant could also cause dilution.
How strong is the company's capital position and credit reserve?
At December 31, 2008, the company and its subsidiary banks were well capitalized, with a Tier 1 RBC ratio of 7.84% and total RBC of 11.83%. The allowance for credit losses was $21.7 billion, covering 319% of nonaccrual loans, and the company said the allowance covers 12 months of estimated consumer losses and at least 24 months for commercial portfolios. The filing warns that further reserve builds may be required in 2009 if housing and employment conditions worsen.
What are the main risks investors should monitor after the merger?
Key risks include continued home price declines and unemployment, which could drive higher losses in Wachovia's Pick-a-Pay option ARM portfolio and in home equity loans, especially in California, Florida and Arizona. Other risks include the possibility that Wachovia loan losses exceed preliminary fair value estimates, integration difficulties and deposit attrition, interest rate and mortgage servicing rights volatility, possible other-than-temporary impairment on securities, and significant pending litigation.
06—Continue