Wells Fargo ((NYSE: WFC) to Return Bailout Money?

Wells Fargo & Company (NYSE:WFC) now faces a dilemma. It wants to return $25B in bailout funds, but do so while keeping its Tier 1 ratio up means either diluting shareholders or paying hefty government dividends. Daniel Indiviglio suggests that Wells may seek to pay back the bailout over the next few years through putting a portion of its profit towards its tab.

NYTime’s DealBook discussed the situation and suggested said, “That's because selling new common stock and being shareholder-friendly are not entirely mutually exclusive. Paying back the relief funds would extinguish $1.25 billion a year in post-tax dividends, freeing up earnings for common shareholders. Wells could issue up to $8.8 billion in stock without reducing the earnings per share available to current holders, according to JPMorgan.”

Indiviglio summarized that the Times then says it could repay the rest with its existing capital cushion. That, however, would still give it a Tier 1 capital-asset ratio below some of its peers, like JP Morgan and U.S. Bankcorp. So I'm not sure if this option necessarily works. I highly doubt in a climate like this Wells Fargo & Company (NYSE:WFC) wants to look riskier than its competitors.

But let's think about this problem from a shareholder perspective. Assuming it takes two years to accumulate enough earnings to pay back the bailout, that's in the ballpark of $1.875 billion in post-tax dividends it would have to pay the government -- if it pays back half each year. If it takes longer than two years, obviously that payout to the government grows. As a shareholder, I'd be pretty annoyed that money is going to Uncle Sam instead of the firm's growth or private shareholders.

So why not do this: raise the capital in the private market and dilute the current shares, but in doing so, make a commitment to repurchase those shares over whatever period -- say two years -- it would have taken to repay the bailout. By making this commitment Wells would provide current investors reassurance that their value will not be lost in the long run. In fact, the value of the firm would ultimately be higher, because it would not have to pay the 5% dividend to the U.S. government, but could instead pay a 3.5% dividend to common shareholders on that new equity (its 5-year average dividend yield). That would save the firm $562 million over those two years. And at the end, it would repurchase the shares anyway, as planned.

Indiviglio’s Conclusion