Wells Fargo: Don't Underestimate This Powerhouse

| About: Wells Fargo (WFC)

Wells Fargo (NYSE:WFC) announced that it plans to double its asset management business over the next 7 years. The bank will expand into international markets to achieve this goal. This comes at a time when its major competitors like Bank of America (NYSE:BAC) and Morgan Stanley (MS) have decided to place their asset management business on the block.

This seems a timely move as major overseas banks are selling off their asset management units to shore up their balance sheets and meet new capital requirements. For example, Deutsche Bank announced that they will pursue selling their asset management business to fill a capital gap of 3.2 billion Euros after European Banking performed several stress tests on the bank. The good news is that valuations of these asset managers are still trading below pre-crisis levels. This means that Wells Fargo will likely get a better deal from acquiring these asset managers. The challenge for Wells Fargo is to attract European institutional clients with its small team in the region. It has 8 sales persons but plans to add five more. It seems that the fastest way to beef up its team is to acquire a European bank's asset management unit.

At present, Wells Fargo manages $215 billion in money market and mutual funds under the Wells Fargo Advantage Funds. The earlier purchase of Wachovia and Evergreen Management unit added in $67 billion in assets. The plan is to add foreign stocks and bonds as part of its strategies and open 6 more Luxembourg-based funds for offshore clients.

For the year that ended March 31st 2012, the Advantage funds increased by $14 billion, making it the 17th largest fund family based on Morningstar data. The fund has $101 billion in long term assets and around $109 billion is on money market funds. Around 52% of the funds have Morningstar ratings of 4 to 5 stars. This seems higher than the industry's average of 30%.

It has an expense ratio of 1.31% for its primary share class. This is higher than the median average of 0.77% for similar funds. Based on the data compiled, it has increased by 10% this year. There are 36 teams managing the fund, including 25 teams at Wells Capital Management.

The outlook may be good for bond funds. This could bode well for Wells Fargo as it has a large exposure to bonds. Based on the latest data of Investment Company Institute, bond funds had an inflow of $31.84 billion in March. This is in contrast to the stock funds outflow of $9.62 billion for the same period. Given the uncertainties surrounding Europe, we may see investors moving funds out of the equities market to better quality assets such as bonds.

Cross-selling overseas is the key driver

The bread and butter business for Wells Fargo has been its mortgage business. This seems an appropriate decision as it has the highest net interest margin among its peers. Over the last 10 years, it has an average net interest margin of 4.9%. This is significantly higher than the industry's average of 3.4%.

This is attributed to its low cost large deposits base, which includes non-interest bearing deposits, interest-bearing checking accounts and savings certificate. Around 67% of its funding comes from deposits, higher than the peer group average of 49%.

I believe that the bank's plan to boost its asset management business is rather a prelude to its foray in the international markets. Its non-interest income, which includes asset management and brokerage business, earned around $7.2 billion. Even if we double this for the next 7 years, this will have smaller impact relative to its mortgage and loans business.

The decision to expand its overseas business via acquisitions of asset managers is definitely a move to cross sell its main bread and butter products and services to various overseas markets. Relative to buying a whole bank or setting up branches, this is one of the cheapest and fastest ways for the bank to achieve scale in the global arena. I also view this as dipping itself into the water before taking a big plunge into the bigger market.

This strategy is a revival of the '90s banking supermarket model. The model allows a bank to capture the growth of its performing business to boost those units that have lackluster performance. It also provides the bank synergies that will also improve its profitability.

In this case, the bank plans to sell its funds through its network of 15,000 advisers from the acquisitions they have made over recent years. With this scenario, the bank is well-positioned to grow its businesses over the next 5 years. It said that it has a target return on assets of 1.3% to 1.6% and a return to equity of 15% depending on regulatory and economic environment. This will likely translate to a dividend payout of roughly 50% to 60%.

Moving forward, I believe that these strategic acquisitions will help expand Wells Fargo's businesses and help improve profitability. It helps that it has a good track record with acquisitions. The biggest is its acquisition of Wachovia in 2008.


Analysts expect the company to earn $3.28 per share this year. This will translate to an earnings growth of 16% compared to the same period last year. Over the next 5 years, it is expected to grow its earnings by 11% a year. At the current stock price, the stock is trading at 9.71 times 2012 earnings. It also carries a dividend yield of 2.80%. Investors can be assured that dividends will be consistent as it recently passed the Federal Reserve's stress tests.

Its competitors are valued lower in terms of multiples. JP Morgan (NYSE:JPM) trades at 7 times earnings and has a dividend yield of 3.60%. Citigroup (NYSE:C) is valued at 6.45 times earnings and carries a dividend yield of 0.20%.

These valuations suggest that investors have not come in a big way to bank stocks. The current environment justifies these valuations. Over the long run, investors will pick up bank stocks that have strong prospects and better profitability. In my view, Wells Fargo will be one of those stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.