The Best Super Bank, But Not The Best Value
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The big winner of the domestic banking industry in recent years among the nation's trillion dollar banks has been Wells Fargo (NYSE: WFC). Its Chief Financial Officer, Time Sloan, represented the bank at the recent Barclays Capital Global Financial Services Conference in New York. Wells Fargo has a great story to tell; the only question is for how long can the good times last?
Owing to acquisitions last decade, Wells Fargo is a truly national retail bank. It has 6,209 branches (stores) scattered across most of the country, but focused in the Southeast and areas west of the Mississippi River. It has a store, mortgage office, or financial advising office in all 50 states, 12,300 ATM's and nearly 30 million online or mobile customers. As a retail bank, it is without peer in this country. As of the close of the second quarter, it has more retail branches than any other bank, and has a number one position in mortgage origination, servicing, small business lending, used car lending, commercial real estate, and middle market commercial lending. It holds number two positions in deposits held and debit cards issued. It also is the country's third leading full service retail broker.
For the most part, Wells Fargo holds an ideally balanced asset blend for a commercial bank. In the first half of 2012, its loan portfolio was 54% domestic consumer focused, 41% domestic commercial focused, and 5% foreign. Its income for the first half of the year was 52% from net interest, and 48% from fees. Those fees were driven by mortgage issuance and servicing, which supplied about 30% of overall fee income. Wells Fargo's trading assets and market risk are small fractions of the other trillion dollar banks, JPMorgan Chase (JPM), Bank of America (BAC) and Citigroup (C).
In the second quarter of this year, Wells Fargo earned $4.62 billion, or $0.82 per share. That represented a 1.41% return on assets, and a 12.86% return on equity. Only U.S. Bancorp (NYSE: USB) came out ahead in these two categories among all banks in this country with over $100 billion in assets. U.S. Bancorp reported net income of $1.41 billion, or $0.71 cents per share in the second quarter. This equates to a 1.56% return on assets, and a 14.58% return on equity. Wells Fargo also managed to reduce its efficiency ratio below the key 60% level, to 58.2%.
But the secret to Wells Fargo's success is in cross selling. The presentation contained a chart on page 22, showing how a customer that has been with the bank for one year has on average of about three different accounts. But a customer with twenty years with the bank has an average of 7.5 different accounts.
Despite the tremendous momentum Wells Fargo has built up in recent times, there are dark clouds on the horizon. Specifically, that net interest margin, which remained stable in the second quarter from the first quarter, is set for a substantial drop, possibly ten basis points or more in this third quarter. The Federal Reserve's new round of quantitative easing will only serve to make it even more difficult for any bank to maintain the integrity of its' interest margin in the wake of a flattening yield curve. Some analysts have downgraded Wells Fargo due to that interest rate risk.
But what quantitative easing takes away, it is also giving back. Wells Fargo has become the nation's dominant mortgage bank in recent quarters. It has obtained that standing during a period of historically low interest rates. The Federal Reserve wants that low interest rate environment to last until 2015. But eventually, interest rates will rise. A sudden and steep rise in interest rates twenty five years ago caused hundreds of S&L's to fail. Of course, Wells Fargo is not as exposed to interest rate risk as the S&L industry was, but it is still vulnerable, albeit not for a few years.
Analysts see five year growth averaging 8.5%, and a 5 year PEG of 1.28. It will take a lot of loan growth to overcome as steep a drop in the interest margin as we expect to see. I look forward to Wells Fargo's third quarter report.
If you need to choose among the country's four large “super banks”, and you are a conservative investor, Wells Fargo is surely the best choice. Yet I see far better values elsewhere in the financial sector.
SunTrust (NYSE: STI) is the last remaining of the nation's $100 billion dollar asset banks to have presented at the Barclays event that I have not covered in this series, with the presentation itself by CEO Bill Rogers. As a true regional bank, it gets the bulk of its income, nearly 60%, from its interest margin, with the balance from fees. So, all the risks of a flattened yield curve I identified with Wells Fargo apply even more so to SunTrust. But this quarter at least, SunTrust had an ace in its hole. Its historical stake in Coca-Cola (KO) is being sold for a roughly $2 billion pretax gain. Much of that is being utilized to add to reserves for agency demands for soured mortgages, and to write down to market the value of assets the bank intends to sell. The balance should present an after-tax boost of $750 million, or $1.40 per share.
After several years of declining revenues, SunTrust is loaning out money again, and is focusing on mid-market commercial lending (up 12% in the second quarter versus the year earlier) and home mortgages (up 24%). Meanwhile, its non-performing loans continue to fall, by 30% from the year earlier.
Looking beyond this quarter, I think SunTrust will hold a leading position from the mid-Atlantic to Florida. This area is likely to outperform the balance of the country in population growth for the foreseeable future. SunTrust in particular is likely to see falling costs as its foreclosed property proceedings ebb. The downside? Well if SunTrust, flush with liquidity from the Coca Cola sale, chose now to mark to market certain assets, how many more assets are being carried substantially above market not just at SunTrust but at all banks?
SunTrust spiked to about $30 per share since the start of September, well above the 52 week target. I would wait until the stock price settles down, as I suspect it will, before investing in this recovering Southern bank.
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