By Steven Edwards
The bank stocks celebrated Barack Obama's re-election by tanking on the Wednesday after election day, with the KBW Bank Index dropping 4.5% and every component in it dropping more than 2%. Of course, it was a bad day for the markets generally. The continuance of split government in the U.S. focused worries on the upcoming fiscal cliff, and of course, problems in Europe continue. But the conventional wisdom was that an Obama re-election would be bad for banks, as the Dodd-Frank bill would stay in place. The election of bank critic and consumer advocate Elizabeth Warren to the Senate added to the angst. Wells Fargo (WFC) got hammered with the rest, dropping 3.5% on the day. But there is reason to believe that this bank, at least, will prosper as the real estate recovery continues.
In terms of assets, Wells Fargo is the fourth largest in America, after Bank of America (BAC), J.P. Morgan Chase (JPM), and Citigroup (C). But Wells Fargo is now far and away the biggest mortgage lender, with a 29% market share, almost three times as much as Citigroup, its nearest competitor.
The real estate market today is still not what it once was. It is dominated by investors, some of them paying cash for distressed properties. Another factor is a large amount of foreign money, much of it from foreign nationals buying a second home in the United States, perhaps as an insurance policy against disruptions in Europe or China. But the current mortgage interest rates, currently under 4%, and Fed Chairman Ben Bernanke's promise to hold interest rates low for the foreseeable future, argues that the real estate recovery will continue. Already the Federal Reserve has reported that home equity in the U.S. now exceeds the levels of 2008, before the crash. The stock prices of homebuilders like D.R. Horton (DHI) or Toll Brothers (TOL) have already appreciated dramatically, and are now looking toppy. Wells Fargo seems like a safer, saner way to play the real estate recovery, while earning a respectable dividend, currently about 2.7%.
Like other banks, Wells Fargo slashed its dividend after the 2008 meltdown. Its current dividend of 22 cents per quarter will likely be raised as earnings recover further. It peaked at 34 cents in 2008.
Wells Fargo also bought back seventeen million shares in the third quarter and the board also increased its buyback authority in October by 200 million shares.
Of course, Wells Fargo is much more than a mortgage lender; it is a diversified financial services company that provides retail and commercial banking. It issues credit cards and offers student and auto loans as well as home loans. It has a wealth management business for high net worth individuals. All of these businesses would likely add to earnings in a general recovery. But the real estate sector has been depressed for several years, and the ongoing recovery is likely to be the main driver for an increase in share price. Analysts expect the company to earn $3.63 per share next year, about 9% better than the current year, not spectacular, but solid growth for a huge bank.
Wells Fargo is number seven on the list of stocks most owned by hedge funds, with Warren Buffett's Berkshire Hathaway (BRK.A) being a major holder. Recently, Tom Russo, who manages the Gardner, Russo and Gardner fund, increased his stake in Wells Fargo up to 5.4% of the portfolio. Wells Fargo director Stephen Sanger recently added 10,000 shares to his portfolio at a price of $34.00 per share, an insider buy slightly above the current price.
The Dodd-Frank bill, which increased regulation of the financial industry in the wake of the 2008 collapse, has been the target of a lot of Republican complaints as excessive regulation. The stated aim of the bill was "to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, (AND) to protect consumers from abusive financial services practices…" which seems like a good thing. The actual effect of the law on bank earnings is difficult to determine, as many of the rules have yet to be written. The added Volker rule, which limits proprietary trading by commercial banks, will probably not impact Wells Fargo adversely, as such trading has never been a big part of its business plan.
In summary, Wells Fargo is a shareholder-friendly, conservatively managed bank currently positioned to profit from a recovery in the real estate markets. I think that it is a buy at its current levels.