Add Wall Street Together and Get Wells Fargo

By Chris Marasco - August 31, 2012 | Tickers: BAC, C, GS, JPM, WFC | 0 Comments

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All eyes are watching the financial sector to see how it responds in this flat market, as the banks often lead the market both up and down.  If we see a major influx of buyers then the financials may get a major bump – and if not – then perhaps it may be better to get an early jump on the “flight to treasuries” trade.

Nonetheless, investors today are keeping close tabs on Wall Street, including Citigroup (NYSE: C), Bank of America (NYSE: BAC), Goldman Sachs (NYSE: GS), JPMorgan (NYSE: JPM), and Morgan Stanley.  But take three of these banks, Morgan Stanley, Goldman Sachs, and Bank of America, and add them together – and out comes the oft-forgotten Wells Fargo (NYSE: WFC) – which controls 1/3 of the mortgage market and 18.5% of loan servicing (billing and collections).

With few to no trading, research, and investment banking services, Wells Fargo is typically overlooked on The Street.  But with a market cap of nearly $180 billion and a customer-focused business model, the bank is far too large to ignore.

Customer-Focused

Wells Fargo CEO John Stumpf knows that the bank lives and breathes on mortgage lending, so he structures his company to appeal to his target demographic of people, those that borrow to own their own homes.  To appeal to these folks, Wells Fargo executives crafted Vision and Values, the company’s 37-page guide detailing how employees will interact with customers.  The guide espouses character traits like honesty, integrity, and ethics.

Moreover, Wells Fargo has held an average of 17 “Home Preservation Workshops” in each of the past three years.  Stumpf knows that it is a major hassle and expense to auction off foreclosed property – and homeowners are brought to tears if their homes are taken away (just yesterday I encountered a man who may lose his home).  The solution?  Restructure the deal to keep both parties happy.

At Home Preservation Workshops, Wells Fargo Employees (called Home Retention Team Members) meet one-on-one with customers whose houses are underwater, meaning they owe more on the home than its current valuation.  Team members offer customers treats and snacks before taking a detailed look at their pay stubs, W-2s, and tax returns.  And the team members have the authority to restructure the loans on the spot. 

This is brilliant.  Customers may be struggling to pay off their 15-year mortgages, so Wells Fargo team members simply roll it into a traditional 30-year or even 40-year obligation.  This gives customers specific attention (so one day they recommend Wells Fargo to their children), and it lets them keep their homes.  The beautiful part of this process is that it has allowed Wells Fargo to keep strong margins compared to its Wall Street counterparts.

Margins

The major takeaway from this chart is that most banks are earning less than their cost of capital.  JPMorgan isn’t faring so bad, but Wells Fargo is absolutely killings its competitors, earning a return on equity that is 27% higher than second-place JPMorgan and 183% higher than flailing Morgan Stanley.  And Citigroup, Bank of America, and Goldman are all returning about the same.

Part of this spread is because Wells Fargo is adept at lending around interest rate volatility, as half of its revenues come from interest rate margins.  This competitive advantage makes Wells Fargo a great bet in both high and low interest rate environments.

Expansion and Diversification

Finally, I believe that Wells Fargo is doing a great job of adding business lines and staying away from risk.  In April of this year Wells Fargo bought Merlin Securities, a prime brokerage firm that provides trading, lending, reporting, and technology services to 500 hedge funds and alternative asset managers.  The prime brokerage business is a more stable business compared to other Wall Street businesses, and it gives the bank a foray into a growing, profitable space.

Also, Wells Fargo has been a wise steward of its loans.  Only 5% of its loans involve firms in the Eurozone.  Let’s take a very rare scenario and say that 20% of its Eurozone loans will eventually go belly-up.  Wells Fargo has lost 1% of its portfolio, leaving it with 99% of stronger loans.  To me, this signals strength.

To wrap up, Wells Fargo is a firm that is often overlooked among its more risky counterparts.  However, the bank has traditional values and makes its customers feel important, which has resulted in returns that are more stable and lush than its competitors.  if we see a market downturn, Wells Fargo may be a stock that you want to buy up on the cheap.

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