Simple Investment Thesis: pre-provision pre-tax earnings and normalized earnings power have NEVER been higher, banks are not paying dividends so tangible book value is increasing rapidly, and capital ratios are higher than ever in an improving economic environment. Wells Fargo's (WFC) stock price is the same as pre-Wachovia despite a huge increase in earning assets relative to the increase in shares outstanding, a fortress like balance sheet with an incredible financing mix (the lowest cost of capital and cheapest deposit base of all large-cap US banks).
In the next few months, the large-cap U.S. banks will go much higher. If you listen to the bears, you will miss the rally (John Paulson and Warren Buffett are far more intelligent than Meredith Whitney, and Dick Bove said to buy Wells Fargo last year when its earnings power was lower, capital ratios were worse, and tangible book value was lower, and its stock price was higher). Anyone investing based on Meredith Whitney and Dick Bove's advice will miss the next leg higher on large-cap banks. Also, Dick Bove should explain why Bank of America (BAC) and Citi (C) are better buys than Wells Fargo, which has a far superior management team, the best deposit base in the industry, and more consistent earnings power. If he thinks Wells Fargo needs more capital, then Bank of America DEFINITELY needs more capital. Personally, I think all the banks capital ratios are much healthier than in any time in the last five years and I would be strong buyer of Wells Fargo, JPMorgan, and Bank of America.
Two of the world's best investors continue to be extremely positive on the large-cap financial institutions.
John Paulson's most recent quarterly letter on November 16, 2009 explains return analysis for Bank of America:
Bank of America
- Pre-Credit Pre-Tax Income (2011) = $57,500 million
- Normalized Provision (1.75% of Loans) = (16,357) million
- Preferred Dividend & Income Tax = (14,963) million
- Net Income (for common shares) = 26,132 million
- Fully Diluted Shares = 8,802 million
- Normalized EPS = $2.97
- Multiple = 10.0x
- Value at 12/31/2011 = 29.81
- Current Price (as of 9/30/09) = $16.92
- Annual Return = 34%
- Multiple of Investments = 1.8x
Paulson forecasts the current write-down cycle will end December 31, 2011, and visibility for growth will resume in 2012.
Warren Buffett added to his Wells Fargo holdings by over 10 million shares in the most recent quarter ended 9/30/2009. John Stumpf, CEO and President of Wells Fargo, made some extremely positive comments on the company this past week.
Commercial Real Estate
Nearly $500 billion in commercial real estate loans will mature in each of the next few years.
“One reason you’re seeing less pain is because interest rates are so low,” Stumpf said. “The carrying costs of these properties are at record low levels. That being said, you can’t carry it forever if there’s no cash flow on these properties.”
“On the Wells side, while like other banks, ours has taken bumps, but I think it’s the finest underwritten commercial loan portfolio in the country,” he said. “On the Wachovia side there was more risk in the portfolio, but at the time of the merger we wrote that down, we took big substantial hits on that portfolio. So in many cases our losses are already behind us.”
Loans
“We’ve got our team marching double time looking for loans,” Stumpf said. “You hear from time to time that banks aren’t lending money, we’re lending all the money we can.”
Industry wide, loan demand is down as businesses retrench. Since the start of the credit crunch, some in business and in government have complained about the lack of bank liquidity, but bankers have generally been quick to counter that they are making loans to creditworthy borrowers, though standards have tightened.
“As an industry I think one of the biggest challenges will be not enough earning assets, not enough loans,” he said.
Stumpf said the banks are one-third of the way into their three-year integration process. Wells Fargo expected $60 billion in losses over those three years as it came to grips with soured loans within the combined Wells Fargo-Wachovia portfolio. Much of that, about $41 billion, was realized in the first year, as planned.
“We’re still in same zip code with those numbers,” he said, adding that synergies from merged operations are being realized a faster clip than originally planned, and losses from legacy Wachovia’s risky option-arm Pick & Pay mortgage portfolio are actually not as steep as originally feared, despite deepening financial gloom.
“We’re on track, we’re on schedule and we’re under budget,” Stumpf said. "I couldn’t be happier, I couldn’t be more excited.”
The bank’s mortgage origination business, he said, “is booming.” The company originates about one in four U.S. mortgages and services one in six.
Georgia is one of the nation’s leading centers of the foreclosure crisis, but Stumpf said the state has fared better than many areas, including Florida.
“On residential side, seeing signs, especially on the lower end, we’ve reached the bottom,” he said.
The bank has seen home prices rebound from the bottom in California, but losses are continuing in regions like the Sunshine State.
Wachovia and Wells Fargo have modified 400,000 home loans and refinanced 1.1 million loans Stumpf said. Overall, the mortgages on its balance sheet, he said, “have held up exceedingly well.”
Conclusion
JPMorgan, Wells Fargo, and Bank of America are the leading commercial banks in America as we emerge out of the financial and economic crisis of the past 24 - 30 months. Their stock prices today reflect current earnings power and not normalized earnings, which John Paulson says will emerge in the back half of 2011. With extremely low short-term interest rates (3-month treasury yields at .01%, 6-month yields at .13%, and 12-month yields at .26%), the steep yield curve makes banking in an incredibly profitable business today.
Disclosure: Long Wells Fargo, JPMorgan, Bank of America
