Why Wells Fargo Is a Great Buy 33 comments
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I find it interesting to read all the negative commentary on banks by a few "highly respected" research analysts, notably Dick Bove at Rochdale Securities and Meredith Whitney at Meredith Whitney Advisory LLC. Dick Bove has been consistently wrong throughout the financial crisis and Meredith Whitney has been wrong on her sell banks for the past seven months (though if anyone considered taking a long-term view on the market, she has been wrong many times - Wells Fargo (WFC) should never have gone down to $8, Merrill Lynch was not a good acquisition for Bank of America (BAC), Lehman Brothers did fail, Goldman Sachs (GS) and Morgan Stanley (MS) did survive and will thrive going forward - she is just a one hit wonder on Citigroup (C)).
Dick Bove continues to argue that Citigroup and Bank of America are great buys despite terrible management teams, no desire to create value for shareholders, and hoarding cash rather than participating in their core lending business. Dick says Wells Fargo is a sell even though the firms pre-tax pre-provision earnings has been more than two times higher than net charge-offs for three consecutive quarters and the firm sells at less than 6.5x normalized earnings. Dick says Wells Fargo's earnings power is not sustainable, even though he has made that argument for three consecutive quarters as well. According to Buffett (who is far smarter and understood the crisis far better than Bove), Wells Fargo can earn 40 billion pre-tax pre-provision (though Wells Fargo is exceeding this forecasted PTPP in an environment with modest loan demand and not including $5bn annual cost savings from merger; they can probably earn 43-45 billion PTPP) and assuming $10-12 billion in credit losses in a normalized environment, pre-tax income is $31 - $35 billion. Assuming 35% tax rate, net income 20-22.75 billion / 4.7 billion shares outstanding = $4.25 - 4.84/share. At 12x earnings, you have a $51 - 58 stock in a normalized banking environment (probably 2012). If you take an average of $54 and discount it back 20% for two years, you arrive at a $37.5 stock currently trading at 26.5. Bove is wrong and I believe his consistent need to influence the market should be investigated by the SEC. He has changed his rating on US Bank several times within a couple of weeks and he changed his mind on Wells Fargo twice on one day. How many times does an analyst need to be wrong before the market stops listening?
The Federal Reserve and Treasury clearly understand Meredith Whitney's note today and I am sure they will avoid an exit strategy that will crash the banking sector again. After saving the financial system, the Fed and Treasury are not going to implement an exit strategy that could potentially destabilize the banking environment. Healthy banks are critical to a strong economy, which should be obvious to anyone who had studied the Great Depression and Japan over the last 20 years.
Wells Fargo will keep earning money even if the economy gets worse and there is no question this stock will continue going higher in the next 12 months merely on the concept of retained earnings. Wells Fargo does not need to raise capital, but the shorts love to create rumors to bring this stock down since management does not respond to rumors. While credit losses are high, Wells Fargo is earning significantly more money than credit losses and Bove should explain why he's willing to wait three years before BofA returns to normal profitability, but not willing to wait for Wells Fargo to return to normal profitability? He probably has no logical argument to explain why he likes Bank of America, but does not like Wells Fargo.
Wells Fargo will soon pay back TARP, buy back government warrants, and will be above $50 within a couple of years for anyone patient enough to hold the stock. As for the shorts who are merely trying to make short-term profits, I hope they get crushed on this investment.
Bove should be fired for being as wrong as he has been or at the very least banned from influencing the market. Meredith Whitney should reconsider whether she has been wrong the last seven months. Does anyone wonder why research analysts are so widely followed given the inaccuracy in their investment calls?
Disclosure: Long Wells Fargo
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This article has 33 comments:
Without the suspension of FASB rules pertaining to off balance sheet holdings and mortgage servicing losses, ignoring mortgage and heloc losses and suspending foreclosures etc, this bank would be toast. Having Buffet behind you only helps bring additional support to manipulate the rules to suit your current problems.
Wachovia was one of the worst ponzi scheme banks in history. They paid employee bonus's on loans that were immediately underwater. Management pushed production over profitability and paid accordingly. Wells bought this mess while their own loan book was imploding.
Enter the government with tax payer money, fasb rules suspensions and SEC rule changes to support the stock. All at the expense of successful local banks that didn't participate in the securitization market.
Your thesis will most likely be right in the long run as the political machine is churning here, but reality is WFC is insolvent (and I didn't even get into their commercial losses). Nice to have friends in high places.
you state WFC "would be toast" if it were not for FASB rules changes. You need to review their 2008 balance sheet what 1) type of securities WFC had, 2) mix of depositors, and off BS 3) type of derivatives sold and bought in tandem with their liquidity.
WFC had a AAA rating and 52 week high pps during late 2008 for a reason.
Where did you get $350B of CRE loans? End of Q309, WFC held $135,161 million of CRE.
yes I read your back of the envelope bar room diatribe.
Purchase accounting can continue for one year means that they can continue to adjust their initial estimates of how many loans they charged off to bad debt and not have it flow to the bottom line. This luxury ends Dec 31st, however this doesn't mean loans already charged off will be coming back onto their books. Because they have already charged off loans to bad debt does not mean their earnings are mythical.... do you understand they've already written them off!! What part of this do you think charging off loans is mythical earnings??
Pick-a-pay loans and Commercial Real Estate loans will understandably add to their loan losses in 2010 but your arguement for more capital doesn't make sense unless WFC starts to lose income at a rapid pace for a prolonged period. Might I add we are already in the "great recession" and WFC capital is presently sufficient.... with all of these foreclosures taking place at the present time how much worse do think the economy is going to become? We have 10% unemployment now, are you even aware of how many foreclosures took place during the last quarter?? Presently WFC is building capital at quite a rapid rate at a time that our economy is a disaster.
Last quarter WFC had approx 106 billion in agency mbs on their sheet which are considered relatively liquid, they do not need additional capital at the present time in my oppinion.
They don't have $2 trillion in off balance sheet obligations and they estimate that $28 billion will be brought on to their balance sheet. Much of your $2T figure is involving derivatives which help them reduce their risk by offsetting each other.
On Nov 05 07:48 AM Steve J wrote:
> donzooab,
> you state WFC "would be toast" if it were not for FASB rules changes.
> You need to review their 2008 balance sheet what 1) type of securities
> WFC had, 2) mix of depositors, and off BS 3) type of derivatives
> sold and bought in tandem with their liquidity.
> WFC had a AAA rating and 52 week high pps during late 2008 for a
> reason.
In my response to you I specifically mentioned to go back to 2008 balance sheet which mitigates your arguement about changes in FASB standards.
I understand your concerns of insolvency, that's why I pointed out the 3 areas (types of securities, mix of depositors, and off setting derivatives) that I did.
Perhaps you are concerned with the reliability of WFC management because of other banks that went under. Regrettably what has happened to each of those banks, however the need for understanding why they went under is important.
For WFC to go under they would have to be lying about the mix of depositors they have, the accounting for unrealized gains & losses pertaining to their securities, and total malicious fiction regarding their derivatives (which by the way would had to be ongoing for several years now).
Personally I can see WFC will have loan losses of over $25B thus earning less in 2010 than in 2009, however they are no where near being insolvent.
There will be about a $2.4 trillion bailout bill in February 2010. Economic activity is declining drastically.
Also, how can someone make the argument about Wells Fargo's off-balance sheet exposure bringing down the stock and then look at Bank of America's off-balance sheet exposure, which is definitely worse than WFC, and say its a buy. Management is not lying about the earnings power of this firm.
They aggressively wrote down the Wachovia portfolio and they have said those marks are approximately right (consumer losses a little less than expected, commercial losses a little higher than expected)
NONE of the longs are arguing that Wells Fargo will not have huge credit losses, but their earnings power is far higher than the credit losses and eventually the credit cycle will turn. Unless you think management is also lying about credit losses peaking in 2010, this company is going to be earnings a significant amount of money within a couple of years. Again, I look forward to hopefully seeing all the shorts get crushed on this investment for the false rumors they are spreading.
Read what Buffett said below...
What about all the smart analysts who think no big bank can survive in its present form, including Wells Fargo?
Almost 20 years ago they were saying the same thing. In the end banking is a very good business unless you do dumb things. You get your money extraordinarily cheap and you don't have to do dumb things. But periodically banks do it, and they do it as a flock, like international loans in the 80s. You don't have to be a rocket scientist when your raw material cost is less than 1-1/2%. So I know that you can have a model that works fine and Wells has come closer to doing that right than any other big bank by some margin. They get their money cheaper than anybody else. We're the low-cost producer at Geico in auto insurance among big companies. And when you're the low-cost producer - whether it's copper, or in banking - it's huge.
Then on top of that, they're smart on the asset side. They stayed out of most of the big trouble areas. Now, even if you're getting 20% down payments on houses, if the other guy did enough dumb things, the house prices can fall to where you get hurt some. But they were not out there doing option ARMs and all these crazy things. They're going to have plenty of credit losses. But they will have, after a couple of quarters of getting Wachovia the way they want it, $40 billion of pre-provision income.
And they do not have all kinds of time bombs around. Wells will lose some money. There's no question about that. And they'll lose more than the normal amount of money. Now, if they were getting their money at a percentage point higher, that would be $10 billion of difference there. But they've got the secret to both growth, low-cost deposits and a lot of ancillary income coming in from their customer base
But back to tangible common equity...
You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where'd the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've got now. And that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently.
They'll have to work through a lot of this stuff that they inherited from Wachovia. Those option ARMs, they explained exactly how they break them down, and in the end they may lose 3 or 4 billion more. Nobody knows exactly. But I would say that California residential real estate is not deteriorating. It hasn't moved up. But it has flattened out with good volume recently. So my guess is that the option ARMs will work out about as they guessed.
I absolutely agree with this article and and Irishnerd. Just take a look at WFC long term performance 20yrs. and they have just doubled in size, so they have a little training to do with the Wachovia people. But the long term strategy is the best.
Skyman
On Nov 05 11:43 AM Irishnerd wrote:
> It’s about time someone with some logic (and brains) wrote the “real
> story”.
Bove Foresees Bank Stocks Doubling as Earnings Growth Surprises
Share Business ExchangeTwitterFacebook| Email | Print | A A A By Rita Nazareth
Nov. 5 (Bloomberg) -- Banks that led the eight-month rally in U.S. stocks will double by the end of next year as investors bet on a recovery in profits, according to Dick Bove.
Bove, the analyst who recommended selling Lehman Brothers Holdings Inc. four months before it collapsed, said earnings at U.S. banks will begin to recover in the second half of 2010 and triple within three years. Lenders have raised the level of cash on their balance sheets to a level where they don’t face the same risks of collapse that they did a year ago, he said.
“Getting another 100 percent out of these stocks from this level is not as big a move as one might think given where they’ve fallen from,” Bove, who works at Rochdale Securities LLC in Lutz, Florida, said in a telephone interview. In the latter half of 2010, “the potential is there for a really surprisingly large increase in bank earnings. That’s why people are buying bank stocks now and are ignoring the near-term losses. They’re buying them because the longer-term outlook for earnings is astoundingly positive,” he said.
The KBW Bank Index tumbled 85 percent from a record in February 2007 as losses and writedowns from the collapse of the subprime mortgage market that climbed to more than $1.6 trillion froze credit markets and sparked the first global recession since World War II. The measure of 24 U.S. lenders has since more than doubled as Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. returned to profitability.
Worst is Over
The 79 banks, insurers and investment firms in the S&P 500 rallied 131 percent from a 17-year low on March 6 through yesterday, the most among 10 industry groups, on speculation that the worst of the credit crisis is over.
Bove’s recommendations haven’t always been prescient. He recommended buying Citigroup in November 2007, before the bank cut its dividend for the first time and lost 87 percent of its value. He told investors in an April 2008 interview to purchase financial companies “very aggressively” because writedowns were near an end. An index of those stocks in the S&P 500 fell another 77 percent through March and trades 47 percent below its level when he made that recommendation.
Earnings at banks in the S&P 500 are projected to grow 177 percent next year after slumping 63 percent in 2009, according to the average analyst estimates compiled by Bloomberg. Overall, S&P 500 company profits are projected to fall 15 percent in the third quarter, extending a record eight quarters of earnings declines, before growing 68 percent in the fourth quarter and 22 percent next year.
‘Not at Risk’
Bove said banks have raised enough cash to protect against another recession or credit contraction.
“Banks in the United States have never had this much cash on their balance sheets,” Bove said. “They can withstand whatever problems come their way. These banks are just not at risk at the moment.” Citigroup has almost doubled its cash to $244.2 billion in the year since Lehman filed for bankruptcy, the biggest such stockpile of any U.S. bank. JPMorgan has tripled its cash and debt securities that can be used as collateral and had total liquidity of $453.6 billion at the end of September. That’s 22 percent of its total assets, up from 9.5 percent before Lehman’s bankruptcy.
Bove, who has been an analyst since 1965, recommended selling Goldman Sachs Group Inc., Merrill Lynch & Co. and Lehman in May of last year, citing concern that earnings would falter. Four months later, Lehman filed a record bankruptcy, Merrill sold itself to Bank of America and Goldman Sachs became a bank holding company to gain access to Federal Reserve funding.
Buy Ratings
While Bove has “buy” ratings for Bank of America, Goldman Sachs, JPMorgan and Citigroup, he said investors shouldn’t buy regional banks because many of them will continue to report losses through the end of next year.
Bove cut Fifth Third Bancorp, Ohio’s largest lender, and Atlanta-based SunTrust Banks Inc., the seventh-biggest U.S. bank, to “sell” last month. Both are estimated to report more losses in the fourth quarter and in the first three quarters of 2010, according to the average of analyst estimates compiled by Bloomberg.
Bove said 200 to 300 more banks will fail by the end of next year, adding to 115 that were shut this year and 25 in 2008. Regulators are closing lenders at the fastest pace since the 1992 savings-and-loan crisis.
“If you look at the ‘smallest shoes,’ they are going to keep dropping because they don’t have access to capital or to funding,” he said.
Wells Fargo & Co., the largest U.S. home lender, was downgraded to “sell” by Bove on Oct. 21. He said the company’s third-quarter profit was “unsustainable” and included an increase in mortgage servicing fees that is “impossible to explain.” Wells Fargo shares then fell 7.2 percent through yesterday, more than double the decline in the S&P 500.
Still, the odds of another financial crisis are “relatively low,” Bove said. U.S. Treasury Secretary Timothy Geithner said last month that he expects the government will receive repayment “relatively quickly” from most of the big banks helped by the $700 billion financial rescue program.
The 20 largest financial institutions in the U.S. are in “extraordinarily good condition,” Bove said.
I said that $2.4 trillion bailout was coming in February 2010 because the above policy will also be applied to commercial real estate (with some other goodies thrown in).
The American is basically dead--we're running on embalming fluid. There is still some music being played and so some people are playing musical chairs.
But there are no chairs.
Did you see the wonderful "productivity" figure? Actually, capacity in the U.S. is declining, it is not "sitting idle." The supply chain is collapsing.
You will see it in agriculture: this sector is about to implode.
And now for our little slap in the face of "Dr." Roberts:
WASHINGTON – Thousands of borrowers on the verge of foreclosure will soon have the option of renting their homes from Fannie Mae, under a policy announced Thursday.
The government-controlled company, through its new "Deed for Lease" program, will allow borrowers to transfer ownership to Fannie Mae and sign a one-year lease, with month-to-month extensions after that.
The program will "eliminate some of the uncertainty of foreclosure, keeps families and tenants in their homes during a transitional period, and helps to stabilize neighborhoods and communities," Jay Ryan, a Fannie Mae vice president, said in a statement.
But the effort is likely to affect a relatively small number of homeowners. In the first half of the year, Fannie Mae took back about 1,200 properties through this process, known as a deed-in-lieu of foreclosure. That pales in comparison to the 57,000 foreclosed properties the company repossessed in the period.
While neither option is particularly attractive for the homeowner, a deed-in-lieu does less harm to the borrower's credit record.
The rental program is designed to help homeowners who don't qualify for a loan modification under the Obama administration's plan, but still want to remain in their homes. Fannie Mae is not planning to market the homes for sale during the one-year rental period.
Fannie Mae has hired an outside company, which officials declined to identify, to manage the properties.
To qualify, homeowners have to live in the home as their primary residence and prove that they can afford the market rent, which would be determined by the management company. The rent can't be more than 31 percent of their pretax income.
Fannie Mae's sibling company, Freddie Mac, launched a similar effort in March. That policy, however, requires the foreclosure to be complete and only allows month-to-month leases. A Freddie Mac spokesman declined to say how many borrowers have participated.
On Nov 05 01:44 PM Dr. Roberts wrote:
> Mr. Ryskamp.......do us all a favor here.....post your drivel over
> on Yahoo with the rest of the know nothings.
The Commercial Paper (CP) market is essentially a private debt market used by corporations as a cheaper means of funding typical recurring operations than drawing on a line of bank credit.
Commercial paper, as financial instrument, is by no means a recent innovation and, in fact, you can read about how the CP market was affected by the many historic financial shocks experienced by the U.S. (read Panic on Wall Street: A History of America’s Financial Disasters).
Although the Federal Reserve was able to artificially bring CP rates down significantly since the shocking 615 basis point spread blowout (A2/P2 spread) of late 2008, they have apparently not been successful in preventing an overall contraction in the CP market.
The Federal Reserve calculates and publishes the total amount of CP outstanding every week and as of the latest published period, commercial paper outstanding is contracting at nearly the fastest rate on record, registering a whopping 17.81% decline year-over-year.
On Nov 05 01:44 PM Dr. Roberts wrote:
> Mr. Ryskamp.......do us all a favor here.....post your drivel over
> on Yahoo with the rest of the know nothings.
The really huge items on the agenda are faltering muni bonds (which will require an RFC-style rejiggering and this will REALLY destroy confidence), and commercial real estate.
These are the last pillars of the on the ground economy, because suburbia is still employed so there is no political will to increase the income of the 60% lowest income earners, or to increase income to those on unemployment or public assistance.
You really have economic apartheid going on here, with suburbia banking on the underclass rolling over and dying, or physical isolation+policing to keep down civil unrest.
However, an unemployment camp on the Washington Mall would really move things to the right, politically.
This doesn't need to be in the article, but I've tried to find out whether her firm has any employees other than herself and her husband, and I haven't been able to. Husband is ex-pro wrestler but that doesn't necessarily mean he can't work for a securities firm.
Also, cap requirements will be raised. Also on the same website.
If WFC is making $40 billion then I sure as heck hope they are paying a ton of taxes!!
Our second quarter PE for 2009 was 122, and I dont know what it was for 3rd quarter, but I bet it was no better.
The us government went on the line for 9.7 trillion total in bailout funds (source for this www.bloomberg.com/apps... ) and we still only have a PE of 122.
Everyone is no doubt laughing at us for continuing to bid our stocks up, just as we laughed at Japan when they did it in the early nineties, only our position is much more ludicrous than theirs ever was. 122 PE. Even growth stocks should not be that high, let alone the entire market.
PE at 139
seekingalpha.com/artic...
No matter how much the Federal Reserve and Treasury invent paper money and Congress continues to unprecedented non-wartime spending, our economic future remains bleak for our great grandchildren. . .if we survive that long.
I honestly think people need to focus on Wells Fargo's funding sources with a cost of capital of 0.84% in 3Q 2009. Yes, interest rates being low don't make any sense right now, but I would bet the government will do whatever it takes to keep interest rates low for as long as they can. I don't think any country in the world today wants to see the U.S. crash, therefore China, Japan, and the rest of the emerging markets will continue to buy our debt.
No one is arguing we don't have structural problems in this country. Eventually, they will need to be addressed, but I rather own a company with $4.50 in earnings power when its trading at $27 instead of cash where I earn 0% interest. Also, 48% of Wells Fargo's revenue is a result of fee based businesses, not even credit related.
You can't have a better funding mix than what Wells Fargo currently has. They have the lowest cost deposits of any company in the country. Also, I truly believe this management team (along with JPMorgan) is more shareholder friendly than any other bank in America.
It seems to me that the people who are saying to short argue Wells Fargo is not being honest about credit losses, though they are reporting huge increases in NPL's and NPA's quarter after quarter (and still making huge profits despite that). They said consumer losses will peak in first half 2010 and commercial losses will peak in second half 2010.
My questions for the shorts -
1. What are your estimates for credit losses, including off b/s?
2. What are your estimates for revenue?
3. Why does a firm thats making money need to raise more capital? As Warren Buffett says, banks don't make money on the equity capital, they make money off of the deposits and in WFC's case, they have the cheapest deposits in the industry. They also have the highest net interest margin of any other banks.
4. While the increase in non-performing assets is worrisome, pre-tax pre-provision income continues to be significantly higher than charge-offs quarter after quarter.