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jclyak
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JD, CPA, 18 years CEO/CFO, investor for 50 years
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  • Book Value Analysis Is Completely Irrelevant To Wells Fargo
    Once again a noted bank analyst this morning on CNBC, on a bullish note, stated that major bank stocks have room to move up. The only problem is that he hopes they can move all the way up to 1.3 times book value.....wow!

    This gets a little problematic for investors in Wells Fargo, WFC that currently trades at 1.37 times book value and US Bancorp USB that trades at 1.93 times book.

    I find it to be totally incredulous that anyone would consider book value for these two banks. The inclusion of these banks in book value analysis has obviously been rejected by the market for good reason and these lazy analysts need to distinguish Wells in particular from this broad brush approach.

    Wells Fargo is the nation's most valuable bank by market cap. Isn't it time you spent a couple of minutes to learn and articulate why it is different than Citi, BAC and even JPM? (In fact it would be nice if CNBC started to put Wells on top of the bank quote chart, instead of ignoring it)

    Listen analysts: Book value of a bank and in particular, tangible book value, is only relevant if a bank's earning power is so low that it has no business value...ie. it is only worth as much as its parts on a fire sale. (Even then, book is a pretty dubious indicator of value)

    Ponder the book value of the following assets:

    • Deposits: What is the book value of $920,000,000,000 of virtually no interest rate deposits? $0 (actually I think they have a $12 bill asset for acquired deposits that is amortizing at $2 bil./year and wrongfully hurting earnings)
    • Wachovia Bank: It has a book value as an asset on Wells Fargo books of around $12 billion, the amount paid for it. It was worth around $100 billion a year before Wells acquired it in an extreme fire sale.
    • Wells has spent $6 billion over the last 3 years integrating Wachovia into Wells. What's the book value of these costs? $0
    • What's the book value of the Coke formula that generates $ billions of annual profits? $1
    • What's the book value of any asset that earns returns that are vastly greater than the book value indicator of "value?"...Yup...it's still BOOK VALUE
    OK, what would the market pay for $920 billion of interest free deposits that can be invested @ 5%? More than $0?

    How about these other assets? More than book?

    In all fairness, the analysts keep limiting the projected value of the banks because they believe their earnings prospects are limited by Dodd Frank (but what the hell does this have to do with book value?)

    Dodd Frank, in particular, the Prop trading and Volcker rule will hurt bank earnings of those banks that relied on these sources for core income...NOT WELLS FARGO

    As long as analysts take such a lazy, one size fits all analysis of big banks they are themselves "irrelevant" and people that will actually look under the hood will profit.

    BTW in 2003 both Wells and USB traded at 3 times book and I believe, if earnings so justify, they'll return there within a couple of years.

    Disclosure: I am long WFC.

    Mar 23 2:24 PM | Link | 2 Comments
  • Wells Fargo's (Banking Industry) "9-9-9 Plan"
    Wells Fargo has lost about $2 Billion a year of fee income thanks to Congress. Making up for this in a transparent way is subject to a ton of negative scrutiny and is essentially impossible, unless Wells and other banks are a bit sneaky going about it. Here's how Wells Fargo can make up for all the lost fee income bestowed on it by Congress:
    • 9 more points on loan originations (including homes)
    • 9 more points in interest; and
    • 90 cents per month more fees per customer
    I believe home loan originators, including Wells are already rightfully asking for more fee income on loan originations. In fact Stumpf recently declared that "margins (as well as origination volume) are up.
    With a run rate of $140 billion a Q for home loan originations, a 9 basis point increase in fees ($180 on a $200,000 loan) would yield $126 million a Q in fee income that is generated below the radar of bank critics, including Congress. Add a simlar increase to all loans originated and I believe Wells generates about $200 million a Q in added revenue...without complaints.

    If Wells simply increases interest rates on its loan book of $$900 billion by 9 basis points over the next 3 years relative to historical levels, it drops an added $810 million/year in undetected revenues.

    Next, figure out how to nickel and dime its 45 million customers to the tune of $.90/month in terms os processing fees, minimum account balances, money orders, etc. In fact, just dropping rewards on debit cards would probably come close to doing this. Net result: $486 million/year in added revenue.

    The total of these items is $2.1 billion a year.

    What's my point?

    Let's draw an analogy to the insurance industry after a natural disaster. Premiums go up for a period of years thereafter and it's pretty much accepted.

    In the case of banks, we've just been through a perfect storm of losses, largely caused by huge pass-thrus of costs to banks (on top of direct loan losses). Furthermore, the government has said banks can't charge for lots of things in a traditional manner and banks must exit traditional and profitable investment bank businesses to wit: Prop trading, derivatives and hedging.

    In short, all banks need revenues and they all know it. The environment for raising fees of all sorts has never been better.

    Contrast Wells with BAC and JPM. Both the latter have been vastly more impacted by the loss of investment bank sorts of revenue than Wells. Additionally, they are vastly shrinking their home lending businesses, making their revenue base even smaller relative to Wells. Net reult: Other banks need to raise revenues much more than Wells does because Wells had no investment banking business to lose and it is growing in home lending.

    I believe bank margins (on all products that are not directly quantifiable by bank gadflies) are skyrocketing, especially for Wells. Let's call it the "9-9-9-9-9-9-9" program. Not only is Wells vastly increasing its market share in all categories, but its margins are going thru the roof IMHO.

    Disclosure: I am long WFC.

    Feb 28 8:22 PM | Link | 2 Comments
  • Wells Fargo Comparison Of 2003 With 2011 (and Profit & Stock Price Projection)

    2003 was fairly typical of the period of 2001-2006 in terms of the first 5 years of the millennium relative to the general economy as well as Wells in terms of its performance and stock price matrix. (Info derived from Morningstar) In other words, 2003 is pretty representative of what we can expect over time and I'm too lazy to do a year by year analysis.

    My point in this article is....Wells stock should revert to its 2003 relationship to its ratios described here and its income should vastly improve...yielding a $90 price in 3-4 years.

    2003 is representative of the years 2001-2006 and is indicative of "normal" for WFC (IMHO)

    .......................12/31/03....... 12/31/11

    Stock price

    (2/4/03 and now) $29............... $30.6

    Book Value/share.$10.90...........$24.40

    Sh price/book..... 2.66............... 1.25

    Shares out..........3.4 Bil............. 5.3 bil.

    12 mos net inc.. $6.2 Bil............ $15.9 Bi.

    Sales/Share...... $8.35.............. $15.50

    Earnings/sh....... $1.83...............$2.82

    Deposits/sh....... $72.65.............$160

    Loans/sh........... $75.................$153

    Net Int Mrg(NYSE:NIM) 5.08%..............3.89%

    Total Assets/Sh ..$114............... $237

    Credit loss/rev..... 6.1%.............. 10.0%

    Credit Loss/Loans .6%................. 1%

    Non-int exp/ revs 60.6%............. 61.4%

    Return on Assets 1.68%............. 1.14%

    Equity/assets...... 10% ...............10%

    Return on Equity 19.21%............ 11.92%

    P/E...................15.8................ 10.85

    Stock yield %..... 6.3%................ 9.2%

    10 Yr. Treas Yld.. 4.2%............... 1.9%

    Analysis

    I believe 4 things will drive Wells stock going forward:

    1. The low yield on bonds will force investors to go elsewhere. The general P/E of the S&P 500 for 2012 is expected to be 12, yielding 8.33% or 4+ times the 10 year Treasury. People are going to be forced to use principal to live on, pensions that assume 7.5% yield are going to need returns…There are no loans to buy real estate on needed leverage…stocks are it for yield…risk be damned.

    2. The financials will be less disfavored in 2012 (they already are). However, in general, skeptical investors will not expand the stock prices of banks to historical P/E ratios. However, this will be largely offset by lower alternative yields on fixed income bets, including Treasuries, so I think P/E's will get back to where they were in 2003.

    3. Investors will once again "trust" WFC and JPM, neither of which has deserved the trashing they have taken. Wells in particular will be seen as an undeserved victim of the trashing…it's a real bank that makes money the way George Bailey does…Midwest, take deposits, make loans and provide excellent service….the old fashioned way. (Forbes…here we come!)

    4. Wells earnings are going to vastly improve over the next year.

    Summary: Wells will attain a forward P/E of 15 13-15 times in a year…probably the end of 3Q as opposed to a forward P/E of 8.7 now. Projected 12 mos. forward earnings will go from $3.20 (now) to $4.50+ by 4Q 2012, if not much earlier.

    Is Wells Stock Cheap Now?

    If you look at the first 8 data points listed above and the last 3 data points assuming that 2003 is typical for Wells and the stock is "CHEAP" The analytical factors 1-3 articulate my premises that the stock will go up a bunch in 2012, closer to normal ratios. It's going to take positive revenue and earnings trends as well to drive the stock to historically normal pricing. However, the growth of earnings will have the double effect of not only affecting a normal P/E, but the denominator ("E") is really going to kick the stock as it goes up much faster than current expectations.

    What is Going to Cause Earnings Gains?

    Macro Economic:

    Timing of this is difficult to predict. In fact, I'm already wrong by a year. We've now had 3 years of economic malaise, overlaid by Obama, bank bashing, bank litigation, interest rate spread compression and about everything else that makes the banking environment horrible.

    I believe that the additional year of bad times has more tightly wound the spring for growth when it happens (I hope now). In particular, housing, jobs,, capital equipment and cars are spring loaded for growth. When this happens, loans will be made, interest rates will go up and banks will click considerably better than historically, as measured by 2003.

    The following will directly benefit from the macro changes as well:

    · Net interest margin will go back to 40 basis points less than the 2003 level of 5.08%. Assuming no deposit growth, pre-tax income would increase by $10 billion annually with this recovery.

    · Bad debts will revert to the 2003 rate of .6% from the 2011 rate of 1% of revenues…about $350 million/year.

    · If Wells can make record profits in 2010 and 2011, just think what will happen if the economy even normalizes, let alone springs back. Wells has performed in spite of the economy…turn that headwind into a tailwind for a couple of years and I believe Wells gets at minimum a $10 billion/year pre-tax swing.

    Wells Specific Profit Drivers:

    Expenses:

    · … are much too high. Wells has announced that it will reduce operating expenses by $1.5 billion/Q by 4Q of 2012, with substantial improvement by 2Q. In 2011 operating expenses were 61.4% of revenues compared to 60.6% in 2003.

    · The completion of the Wachovia integration drops $500 million/Q of expenses, so where does the rest come from? I believe Wells is blowing at least $1.5 billion a Q on the housing mess. It lost $404 million alone on Fannie Freddie mortgage warranties last Q, with like amounts before. The wind down of foreclosures, refinances and litigation has got to further enhance this savings. Wells has about 30,000 extra employees handling this, let alone lawyers, lobbyists and outside contractors.

    · Wells has completed a single computer platform to run its entire business, down from 100+ a couple of years ago. Not only is this going to halt the conversion costs, but what about the efficiency going forward…another tailwind replaces a severe headwind?

    · Technology and size of the enterprise should vastly lower expenses relative to revenues. Think about 14,000 envelope-free ATMs compared to what was available in 2003. Overlay going from 100 computer platforms to manage them (along with 45 million accounts) to 1 in the last 2 years?

    · How much money is being saved thru Wells best-in-class internet banking offering (also now on one platform)?

    · How much money is being saved by rolling up to a single bank with $1.3 Trillion in assets in terms of highly paid duplicative management? We're talking about 1 CEO, etc. here.

    Conclusion: Wells expense savings projection of $1.5 billion/Q seems quite conservative.

    Buffett said a couple of years ago that Wells is quite capable of a PTPP (pre-tax, pre-provision) profit of $40+ billion in normal times. If one overlays Wells announced expense reductions of $1.5 billion/Q with the current PTPP of $8.1 billion, it is almost there. Throw in the macro-economic factors plus Wells's market share gains and we're talking of a PTPP of $50 billion + annually. Deduct say .7% of credit losses and pre-tax income hits $44 billion +.

    After tax, $28.5 billion or $5.65/share? A 16 P/E? ….a $90+ stock price?

    Disclosure: I am long WFC.

    Feb 13 2:09 PM | Link | 4 Comments
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