Why Warren Buffett Loves Wells Fargo 41 comments
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I am in the process of putting together a detailed presentation on Wells Fargo (WFC), but I thought it would be useful to understand why Warren Buffett loves Wells Fargo. Wells is the most diversified financial services firm with a leading position in US banking stores, small business lending, mortgage origination, middle market commercial banking, agriculture lending among US banks, commercial real estate brokerage, bank-owned insurance brokerage, banking deposits in the US, debit card issuers, foreign exchange sales, retail brokerage, and wealth management. Wells Fargo has the highest net interest margin, return on assets, and return on equity of all large-cap US banks YTD 2009. Their efficiency ratio is third best in the industry behind only U.S. Bank (USB) and JPMorgan (JPM) (both great banks and great stocks to own as well). Growth opportunities for Wells include investment banking, international growth, and expansion of their business model within the US.
I think it's important to realize that the economy is improving, even though it is a result of easy monetary policies and fiscal stimulus. With unemployment at 10.2% and capacity utilization around 70%, the Federal Reserve will probably not increase interest rates for another six to twelve months. With credit losses peaking for the major commercial banks in 2010, they are set for incredible earnings growth in 2011 and 2012. There is a reason why Warren Buffett owns Wells Fargo, U.S. Bank, and Suntrust (STI) and John Paulson (who has been right throughout the entire financial crisis) is now long Bank of America (BAC), Citi (C), JPMorgan, Suntrust, etc.
All the large-banks capital reserves are much higher than before the financial crisis started. Wells Fargo's stockholders' equity of $122 billion, up $23 billion since year-end 2008 and up $50 billion since pre-Wachovia position at 9/30/08, excluding the U.S. Treasury's $25 billion Capital Purchase Program Investment. Wells Fargo's Tier 1 Capital has increased from 7.8% in 4Q08 to 10.6% in 3Q09 and Tier 1 Common Equity has increased from 3.13% in 4Q08 to 5.18% in 3Q09. Also, Wells Tier 1 Capital and Tier 1 Common Equity ratios would be significantly higher if they did not eliminate $20.1 billion of Wachovia nonaccrual loans at 12/31/2008 through purchase accounting. Wells estimated $40.9 billion losses in their purchased credit-impaired loan portfolio and YTD 3Q09 have taken $13.3 billion in losses, leaving the firm with $27.6 billion in reserves still available (in their credit-impaired loan portfolio). In addition, as the economy improves and these banks earn more money, their capital ratios are increasing. As a result, all large-cap banks are overcapitalized today, especially if you include the government's preferred stock investment.
The health of the American economy is dependent upon a strong banking system where capital is available to consumers to buy a house, car, student loans, etc. and businesses to pursue growth opportunities and borrow prudently. The Federal Reserve, U.S. Treasury, and U.S. Government understand the importance of cleaning the financial system from the toxic assets on the banks balance sheets so they can lend prudently.
The banking system is well-capitalized and the consolidation of the sector has created incredible growth opportunities and earnings potential for the strongest banks. Marc Faber, Charlie Munger, and Warren Buffett have said many times before - in recessions, the strongest companies become even stronger because the weak competition goes away. Bill Gross has also argued that the government will keep interest rates low for an extended period of time because they would like nominal GDP growth of around 4-5% in order for unemployment to go down and capacity utilization to increase. As an investor, I think it is important to understand the government's objectives and invest alongside the government. With $115 billion in preferred stock in Citi, Bank of America, and Wells Fargo along with warrants, it is in the best interest for the U.S. taxpayer to see the value of these firms increase.
Wells Fargo's earnings power has never been higher. Buffett estimates $40 billion in pre-tax pre-provision (PTPP) earnings power, but Wells Fargo is already exceeding that pace prior to merger synergy cost savings. Estimating $45 billion in PTPP and $10-12 billion in credit losses annually in a normalized environment leads to $33-35 billion in pre-tax income. Assuming a 35% tax rate, normalized net income is $21.5 - 22.75 billion / 4.706 bn shares outstanding = EPS of $4.57 - $4.83. At 12x earnings, the value per share is roughly $55 - $58.
Maybe I disagree with Dick Bove and Meredith Whitney because the timing of their calls are so short-term. Bove says to sell Wells Fargo, but then says that bank earnings will double over the next couple of years. Why would I sell a company trading at half its intrinsic value when it continues to earn money, build capital, and has the potential to double within two to three years? Meredith Whitney argues that banks don't have normalized earnings, but that argument does not make any sense. Banks make money by lending their cheap deposits or buying securities. Wells Fargo's business model is generating revenue at the fastest pace in the company's history - what is wrong with their business model?
As the government slowly reduces their purchase programs, interest rates will probably move higher, but in an orderly movement. I don't think there are any signs of an disorderly decline in the dollar or increase in interest rates. The banking environment will probably not have many surprises from this point onwards. Consumer and commercial credit losses are expected, but will not exceed projections from the SCAP test. Wells Fargo's PTPP is tracking above Company's internal SCAP estimates and 35% above supervisory adverse scenario estimates. Even if you assume the SCAP loss estimate are accurate, Wells Fargo was estimated to have $86.1 billion in losses for 2009 and 2010, including purchase accounting adjustments. After three quarters of 2009, Wells still has taken losses of $13.3 billion for their credit-impaired portfolio and charge-offs of $12.75 billion. Wells Fargo still has $27.6 billion in provisions available through purchase accounting and $24.5 billion in provisions for credit losses, which comes out to $52 billion of future losses they have accounted for. If the SCAP tests were accurate and Wells Fargo's models are accurate, they have provisioned accurately for their 2009 and 2010 losses already.
Banks will continue making money in the low interest rate environment for several years to come. While we are seeing inflationary pressures through a weaker dollar, long-term interest rates remain low. With the $8,000 first home tax credit continuing until the end of 2010 and low interest rates, we will see a favorable environment for housing. Robert Shiller and Warren Buffett have said California real estate has bottomed with strong volume, which is great for Wells Fargo.
Wells Fargo has an incredible future and shareholders will prosper over the next couple of years.
Buffett on CNBC 9/24/2008:
And I know that there is no company, there's no banking institution, during the last six months, that has done a better job for its holders, for its depositors, and for its borrowers, than Wells. Wells has been lending more and more money. They've been pumping money into the economy during the last six months while other institutions have been contracting. So I think Wells is a wonderful home for Wachovia. There are only two domestic stocks that I own personally. One is Berkshire Hathaway (BRK.A) and the other is Wells Fargo. But I've got quite a bit more of Berkshire Hathaway.
Buffett on CNBC 3/9/2009:
I think there--you need legislation. I mean, whether it's exactly Glass-Steagall. Glass-Steagall brought in the FDIC. It was a wonderful thing. We need banks to get back to banking. I mean, we have learned that handing these people, you know, exotic instruments and all kinds of ability to do things off balance sheet and this desire to improve your earnings a little every quarter, you can't run a financial institution and show nice, smooth growth and earnings. One way or another, you're going to cheat. And there was a lot of that that went on and we need--we need banks to get back to banking. But we need to get through this situation. We should not be giving lectures to people. And incidentally, the one thing that's very important now is banks--and this may come as a surprise to you. Banking has never been better in one sense. I mean, the banks are getting their money very cheaply, deposits are coming in, spreads have never been wider, all the new business they're doing is terrific. They will earn their way out of it, in most cases, overwhelming number of cases. And they should not be spooked by the idea they're going to have to issue tons of stock at some very low price under the circumstances where the very actions of--that that may be coming keep pushing down the price. So that's spooking, you know, people in the banking business. But the banks can earn their way out of this. I mean, the average cost of funds for Wells Fargo, for example, the fourth quarter last year, was 1.44 percent. I can earn money with money at 1.44 percent. I mean, it's cheap. It's abundant and the spreads are terrific.
Now, if I looked at the performance of Wells Fargo, we'll say, I see that, you know, in a couple years--and management doesn't have anything to do with what I'm saying here. I--these are not from them. But I would expect $40 billion a year pre-provision income. And under normal conditions I would expect maybe 10 to $12 billion a year of losses. I mean, you lose money in banking. You just try not to lose too much. So, you know, you get to very interesting figures. I mean, the spreads are enormous on what they're doing. They're getting the money at bargain rates. So I--if there were no quote on Wells Fargo and I just owned it like I own my farm, I would look at the way the business is developing, and I would say, you know, it's--`These are a couple of tough years for losses in the banking business, but you expect a couple tough years every now and then.' And that the earning power is never--is going to be greater by far than it's ever been when you get all through with it. The only worry in that is the government will force you to sell shares at some terribly low price. And I hope they're wise enough not to do that. That would--that's what--that's what's spooking the banking market to a big extent.
I--that's one of the reasons. I particular--I think clarity is a good thing for the whole country on a--on a lot of--any issue to do with people's money, clarity's important. People want to be clear about their money. But I would say that if--if we own US Bancorp, which we do, or Wells Fargo, their prospects three years out have been better than ever.
Buffett on CNBC 5/4/2009:
I know US Bancorp and Wells Fargo. I don’t know the business model of SunTrust that well. So I can’t talk about SunTrust intelligently. But I can tell you that US Bancorp and Wells Fargo are extremely strong banks. They have terrific earning power and earning power is enormously important in looking at what happens to a business in the future. And you couldn’t have two better banks virtually positioned than those two for future earnings. They got – things could get a lot, lot worse and most companies would come through fine.
I’ve owned Wells Fargo since 1991. I’ll probably own it five or ten years from now, so it really doesn’t make any difference to me whether Wells Fargo’s stock goes up or down in a day or a week or a month. It does make, it’s enormously important to me how they conduct their business. And I think they’ve done an incredibly good job of running their business. They’ve got the lowest cost of money in the country; they’ve got the greatest community banking system that the world has ever seen. And incidentally, when the government needed to do something with what was probably the fourth largest bank in deposits, Wachovia, they transferred it over to Wells Fargo and they didn’t have to put up dime of guarantees or money by the FDIC. So the government obviously had to think pretty well of Wells Fargo at that time.
Warren Buffett – Fortune Article
SAN FRANCISCO (Fortune) -- As the largest shareholder of Wells Fargo through Berkshire Hathaway (BRKB), Warren Buffett knows the San Francisco bank deeply. He first invested before Wells Fargo was bought by Norwest, where current Wells Chairman Dick Kovacevich was CEO. As part of his reporting for his feature on Wells Fargo (WFC, Fortune 500), Fortune Editor at Large Adam Lashinsky spoke at length with Buffett by telephone on March 26.
Disclosure: Long Wells Fargo
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This article has 41 comments:
Ron Beasley
Investment Advisor
rwbi.net
I remember when he bought WFC in 1989 and everyone said he was makinga huge mistake
However if they were so smart how come Buffett has made 158 billion dollars for he and his investors?
! common ratio is too low....JPM is 8.2%,BAC is 7.2% Wells is 5.2%...
the issue of further dilution hangs over them.....
But do you think WFC is really more risky because of the TARP money?
Author did a great job on this
And since these banks are allowed to hide the true value of the assets, how do we know WFC, JPM or the others are even solvent?
Buying any of these banks is a big risk, especially since the commercial real estate bust is just getting started.
I think John Paulson and Warren Buffett understand the true value of the assets as well as anyone else in the business. I honestly don't think Wells Fargo is misstating the value of their assets more than Citi and John Paulson has been buying lots of Citigroup stock lately.
..................
But Wachovia also brings credit problems that could take years to resolve. A big worry is its range of “Pick-A-Pay” retail loans, which allowed borrowers to defer principal as well as interest payments: of those that were still current at the time of the merger, 3.2% were seriously delinquent as of June 30th, up from 1.1% in March. The default rate on the bank’s $38 billion of property-development loans is several times the national average (though Wells argues that the official numbers do not reflect merger-related adjustments). A big chunk of its $127 billion commercial-property portfolio consists of interest-only loans with a balloon payment at the end, the wholesale equivalent of Pick-A-Pays. These will be hard to refinance.
Another worry is the large amount of credit protection that Wachovia is thought to have sold on risky tranches of mortgage-backed securities. Wells points to its latest filing, which shows $105 billion of protection sold and a similar amount bought. But the extent to which the latter really offsets the former is unclear.
................
End of quote.
But Wachovia also brings credit problems that could take years to resolve. A big worry is its range of “Pick-A-Pay” retail loans, which allowed borrowers to defer principal as well as interest payments: of those that were still current at the time of the merger, 3.2% were seriously delinquent as of June 30th, up from 1.1% in March. The default rate on the bank’s $38 billion of property-development loans is several times the national average (though Wells argues that the official numbers do not reflect merger-related adjustments). A big chunk of its $127 billion commercial-property portfolio consists of interest-only loans with a balloon payment at the end, the wholesale equivalent of Pick-A-Pays. These will be hard to refinance.
Another worry is the large amount of credit protection that Wachovia is thought to have sold on risky tranches of mortgage-backed securities. Wells points to its latest filing, which shows $105 billion of protection sold and a similar amount bought. But the extent to which the latter really offsets the former is unclear.
End of quote
But Wachovia also brings credit problems that could take years to resolve. A big worry is its range of “Pick-A-Pay” retail loans, which allowed borrowers to defer principal as well as interest payments: of those that were still current at the time of the merger, 3.2% were seriously delinquent as of June 30th, up from 1.1% in March. The default rate on the bank’s $38 billion of property-development loans is several times the national average (though Wells argues that the official numbers do not reflect merger-related adjustments). A big chunk of its $127 billion commercial-property portfolio consists of interest-only loans with a balloon payment at the end, the wholesale equivalent of Pick-A-Pays. These will be hard to refinance.
Another worry is the large amount of credit protection that Wachovia is thought to have sold on risky tranches of mortgage-backed securities. Wells points to its latest filing, which shows $105 billion of protection sold and a similar amount bought. But the extent to which the latter really offsets the former is unclear.
End of the quote
The other portfolio I would like to highlight is the Pick-a-Pay portfolio. We are very encouraged with the performance to date of the Pick-a-Pay portfolio and actually expect lower life-of-loan losses than we’d estimated at the time of merger for both the credit impaired and non-impaired portfolios. Due to our improved current outlook, beginning in the fourth quarter, we expect to recognize a modest yield increase in our impaired portfolio, recapturing a portion of the life-of-loan purchase accounting marks through net interest income. While the housing market, unemployment and the economy levels will affect future performance, let me explain why we are optimistic about the future performance of this portfolio.
• First, we have been actively modifying these loans and have completed nearly 20,000 full-term modifications in the third quarter and over 43,500 modifications year to date, modifying 22 percent of the loans in the impaired portfolio. Nearly 98 percent of the modifications completed have decreased the payment materially for the customer, which we believe is the key driver of success. All modifications are reunderwritten, income is verified and the negative amortization feature is eliminated. For the modifications we completed earlier this year, our redefault rates after 6 months have been less than half the 41 percent redefault rates for industry modifications with a comparable amount of seasoning. But, we acknowledge it is still very early in the lives of these modifications and we’ll continue to report on performance going forward.
• Second, we’ve continued to reduce the size of the Pick-a-Pay portfolio to a total of $87.8 billion outstanding, down $2.6 billion from second quarter and down $7.5 billion from year-end. This decline reflects loans paid in full, loss mitigation efforts and the fact we are not originating any new loans in this portfolio.
• Third, while this portfolio is called the Pick-a-Pay portfolio, only 74 percent of it is Pick-a-Pay loans which have negative amortization potential, down from 86 percent at year-end, a $22 billion reduction. So, not all loans that we include in our Pick-a-Pay portfolio are pay option loans with negative amortization potential.
• Fourth, deferred interest balances declined for the second consecutive quarter due to the combination of lower interest rates and the impact of gradually increasing minimum payment requirements, as well as our modification programs. In September, approximately one-third of the customers who chose to make the minimum payment did not defer interest. While customers’ minimum payments have continued to increase annually, market interest rates have decreased and many customers are at the point where their minimum payment not only covered the interest due, but paid down some principal as well. We expect this trend to continue.
• Fifth, the stabilization in the outlook on home prices in certain markets where we have significant exposure benefits the expected performance of the portfolio.
• Finally, we have observed improvements in delinquency roll rates compared to projections earlier in the year.
There are limits to how much of a company they can own.
This selling is more for purpose of complying with regulations than it is for reallocating assets though it would make sense from that angle also considering the amount of shares are with the Foundation currently.
On Nov 15 09:16 PM Karldean wrote:
> Article was well written and insightful, but I am biased, I love
> Warren! I don't think spit of Gates, he sold 600 shares of Berkshire
> the day Buffet bought the railroad, seems to me a vote of no confidence
> on his part, sold stock Warren gave him. I never sell a gift, it
> just ain't done where I come from. Think I will buy some Wells stuff
> just because I like stagecoaches and maybe some train stuff, besides
> I already own an antique red and green Santa Fe signal light, original
> bulbs and it still works, that ought to tell ya something.
On Nov 15 08:06 PM huangthomas wrote:
> How come I received two thumb down just by asking questions? There
> must be something to hide regarding Wachovia and Wells Fargo. A few
> weeks ago, an article in "Economist" discussed the trouble Wells
> Fargo were in because of toxic assets from Wachovia. It took Wells
> Fargo 5 days to transfer cash from my account to another bank. It
> must be short of cash. Short of cash already?
Why people think the economy is improving is simply because the government and media are telling you this. You aren't the people in the trenches. Get in the trenches and then look me in the eyes and tell me the economy is improving.
Also note Warren Buffet's investments and how many of them received Government aid: American Express, Wells Fargo, Goldman Sacks. No wonder Buffet is in bed with Obama. Any closer relationship and Buffet's nose would be brown. Shame on Buffet and shame on the US Government for their lies.
EE
On Nov 15 09:19 AM EddieTa wrote:
> Good article, thanks.
On Nov 15 10:38 PM Amit Shah wrote:
> Stop posting the same statements again.
This includes big pharma, banks, energy trading, psychiatric hospitals, etc. You do OK for a while, then the company's moral inadequacies hit and you lose. OK, rather than say 'you' I should say "I".
So, would I invest in a bank? No. For moral reasons? No. These companies are built on betrayal and they will betray their share holders in the end. Trading is OK, but not investing.
Just because there're a few (or even a dozens) of crooks in a particular industry, it doesn't makes all the rest who are decent crooks as well. Why use a broad brush to paint over everyone? There're crooks in all industry. So what? That doesn't mean you should sit around doing nothing. What is important is to evaluate each individual by their own merit, and that's fairness.
If a person behave like a cat that sat on a hot stove before, and never sit on another stove ever again regardless if the stove is hot or cold, he or she will miss out on all things.
rattenads.com
I believe, without a sound monetary system, it is impossible to have a sound banking industry. This is where we are right now. The US dollar is going to collapse to ZERO, all banks will be destroyed in the process. No one is going to leave money in a bank when hyper-inflation hits. Without depositor customers, all banks are out of business.
From the philosophical point of view, America's problem today is we have too little of the productive sectors left (our manufacturing jobs are outsource to foreign countries), but too much of the non-productive and DESTRUCTIVE sector, the banking, finance, and wall street manufactured derivatives bubble. No material fortune is created when money is exchanged from one hand to another.
To fix that imbalance, the banking industry of America must experience some destruction, and the productive industries of America must thrive. The world does not need America's Goldman Saches or the FED, but the world definitely needs our Microsoft, Intel and Boeing airplanes.
Get out of banks and get into the real productive sectors of America.
seekingalpha.com/autho...
I do not advocate shorting banking stocks. I do not advocate shorting anything at all. To short any position also means to hold a long position in US dollars (long cash), which is not right. The only thing that needs to be shorted is the US dollar.
At some point when more people see the coming of hyper-inflation. There WILL be chaotic bank runs. Such bank runs are not due to worry about health of individual banks, but due to worry about the health of the US dollar itself. When you are losing purchase power fast, it makes no sense to leave cash in a bank.
Will the government impose daily cash withdraw limit? You bet. It is better to get your cash out while you still can and while there is still not a significant limitation. Put into real assets like precious metals.
On Nov 16 01:55 PM Mark Anthony wrote:
> ...I believe, without a sound monetary system, it is impossible to have a sound banking industry. This is where we are right now. The US dollar is going to collapse to ZERO, all banks will be destroyed in the process. No one is going to leave money in a bank when hyper-inflation hits. Without depositor customers, all banks are out of business.<
The dollar was worthless, given 12%+ annual inflation
Gold was going to $1500/once
The US debt was skyrocketing, and the US was becoming the largest debtor in the world.
The US trade balance was the worst in history, and getting even worse
The US was no longer making anything
The major banks were going to go under because of their enormous holdings of Latin American debt.
Japan was going to rule the world
Diamonds were clearly the best investment because the prices were controlled by DeBeers, and they were the perfect hedge against a worthless dollar.
Oil will rise to at least $50/barrel by the end of the decade.
Stocks were dead money investments -- only a fool would invest in US stocks.
I am SURE there will be a crisis of some kind in our future. I do not know when or how.
But, I do know that it will almost certainly not play out the way all the doom and gloom gold bugs think it will.
On Nov 16 02:03 PM Mark Anthony wrote:
> But let me make it clear:
>
> I do not advocate shorting banking stocks. I do not advocate shorting
> anything at all. To short any position also means to hold a long
> position in US dollars (long cash), which is not right. The only
> thing that needs to be shorted is the US dollar.
>
> At some point when more people see the coming of hyper-inflation.
> There WILL be chaotic bank runs. Such bank runs are not due to worry
> about health of individual banks, but due to worry about the health
> of the US dollar itself. When you are losing purchase power fast,
> it makes no sense to leave cash in a bank.
>
> Will the government impose daily cash withdraw limit? You bet. It
> is better to get your cash out while you still can and while there
> is still not a significant limitation. Put into real assets like
> precious metals.
On Nov 16 01:55 PM Mark Anthony wrote:
> What evidence do you have that Warren Buffett loves banks? If he
> does, then he is completely wrong. Warren Buffett does not understand
> gold, so he does not understand that all fiat currency would fail
> at the end, either. He doesn't have that concept.
>
> I believe, without a sound monetary system, it is impossible to have
> a sound banking industry. This is where we are right now. The US
> dollar is going to collapse to ZERO, all banks will be destroyed
> in the process. No one is going to leave money in a bank when hyper-inflation
> hits. Without depositor customers, all banks are out of business.
>
>
> From the philosophical point of view, America's problem today is
> we have too little of the productive sectors left (our manufacturing
> jobs are outsource to foreign countries), but too much of the non-productive
> and DESTRUCTIVE sector, the banking, finance, and wall street manufactured
> derivatives bubble. No material fortune is created when money is
> exchanged from one hand to another.
>
> To fix that imbalance, the banking industry of America must experience
> some destruction, and the productive industries of America must thrive.
> The world does not need America's Goldman Saches or the FED, but
> the world definitely needs our Microsoft, Intel and Boeing airplanes.
>
>
> Get out of banks and get into the real productive sectors of America.
>
> seekingalpha.com/autho...
In many respects the lack of a pullback in the market can be traced to the falling dollar. We see this meteoric rise (The Dow over 10K again?!?!) and kinda scratch our heads. But if you look at the US market from, say, a European perspective, it looks very different.
In anycase, the #1 enemy for a bank like Wells is inflation. Well, that is really the ONLY enemy for a bank like Wells now. They've dealt with all the other enemies. So it all comes down to how well the Fed handles ye old greenback.
Even though the Fed has stated that they would try to continue keeping interest rates low for the next few years, and even though we know that a weak dollar is about the only thing capable of jump-starting our exports (and thus our manufacturing), at the same time they also know they can't let the dollar fall too far. I doubt the Fed will allow the Euro to break $2 (we're at around $1.50 as of this writing).
There is also China. China's currency is locked to the dollar and the falling dollar is causing China's economy to become red-hot. Their hand might be forced too. Even if they don't unlock their currency they may change the conversion ratio. As *THE* major trading partner with the US as well as holders of $2T in US debt, China is the 10-ton gorilla in the room. If China is forced to adjust the ratio it will (obviously) cause prices in the US to go up even if China decided not to sell a single penny of the US debt they hold.
So at some point down the line someones hand is going to be forced it we'll just have to see how well the Fed manages inflation when that time comes.
-Matt