Wells Fargo growth challenged by stock prices

While it may make strategic sense for Wells Fargo & Co. to use a huge bond offering to go on a small-bank buying spree to protect its turf, industry insiders say stock prices, the currency of the buyout, are working against the San Francisco giant.

Wells Fargo says it recently sold $3 billion dollars in 30-year convertible debt securities and may sell an additional $450 million in debt to build a war chest.

The bank joins a growing trend among its peers, saying current interest rates proved too tempting to ignore.

“We were able to secure some very attractive funding due to timing in the market,” says Wells Fargo spokeswoman Janis Smith.

“This arrangement represents cheap, opportunistic financing for us,” she says.

But $3 billion is a lot of money and Wells Fargo is tight-lipped about what it will be used for.

“It’s for ‘general corporate purposes,’” Smith says, quoting her company’s press release. “That could include possibly buying back stock or we could refinance debt at a lower rate.”

With $370 billion in assets, Wells Fargo, is the fifth-largest U.S. bank. Many of the 23 Wall Street analysts who cover Wells Fargo (NYSE: WFC) speculate that the bank may be raising money to buy one of its competitors to get even bigger.

“That’s the first thing everybody asks” Smith says. When pressed, she does concede an acquisition would fall under the “general corporate purposes” definition.

As the banking industry continues to consolidate, Wells Fargo’s consumer banking competitors continue to move in on its Bay Area home turf. Recent examples include New York-based Citigroup Inc.’s purchase of Cal Fed Bank and Minneapolis-based U.S. Bancorp’s acquisition of Bay View Bank’s 57 branches.

But A.G. Edwards & Sons Inc. analyst David Stumpf says Wells Fargo is under no pressure to go on a buying spree.

“We are no longer concerned that Wells Fargo may be feeling some pressure to pursue larger acquisitions,” Stumpf says.

He says the bank continues to grow organically by cross selling products such as insurance, mortgage refinancing and brokerage services. Stumpf does not own shares of Wells Fargo and his company does not make a market in the stock.

He says investors anticipating consolidation have pushed up stock valuations of banks, effectively pricing would-be deals out of the market.

Wells Fargo could be looking at expanding its other services in the insurance or brokerage sectors, Stumpf says. Both of those have seen stock prices plummet after a one-two punch from the dot-com bust and the 2001 terrorist attacks.

RBC Capital Markets analyst Joe Morford agrees that Wells Fargo’s cross-selling strategy is working and says the bank’s deposit business is seeing a benefit from the slumping stock market. RBC holds a stock position in Wells Fargo and has had an investment banking relationship with the bank.

Noting that roughly one-third of Wells Fargo’s cash deposits growth is due to mortgage refinancing, Morford says, “Wells is also benefiting from withdrawals from the equity markets.” He says Wells is becoming the proverbial mattress where people are stuffing their cash.

But Wells Fargo’s growth plans are not limited to cross selling.

“The bank did indicate that they are interested in pursuing deals on small community banks to fill holes in their current markets,” A.G. Edwards’ Stumpf says.

Stumpf says Wells Fargo has been successful in buying small bank groups in the past by developing close relationships with them before he merger.

Organic growth may be a more viable option than an expensive M&A strategy.

“Bank stocks are in a fairly tight range as the market is not distinguishing much between the strong companies and the weaker players,” Stumpf says. “This makes it much more difficult for the buyers.”

Wells says there are other ways to grow.

“In the Bay Area, we’ve opened about eight new branches this year,” says Tim Silva, Wells Fargo’s Santa Clara County market president. He was responsible for opening new branches in San Jose, Santa Clara’s Rivermark development and in the Pruneyard in Campbell and has more local expansion planned.

“We are fortunate that we are a big bank,” says Silva. “But we run our branches as community banks.”

Wells Fargo’s community banking operations are making money.

In it’s quarterly report issued April 15, that division posted profits of $1.06 billion, a year-over-year growth of 11 percent.

Overall, Wells Fargo reported a net profit of $1.49 billion in the first quarter ending March 31, an increase of 8 percent over last year.

According to Wells Fargo CEO Dick Kovacevich, his company reported earnings per share of 88 cents, beating the Street consensus by a penny. EPS was up 10 percent from the 80 cents per share recorded in the first quarter last year. That marked Wells’ seventh-consecutive quarter of record earnings.

“Wells Fargo continues to be one of the handful of companies that is generating both strong revenue growth and earnings per share growth irrespective of the economic environment,” Kovacevich said in a statement.

Bear Stearns & Co. analyst David Hilder agrees. He says the bank is the best-performing and best-managed bank franchise he covers. Bear Stearns & Co. does not make a market in Wells Fargo stock.

But how the largest Bay Area-based bank parlays its current good fortune into future prosperity is yet to be seen.