Wells Fargo & Company
Ngoi Se Chai
Business description:
Wells Fargo is a bank holding company registered in the United States (U.S.). It involves in providing diversifiedfinancial services including banking, insurance, investment, investment banking, retail banking, mortgage banking,brokerage and consumer finance mainly in the U.S. It acquired Wachovia Corporation in a transaction valued at$12.5 billion to Wachovia shareholders on 31 December 2008.There is no doubt that bank stocks are among the hardest to analyse. Nevertheless, it is still worth to give it a trygiven the extreme decline in the share prices of most bank stocks as well as the fact that banking is a utility, weneeded it as if we couldn't live without electricity.
Short history of U.S. banking industry:
Banking crises have developed many times throughout history. Prominent examples include thebank run thatoccurred during theGreat Depressionwhich led to the formation of FDIC; the U.S.Saving and loans crisisn the1980s and early1990s, and thesubprime mortgage crisisin 2007 to 2009.Nevertheless, the banking industryconsolidated and grew larger each time.It is believed that in order to come out from the current subprime crisis, the banking industry will need to take thefollowing three steps:1st Stop denial and write off bad loans and mortgages on-balance sheet as well as off-balance sheet.2ndDeleveraging -It would be a prolonged and difficult period for most banks.3rd Rebuilding its capital base.
Methodology:
Isolated analysis and evaluation of an individual security is impractical. While this report will focus its discussion onWells Fargo, its financial performance and situation are compared with a group of four other major U.S. banks..When interpreting financial ratio, it is most informative to look at a period which cover a complete business cycle. Aseven-year period (2002 to 2008) is used as it covers the period after the Dot-Com bubble (the rise of sub-primemortgage loans) to the end of sub-prime mortgage eraThe key determinants of a successful bank are Return on assets (
ROA
), Net interest margin (
NIM
) and
Underwriting practices,
and Wells Fargo has performed brilliantly in all three.Business model and moat:1.'Cross-selling' wastheirmajor strategy, Wells Fargo hadthe highest cross-selling ratio of 5 products percustomers in 2008. Another important strategy was to grow by acquisition.2.Wells Fargo had a NIM of 4.90% in 4Q08 and an average of 4.97% in the past seven years, which was thehighest among its peer. NIM could act as a cushion for bad loan ashigh NIM could provide high margin of safety against losses from bad loans.3.Wells Fargo had a hugecore depositbase. Average core deposit had been growing at a CAGR of 9.95% overthe past seven years, excluding the substantial amount of core deposit it gained from Wachovia acquisition.Ratio of core deposits to earning assets was over 60% in 2008.4.An average 1.67% ROA between the period from 2002-2007 was at or near top of its industry.Underwriting practice:1.This was the most important factor determining the fate of a bank as a highly leveraged financial institution.A loose underwriting practice could easily wipe out 100% of the bank's equity in a crisis.2.Wells Fargo didn't not participate to any significant degree in CDOs,SIVs to hold assets off balance sheet,the underwriting of highly leveraged loans and the subprime mess. As a result, they lost between 2 and 4percent in mortgage origination market share from 2004 to 2006.3.Almost all banks stated that they had followed sound underwriting practices but the fact was that many of them didn't. Wells Fargo's management had shownthat they had the culture and discipline to reject newbusiness which were under-priced.
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