An Extraordinary Bank
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The banking business is certainly very particular, investors don't have enough information to analyze the financial position or risk management policies of each institution in a transparent way, and that's why the ability to trust senior management is absolutely key before committing to a bank stock for the long term. One bank stands above the other big US financial institutions when it comes to risk management and trust, and that's no other than Wells Fargo (NYSE: WFC).
The bank has done much better than its peers during the financial crisis, not by using complex hedging strategies or by being faster and smarter that the rest. Quite the contrary, Wells Fargo simply avoided taking too much risk and in that way it delivered superior returns for its shareholders.
When it comes to investing, intelligence is not necessarily related to complex thinking; the ability to control greed and avoid following the herd can be much more relevant for long term success, or even for simple survival. In the words of Warren Buffett:
Success in investing doesn't correlate with I.Q. once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.
Wells Fargo did precisely that, it avoided the big and costly mistakes that most of its competitors made by taking too much leverage or entering into deeply complex financial transactions with the idea of getting a few more dollars in profits. This simple and effective risk management technique comes straight from Buffett´s book, and it makes sense considering that Wells Fargo is one of Berkshire Hathaway´s (NYSE: BRK-A) (NYSE: BRK-B) biggest holdings and arguably Buffet´s favorite bank stock.
Jamie Dimon has traditionally been considered one of the best bankers alive, and he probably deserves that privilege. But managing an enormous financial institution like JPMorgan (NYSE: JPM), which deals in every kind of securities market all over the planet, is certainly is no easy task at all. In fact, the infamous London Whale scandal was related to trading activities which were supposed to hedge the bank's risks, but turned out to be an embarrassing mistake.
Dimon and his team deserve to be held responsible for what happened at JPMorgan, but this was likely a onetime event which will not be repeated anytime soon. Even if you are one of the smartest bankers in the world, you get exposed to many risks when you try to do complicated things in our unstable and sophisticated financial markets.
The irony of the matter is that Wells Fargo not only avoided many important risks and achieved higher profits by following a simple and conservative strategy, it most likely planted the seeds for better returns in the future too. Being a more transparent institution, Wells Fargo has lower funding costs than its competitors which allows for superior profit margins.
Also, the bank has been capitalizing its financial strength to get into mortgage backed securities and student loans, sectors from where other banks are running away in their search for higher liquidity and less risk. Unless Wells Fargo loses its grip and assumes too much risk in these areas, it now has the potential to buy much cheaper into risky sectors where competitors need to stay away.
Other banks like Citigroup (NYSE: C), which took too much leverage during the subprime mortgage bubble, can´t even think about entering the competition for these high margin deals that Wells Fargo is doing. In fact, Citigroup is still trying to put its house in order before it can think about growth. Wells Fargo is not only safer, but also likely to remain more profitable than its peers for some time.
Slow and steady wins the race, and Wells Fargo has chosen that path by avoiding the complex financial activities which brought so much trouble for its competitors. Keeping in mind that it’s very hard for investors to analyze the risk positioning of these companies, I would stay with the bank which has proven its commitment to simple and effective risk management.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Berkshire Hathaway, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short APR 2012 $21.00 puts on Wells Fargo & Company, short APR 2012 $29.00 calls on Wells Fargo & Company, short OCT 2012 $33.00 puts on Wells Fargo & Company, and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Berkshire Hathaway and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.