Wells Fargo: Success Hinged on US Economy
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As the dust settled on the chaos that was the financial crisis of 2007-2009, the list of companies that did not make it through the storm as well as those that just barely scraped through reads like a list of what were hitherto the world’s most respected financial services brands. Bear Stearns, Lehman Brothers, Wachovia Bank and Washington Mutual had to give up reputations built over anywhere between 80 and 160 years as they faded away in ignominy.
Others like Citigroup (NYSE: C) and AIG barely survived and required billions of taxpayer dollars to keep afloat. Thanks to the interconnectedness of the world’s financial system, virtually no major multinational bank in the US and Western Europe escaped the fallout.
Some, like Wells Fargo (NYSE: WFC), came out better than most.
Though the bank received $25 billion as part of TARP, it largely avoided the hits from the sub-prime mortgage crisis thanks to its consistent focus on near-prime and prime mortgages while avoiding the notorious option ARMs (Adjustable Risk Mortgage). Whereas this may seem like a somewhat ordinary achievement, its significance can only be appreciated by looking at the prevailing risk management culture among the biggest lenders in the US at the time. The bank’s relative stability was part of the main reason for its success in acquiring troubled Wachovia.
Though the drive to geographically diversify markets saw some of America’s biggest banks like Citigroup aggressively pursue global expansion in the 90s and 2000s, Wells Fargo is not as well known outside North America. Today, Wells Fargo’s focus on North America is proof that geographical spread is no panacea for effective risk management.
The steadfast confidence of billionaire Warren Buffet in this financial services conglomerate (Berkshire Hathaway has a 7.6 percent stake) has continued to position the company in a positive investor light. Like all mortals, the Sage of Omaha has made a couple of wrong moves in his lifetime (obviously far fewer than most of us) but if Wells Fargo’s performance is anything to go by, he is right on the money with this one.
With its share price currently hovering around $33 which is just below its 52 week high of 34.59, Wells Fargo has a P/E of about 11.6. The market appears to have a slightly more positive view of Wells Fargo if you were to compare to JPMorgan Chase (NYSE: JPM) at a P/E of 9.5 and Citigroup with a P/E of 9.41. It is just marginally below the P/E of smaller competitors such as US Bancorp with a P/E of 12.1 and PNC Financial Services’ P/E of 12.
As Citigroup grapples with the toxic assets in Citi Holdings and Bank of America (NYSE: BAC) struggles to temper a consumer backlash from increased charges, Wells Fargo is well on its way to becoming America’s most profitable bank. In 2011, the bank’s 30 percent growth in earnings to touch $15.9 billion was well ahead of performance by the other ‘big four’ banks - JP Morgan and Citigroup were in single digit growth while Bank of America on its part returned from a 2010 loss to post a profit in 2011. At $4.2 billion, Q1 2012 results continued a consistent rise in earnings that now goes back 7 quarters.
One of the developments likely to give impetus to Wells Fargo’s growth is the revised HARP (Home Affordable Refinance Program). Launched in early 2009 but expanded in December 2011, HARP is meant to assist refinance homeowners that are current on their mortgage payments but whose house value has plummeted below the outstanding loan balance.
Its acquisition of Wachovia coupled with its own mortgage business ‘pre-Wachovia’ has seen the bank have the largest proportion of mortgage and housing-related revenue compared to other major lenders in the US. A property shortage in the US is projected to lead to a drop in inventories with a resulting increase in demand for housing. This will in turn push home prices higher which would be a boon for Wells Fargo.
Indeed, in retrospect, the acquisition of Wachovia was a master stroke. As a recognized lender with a coast-to-coast network and decades of expertise, both smaller and larger banks may find it difficult to compete with Wells Fargo in this niche. The bank is looking to replicate its ‘Wachovian luck’ with bargains by purchasing assets, insurance and wealth management businesses from European banks looking to cut back on its participation in these sectors to comply with emerging regulations. Already, Wells Fargo has snapped up BNP Paribas’ energy business in North America, Bank of Ireland’s asset lending arm and some of Allied Irish’s US assets.
Buying Wachovia did come with certain baggage. Wells Fargo (due to its acquisition of Wachovia) together with Citigroup, JPMorgan Chase, Ally Financial and Bank of America, agreed to pay over $25 billion as settlement for a federal government investigation into wrongful foreclosure practices. While this is no guarantee that the company and other big banks will not have to cough up more cash as settlement and penalties for issues related to the subprime mortgage crisis, shareholders will be relieved that this provides closure at least to some extent.
Wells Fargo has done well. But its heavy dependence on the US market means the company’s continued growth will be greatly hinged on the recovery of the US economy.
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