The victory party is under way for Wells Fargo & Co., the winner in the fight to buy Wachovia Corp. But analysts cautioned Friday that the San Francisco-based Wells still faces plenty of challenges as it proceeds with its purchase of the Charlotte bank, including an uncertain market and losses in Wachovia's portfolio that could prove bigger than expected.
“Now comes the hard part,” R. Scott Siefers, an analyst at Sandler O'Neill + Partners, wrote Friday, the day after Citigroup Inc. said it would stop pursuing its bid to buy at least a piece of Wachovia.
For one thing, Wells Fargo wants to raise $20 billion from investors to help pay for the Wachovia purchase, valued at $5.64 per share based on Friday's closing price. Although Wells is one of the banking industry's relative stalwarts, it still could run into trouble reaching that goal. Charlotte's Bank of America Corp., also seen as a comparatively strong bank, had to price its $10 billion capital raise at a substantial discount this week. That meant it had to issue more shares than anticipated, which dilutes the value of current shareholders even further.
“Although we are not suggesting that Wells Fargo will have trouble getting such a large offering done even in this difficult market, we are not sure why investors would be overly excited or tempted to buy shares ahead of this potential offering,” wrote Christopher Mutascio, an analyst at Stifel Nicolaus.
Analysts also expressed concerns that Wachovia's losses would prove bigger than Wells has accounted for, even given Wells' generous estimations. For instance, Wells says it expects losses of about 26 percent on Wachovia's $122 billion portfolio of Pick-A-Payment mortgages. Wachovia had planned for 12 percent.
“Wells Fargo assumes it's getting a bargain,” said Ira Rheingold, executive director of the National Association of Consumer Advocates. “But there's no telling what they're really buying.”
New York-based Citi said Thursday evening that it had “dramatic differences” with Wells Fargo over how to value the risks associated with buying Wachovia, raising speculation that Citi saw more problems in Wachovia than Wells did. Moody's Investors Service said Friday that it's considering cutting its rating of Wells, in light of the increased risk with the Wachovia purchase.
In a statement Thursday night, Wells chairman Dick Kovacevich gave a nod toward worries about Wachovia's balance sheets. He sought to diminish them by noting that credit teams from the two banks have been working together and that Wells will record Wachovia's credit-impaired assets at fair value. He said he thinks “we have adequately evaluated the risks inherent in the portfolios as of the time of this merger agreement.”
Another wild card is Citi's continuing legal fight against Wells and Wachovia. Citi is suing Wells for $60 billion in damages, alleging that it wrongly interfered with Citi's agreement to buy Wachovia. And it's suing Wachovia, saying it breached an agreement to not talk to other suitors.
It's unclear if Citi's lawsuits will be any detriment to Wells. Some legal experts say that Citi has a strong case for damages. Friday, Wachovia lawyer David Boies in a conference call told a federal judge in Manhattan there is still “significant urgency” in the battle with Citigroup, according to Bloomberg News.
If Citi successfully sues Wells, then Wells may be able to back out of the Wachovia deal by claiming “material adverse change,” said Joe Morford, an analyst at RBC Capital Markets.
But at least one lawsuit has been dropped: Former Wachovia chairman Bud Baker dismissed his temporary restraining order against Citi, which was meant to keep Citi from interfering in Wells Fargo's bid.
Though Wells is performing better than most peers, it's still posting losses in its consumer-heavy portfolio, and its earnings in the second quarter fell 23 percent from the year before. It also must deal with the challenges inherent in any big acquisition, such as persuading Wachovia customers to stay with their new bank, merging technologies and cultures, and rebuilding capital.
It will also need the customary approvals from regulators, as well as approval from Wachovia shareholders. Friday, the Federal Trade Commission gave its blessing to the purchase. Wells has asked the Federal Reserve to expedite its application.
Still, analysts praised the Wells Fargo/Wachovia combination as a deal that makes good strategic sense, combining East Coast and West Coast powerhouses. And though Wells is paying more than Citi would have, analysts still seemed to think Wells is getting a bargain. Its offer was valued at $11.8 billion at Friday's close – about half of what Wachovia paid in 2006 for Golden West Financial, the mortgage lender that led to its downfall.
On a day when the Dow fell 1.5 percent, the shares of all three banks in the Wachovia triangle rose, as investors rewarded the relative certainty afforded by Citi's backing out of the fight. Shares of Wachovia soared 43 percent, albeit from gutter levels, to $5.15. Shares for Wells Fargo rose 4 percent to $28.31. Shares of Citigroup, the spurned suitor, rose 9 percent, to $14.11.
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