On Friday, the FHFA, the regulator of Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) sued 17 of the largest banks in the world. Included in that list are Bank of America (BAC), Ally, JPMorgan (JPM), Citi (C), GE (GE), Goldman Sachs (GS), Barclays (BCS), and HSBC (HBC). And while we think this lawsuit is counterproductive, since suing banks to recover losses goes against the governments wishes of higher capital ratios and increased lending, for better or worse, the suits have been filed. All the largest banks in the U.S. were sued for selling Fannie and Freddie shoddy and misleading mortgages. All except one, that is.
Wells Fargo (WFC) is unique among the Big 4 U.S. banks in that it has largely stayed out of the causes of the financial crisis and recession, as well as the regulatory responses to it. Its peers are constantly attacked, by both regulators and the markets, while at Wells Fargo it is business as usual. Because Wells Fargo did not violate the fundamental principle of banking (no lending money to people than cannot pay it back) it has not suffered anywhere as much as its bigger peers. Indeed, this is the most likely reason Warren Buffet is the bank's largest shareholder, owning close to 7% of the company. And he has publicly stated that he wishes he could by the entire bank if regulators would allow him. History has shown U.S. that Warren Buffet is usually correct over the long term, and we feel he is correct in placing his faith in Wells Fargo. The bank's focus on actual banking is what has allowed Wells Fargo to weather the current environment far better than its peers, and it shows in its share price, which has fallen by a fraction of its main competitors, Citi, Bank of America and JPMorgan Chase.
While we are long Citi, we do see Wells Fargo as having many unique qualities that make it a fine investment. Wells Fargo, despite the current market headwinds, still trades at a premium to its book value of $23.84/share. We see this not as a sign of overvaluation, but as sign of strength. Even JPMorgan, seen by many as the pre-eminent US bank trades at a steep discount to book value (though nowhere near where Citi or BofA trade) Wells Fargo has steadily increased its book value for 5 straight quarters and its balance sheet is far cleaner than any of its primary competitors.
While its competitors are either bleeding money (BofA) or just returning to profitability, (Citi) Wells Fargo reported record profits during its most recent quarter, a feat that JPMorgan will most likely fail to match after this quarter. Furthermore, Wells Fargo stayed profitable throughout the recession as its peers teetered on the brink of bankruptcy (even JPMorgan reported a loss during the recession) Wells Fargo is now the 2nd largest U.S. bank by market capitalization despite being the 4th largest by assets, a feat we think is due to its common sense approach to banking.
While critics may contend that Wells is too exposed to the US, (whereas Citigroup (C), for example, generates more than half its profits overseas), we think this is only an issue when management is incompetent (as is the case at BofA) Wells Fargo, due to its narrow focus, can actually concentrate on the banking needs of its customers, and can make record profits while doing so.
Wells Fargo has a Tier 1 common equity ratio of 7.4% under Basel III, and it was still able to both boost its dividend and resume share buy-backs. The stock currently yields nearly 2%, and we believe that there is more room for the dividend to rise, as Wells Fargo should continue to report strong earnings. In addition, Wells Fargo has begun redeeming its trust preferred securities, which should boost earnings going forward by saving the bank hundreds of millions in interest expenses.
We think Wells Fargo is a buy do to its unique stature among U.S. banks. The company has among the lowest funding costs in the industry and its loan performance is among the best. Now is a great time to add to or initiate a position in a U.S. bank that truly knows how to succeed in banking.