Love to them as a partner Posted by: firerat
In reply to: None Date:8/4/2007 5:25:44 PM
Post #58198 of 58229
Be nice to be associated with these guys!!!
Analyst Note 07-20-2007 by Jaime Peters, CFA, CPA
Wachovia WB posted second-quarter results on July 20 that were in line with our expectations. We are maintaining our fair value estimate. Wachovia's strong fee income generation helped increase earnings per share by 4% from the second quarter of last year to $1.22. Proprietary trading was the largest contributor to fee income growth, up by 58% to $298 million. Larger than normal fluctuations in interest rates were behind the higher proprietary trading revenues. We do not expect this level to be sustainable. Another major source of fee income, Wachovia's brokerage business, had another excellent quarter. Wachovia is actively hiring new brokers and keeping attrition to a minimum, which we believe is key to long-term success in the brokerage business. The anticipated acquisition of AG Edwards remains on track and should close in the fourth quarter as expected. Finally, we want to mention Wachovia's continued excellent credit quality. When Wachovia bought California-based thrift Golden West, we were astounded by the price, but knew the bank was buying a gem. With so many headlines about California housing, it is easy to worry about the mortgages Wachovia bought. We admit there has been an increase in poor-performing mortgages in the Bay area, but overall credit quality remains excellent. Loan losses were only 0.14% of total loans, down from 0.15% in the first quarter. We expect over the next year that loan losses will start trending upward as the national credit environment returns to a more-normal level of losses.
Thesis 02-16-2007
With a focus on customer service, Wachovia has become the dominant player in the attractive southeastern U.S. market. We like this bank's prospects. Its new California footprint and capital market businesses are creating new opportunities for this jewel.
Retail banking in the Southeast and Mid-Atlantic states is the bread-and-butter of this financial-services giant, making up over half of Wachovia's earnings. Excellent execution of its high-touch customer service propels the bank's bottom line. An intense focus on the customer experience and wide product offerings allowed Wachovia to add 1.3 new customers for every customer it loses. Active online customers increased 25% in 2006; these services tie clients more closely to the bank and create a barrier to customer switching. We believe Wachovia excels at attracting and retaining its customers.
Wachovia's three capital market businesses give this giant a growing source of fee-based revenues. In a joint venture with Prudential, Wachovia Securities has offices in 49 states and $276 billion of assets under management, making it the nation's third-largest retail brokerage. Adding the company's investment bank and wealth management arms, more than 30% of Wachovia's earnings are dependent on the capital markets. While more cyclical than retail banking, over the long run, these businesses should grow faster than the bank and produce excellent returns.
Wachovia is a serial acquirer. As soon as the bank finishes integrating one acquisition, it trains its sights on another target. With $707 billion in assets, it takes a large acquisition to move the performance needle. Therefore, its experienced acquisition team is one of Wachovia's greatest assets.
Wachovia's latest acquisition, California-based thrift Golden West, is a bit out of line with its previous acquisitions. Historically, Wachovia has purchased banks with similar operating models inside or adjacent to its footprint, where it can add economies of scale and still be in a demographically attractive market. While California certainly meets the last criterion, which we believe was the motivation behind this acquisition, Golden West's consumer mortgage concentration is out of sync with Wachovia's business model. Wachovia plans to introduce commercial banking into its newly acquired branches, a major undertaking. It will likely take years to get Golden West's branches up to speed with the rest of the franchise. While this gives Wachovia a great outlet for growth, the high price paid suggests it will take some time for shareholders to realize any benefits. Given Wachovia's track record we are willing to be patient.
Valuation
We estimate Wachovia's fair value to be $61 per share. We anticipate the net interest margin will continue to struggle in 2007, ending the year close to 2006's 3.12%. As the difference between long-term and short-term rates returns to normal, we expect Wachovia's net interest margin to expand to 3.30%. Wachovia should be able to grow loans and total assets about 7% annually without acquisitions. We estimate total internal revenue growth to average 9% driven by noninterest income growth from Wachovia's capital market businesses. With recent signs of weakening credit quality, we believe Wachovia will need to rebuild loan loss reserves, which ended 2006 at 0.80% of total loans. As a result, we expect loan loss provisions to exceed net charge-offs through the next three years, lowering earnings per share in the short run. Finally, we believe Wachovia's focus on cost control will benefit the bottom line, lowering the efficiency ratio to 55% by 2010 from 58% in 2006.
Risk
In addition to the constant threat that one of Wachovia's large-scale acquisitions will blow up, we worry about Wachovia's lack of loss reserves. Wachovia's allowance for loan losses to total loans was just 0.80%, compared with an average of 1.16% at the 10 largest U.S. banks. We expect credit losses will begin to increase, and Wachovia will be forced to rebuild its allowance ratio. Assuming an increase to a still historically low 1% of loans, the bank would need to take $840 million of additional provisions for loan losses, or approximately $0.29 per share aftertax in 2007.
See Previous Analyst Reports
Close Competitors TTM Sales $Mil Market Cap $Mil
Wachovia Corporation 32,419 85,483
* SunTrust Banks 8,142 26,882
* Bank of America 73,439 208,606
* FleetBoston Financial 14,240 47,262
* J.P. Morgan Chase & Co. 65,230 149,113
* Morningstar Analyst Report Available | Compare These Stocks
Data as of 03-31-07
Strategy
While Wachovia is busy growing its top line through acquisition, the bank is also concentrating on expense controls. With three high-service, high-cost capital market businesses, Wachovia will never have the low efficiency ratio of a mono-line bank, but we believe its goal of 55% is achievable. The company is nearing completion of its $1 billion efficiency campaign.
Management & Stewardship
CEO and chairman Ken Thompson has run Wachovia since it formed in 2001 upon the merger of First Union and the old Wachovia. We are impressed with Thompson's ability to gather effective leaders around him. A bank the size of Wachovia cannot be run alone, and we believe Thompson has formed a deep bench of capable managers. Wachovia is one of our most shareholder-friendly banks. In 2006, shareholders successfully pushed through a proposal to require shareholder approval for golden parachutes. Wachovia was one of the first banks to begin expensing stock options. Management announced plans to recommend annual elections for its board of directors at its next shareholder meeting in April 2007. In addition, we love that management is required to hold 75% of stock grants until retirement. The only two blemishes for Wachovia's corporate governance is the presence of a poison pill and the fact that Thompson holds both the CEO and chairman positions.
Profile
Wachovia is the fourth-largest bank by assets in the United States. The bank operates in 21 states and has a dominant market position in the fast-growing southeastern United States and the wealthy Mid-Atlantic. In addition, recent acquisitions have given Wachovia a presence in California. Wachovia also runs an investment bank and wealth management business. Wachovia Securities, a joint venture with Prudential, is the third-largest retail brokerage business in the U.S.
Growth
Built through a series of acquisitions, we believe Wachovia will continue to make large acquisitions for its bank. Internally, the bank should be able to increase revenues 8%. We expect the capital market businesses to grow faster, around 10%.
Profitability
Wachovia's return on equity is dragged down by the large amount of goodwill derived from its acquisition strategy. But with its focus on expenses, Wachovia's return on tangible equity was a healthy 26%.
Financial Health
Wachovia is well capitalized. Set on returning 40%-50% of earnings to shareholders through dividends, the company also has a large share repurchase program in place.
