WFC - Wells Fargo

[Guest Schwab711]

If they have an asset ceiling for too long (multiple years) then their treasury management is going to become tricky and NIM will contract some for a prolonged period. I don't think WFC is the slam dunk it looks like at the moment. I don't see how earnings grow appreciably with anything but a short term asset ceiling.

 

I've owned WFC this year. I really like their bank model. I do think I failed to appreciate the significance of the asset ceiling and the unknown of how long it will last.

At this point I'm not too worried about the asset ceiling. I agree that if it'll be in place for a long time it will cause serious damage. But does the Fed really want to knee cap one of the majour banks? I don't think so. If evidence to the contrary surfaces I will change my opinion.

 

What I like about the asset ceiling is that management at WFC turned out to be a bit delusional and this served as a big wake-up call. That can be very healthy for a business. Wake up, get your ass in gear, dust off the cobwebs, increase efficiency, etc. Wells seems to be doing that and that's promising. It'll come out a much stronger company on the other end.

 

What seems to be happening is not so much that they're hurt by the asset ceiling, but that they've taken their foot off the gas a bit as they sort all of this stuff out and JPM and BAC are eating some of their lunch. Frankly that's fine if they sort out their business and come out swinging at the other end. One of the reason why WFC seemed like a slam dunk is that they had a very good business model and the were executing on it. The business model is still there. There were negative headlines, and stock price declines, so it has hair. But then when it was a slam dunk you didn't get this valuation. That's this business of ours. If we want good valuations  we'll have to deal with some hair.

 

Ask yourself this. Would you own JPM without Jamie in charge?

 

First, I agree with the arguments you make about why the asset ceiling could be beneficial. I think I've made them in this thread too and it was certainly my reasoning to continuing holding earlier in the year. However, I'm not convinced the ceiling will only remain for 1 year or so. Consider longer periods:

 

1. Currently, WFC has $1.87T assets, down from $1.95T (the ceiling) at 12/31/2017. For WFC to increase absolute income, NIM must rise or non-interest income must increase at a rate fast enough to grow overall earnings, potentially with contracting NIM.

 

2. If WFC wants to continue to expand current and new relationships, they will either need to: (1) cull current relationships; or (2) decrease their L:D ratio. Certainly #2 sounds like a safer bank but that would likely lead to contacting NIM. Further, WFC will always need to leave some buffer between $1.95T and present assets to avoid tripping the ceiling. This will likely lead to more asset sales and a reduction in current and new relationships to promote continued NIM growth.

 

3a. If the latter of #2 is true (less likely in my opinion, but let's try to evaluate all scenarios), to avoid declining earnings, WFC must: (1) increase non-interest income (fees - given the current bank model); or (2) lend at higher yields. In the short-run, WFC could increase their fees but industry-wide the opposite is occurring. MTB has experienced a contracting deposit base because of increased fees/static yields. Their customers are going elsewhere even though MTB has higher market concentration in their footprints relative to WFC.

 

It would be difficult to increase fees in the asset management business because trends there are to contracting fees as well. LoC, SBA loans, and those types of asset-lite banking won't move the needle. Wholesale banking expansion would help, but that unit is presently under investigation by the DOJ.

 

3b. If the former of #2 is true, then WFC is ultimately going to run the risk of losing market share and experience declining efficiency rates. Otherwise, WFC may need to contract their overall footprint to avoid diluting their footprint throughout the country. Contracting the customer base is the anti-thesis of the standard banking business model.

 

4. WFC will obviously be a bank-holding company going forward. At their size, I believe they have a 11.5% ratio requirement. WFC is only so excessively capitalized. If the idea is buybacks will increase eps then I'd be careful on the math since a dividend increase is more likely within 1-2 years. Without increased earnings, buybacks would cause WFC to trip the 300% commercial exposure. While plenty of banks exceed this, it would be just one more reason for regulators to scrutinize WFC and management.

 

5. Given present asset growth potential, WFC's interest rate exposure probably slightly overstates exposure to LT rates and slightly understates exposure to ST rates. That divergence will probably widen slowly during each quarter/year with an asset ceiling. The issue for WFC comes from the fact that ST rates seem to be nearing a near-term peak. We are expecting one more hike but, at least today, it's hard to count on too many more rate hikes. Who knows with rates.

 

While WFC is less rate sensitive relative to BAC or C, they are barely comparable to the House of Dimon. JPM is a machine when it comes to naturally hedging between units/lines of business. Jamie Dimon's CEO career is a mandatory case study for a degree in banking (if one existed).

 

 

Ultimately, I agree that WFC is a great bank and it looks cheap, I think I'd rather own BAC then WFC if I wanted high upside. If I want a cheap company that is less risky then either, I'd be in JPM. At the moment, I don't think WFC is the same WFC that Buffett used to rave about...

[Spekulatius]

My best guess is that the asset cap will stay in place at least another year. That’s based on the harsh tone in Powels 11/28 letter. It also seems to me that they are pushing for Sloan’s (WFC’s current CEO) to resign. I think WFC will look at 2 years of foregone growth, due to the asset cap. Note that JPM is cranking up and moving into Boston and Washington DC, cities where they didn’t have presence. WFC is not present in MA and barely present in CT and I guess that will remain this way.

 

Also note that Elizabeth Warren is harsh on WFC, which I think is mostly due to WFC not having a presence in her state. (No constituents to worry about, no one loser his/her job). While I think that this is all somewhat reflected in WFC’s share price, I think it will put a cap on the stocks upside for the time being. FWIW, I one now a few shares.

[dutchman]

now that dems have congress, can they further constrain wfc aside from yelling and screaming.?

[Guest Schwab711]

now that dems have congress, can they further constrain wfc aside from yelling and screaming.?

 

Not easily, just through hearings and public sentiment. They could force infighting between the big-4 through those actions.

[SHDL]

Another thing to note regarding the numbers/valuation is their scandal-related litigation costs.  I may not have the exact numbers, but the company did say in their 2017 annual report that the litigation costs included 3.7 bn that were not tax deductible.  Their reported net income for the year was a bit above 20 bn, so one could say that the core business was actually earning > 24 bn and that the normalized P/E (i.e., assuming the litigation expenses are temporary) is already < 10.  That’s probably cheap enough to make this a good investment even if the company does not grow at all. 

[Viking]

Is WFC not forcasting pretty aggressive cost reductions each of the next couple of years? Part of this will be taking out all the extra costs associated with the retail scandal (all the extra people they have hhad to hire to correct the issues). WFC also seemed slow to reduce their cost base generally (driven by efficiencies in mobile) so they likely have some catch up here.

 

Having said all that, an organization can’t cut their way to prosperity. Until they are able to grow the top line it is hard to get too excited about their future. It doesn’t sound like the governement is finoshed with them yet...

[rb]

The required capital ratio is included in the fact that they are well over it as are pretty much all the majours, not just Wells.

 

How would you value financials on the back of an envelope? What's your valuation for the thing? Is it overvalued? How are they not still top of the line? Are they under-earning on their assets? Do they have a pile of overvalued assets that are sucking wind? Please point me in the right direction cause I would really like to know where I am really wrong here.

 

Back of the envelope I'd take a through the cycle ROTA and multiply by the leverage ratio to get a through the cycle ROTE. I use 15% ROTE, that same 4% growth number, and a discount rate of 10%. With $31.49 of TBV I get NPV = (31.49*(.15-.04))/(.10-.04) = ~$57.

 

Obviously you can feel different about any of those numbers, but the biggest difference here is that you aren't  deducting the portion of earnings that WFC needs to grow that 4% over the long-term. If you want to say that they're overcapitalized by $10bb or $20bb or whatever then maybe you pull some equity out of the model, which will get you a higher ROTE, then add the value of the excess capital back on top of the resulting value, but when you just use actual earnings as the numerator you're assuming they never need any more capital ever. That might be true for another business but not a bank.

I don't have much to gripe about your approach. As this is all back of the envelope stuff.

 

One thing is that you're formula is wrong, you've missed one year of growth in the numerator. By fixing that you get $60/share.

 

Also as I've said previously, in my opinion r at 10% is unreasonable with the 10 year at 2.9%. At these levels, with a historical ERP of 5, r should be 8%. Using 9 you get on the high side. And if you use 9 instead of 10 you get $72 per share instead of $60. Anyway, changing r around is easy for everyone to do according to their feelings on the matter. But I think what's becoming clear is that at 46 it's seriously undervalued any way you slice it.

[khturbo]

The required capital ratio is included in the fact that they are well over it as are pretty much all the majours, not just Wells.

 

How would you value financials on the back of an envelope? What's your valuation for the thing? Is it overvalued? How are they not still top of the line? Are they under-earning on their assets? Do they have a pile of overvalued assets that are sucking wind? Please point me in the right direction cause I would really like to know where I am really wrong here.

 

Back of the envelope I'd take a through the cycle ROTA and multiply by the leverage ratio to get a through the cycle ROTE. I use 15% ROTE, that same 4% growth number, and a discount rate of 10%. With $31.49 of TBV I get NPV = (31.49*(.15-.04))/(.10-.04) = ~$57.

 

Obviously you can feel different about any of those numbers, but the biggest difference here is that you aren't  deducting the portion of earnings that WFC needs to grow that 4% over the long-term. If you want to say that they're overcapitalized by $10bb or $20bb or whatever then maybe you pull some equity out of the model, which will get you a higher ROTE, then add the value of the excess capital back on top of the resulting value, but when you just use actual earnings as the numerator you're assuming they never need any more capital ever. That might be true for another business but not a bank.

I don't have much to gripe about your approach. As this is all back of the envelope stuff.

 

One thing is that you're formula is wrong, you've missed one year of growth in the numerator. By fixing that you get $60/share.

 

Also as I've said previously, in my opinion r at 10% is unreasonable with the 10 year at 2.9%. At these levels, with a historical ERP of 5, r should be 8%. Using 9 you get on the high side. And if you use 9 instead of 10 you get $72 per share instead of $60. Anyway, changing r around is easy for everyone to do according to their feelings on the matter. But I think what's becoming clear is that at 46 it's seriously undervalued any way you slice it.

 

Right, all the little stuff is semantics. I would still use the $31.49, but that, along with the exact discount rate or growth rate doesn't really matter.

 

One interesting thing is that assuming they can hit that ~15% ROTE, even if they don't grow - maybe if the asset cap does stay for a long time - you still get a ~10% IRR at a constant valuation. So it's not like you need a lot of growth from here. And if you put a gun to my head and made me guess over or under on that 15% over the next 10 years I'd probably guess over

[ander]

I think part of the opportunity here relative to the other banks is the asset cap. Whenever that comes off we are likely to see a start in earnings acceleration.

[nkp007]

I think part of the opportunity here relative to the other banks is the asset cap. Whenever that comes off we are likely to see a start in earnings acceleration.

 

The asset cap has NOT been holding back earnings. They're easily operating way below it as they have let certain loan books run-off and reduced amount of commercial real estate loans written due to the aggressiveness of market terms.

[Guest Schwab711]

I think part of the opportunity here relative to the other banks is the asset cap. Whenever that comes off we are likely to see a start in earnings acceleration.

 

The asset cap has NOT been holding back earnings. They're easily operating way below it as they have let certain loan books run-off and reduced amount of commercial real estate loans written due to the aggressiveness of market terms.

 

We're 6 months in. Of course it hasn't yet. If WFC is over-capitalized and can't grow, they should be returning 100%+ of earnings. They can't. They will remain over-capitalized until the ceiling is eliminated. It will also affect them from a competitive standpoint as all their existing relationships need more money over time.

 

Given management incentives not to languish, we could see bad decision making. I don't think mid-$40s is a bad price to enter but it makes me concerned that no one is concerned about the downside to WFC.

[ERICOPOLY]

If the idea is buybacks will increase eps then I'd be careful on the math since a dividend increase is more likely within 1-2 years. management.

 

Same math with buyback or dividend, aside from taxes (assuming your dividend purchases more shares).

 

If it weren't for this f'ing divorce I would buy WFC.  I'm not allowed to buy anything without her consent.

[John Hjorth]

JBTC,

 

I'm not Rasputin, but the key here is to do some calculations about the share buybacks for WFC.

 

Thank you John. Buybacks alone could make EPS a bit higher, but seem unlikely to make it "far higher" as suggested.

 

I have to say I am surprised that it's been more than two years since the account-opening scandal initially broke. I thought at the time that by now, the co would have completely sorted everything out and started performing. I assumed it's a fundamentally good company and has good management and culture etc despite some issues.

 

Do people still think that and why?

 

I'm sorry for getting back to you late here, JBTC,

 

My post quoted above by you did not turn out well, actually. In stead of "buybacks", I actually meant "capital return" [as defined here on CoBF by Viking as the sum of dividends and share buybacks], so, - somehow -, this post is actually triggered by the last post in this topic by ERICOPOLY.

 

- - - o 0 o - - -

 

In general, I don't post in topics in the Investments Ideas forum, where I'm not invested - unless it's about the products from the company and such. Some persons here on CoBF calls what WFC is subject to from the FED right now an asset ceiling - I call it a straight jacket. Personally, I sold WFC back in the middle of April 2018. My reason for getting back posting is this post by Cigarbutt.

 

WFC for me just seems too much beat up by the market right now, and if you think carefully about what Cigarbutt has linked to, it actually contains more than one business strategy going forward for WFC, that could turn out successful - not just successful, but very successful - going forward.

[rb]

I have a small bone to pick in the dividends vs. buyback section. They're the same is you think that markets are efficient and MV=IV always. They're also the same if you MV actually equals IV (excluding tax issues). They're also the same if you take your dividends and promptly reinvest them in the stock.

 

But... If for example WFC gets to hypothetically buy back 50 billion at 67% of IV (1/3 of IV) then they create an extra $25 billion for their shareholders. Hello an extra 11% return! If a company buys back $50 billion at 33% (1/3) over IV then that company is GE and goes from industry titan to people wondering whether Chapter 11 is a possibility. So yea, this stuff matters.

[plato1976]

Is WFC much more preferably against BAC?

 

If the idea is buybacks will increase eps then I'd be careful on the math since a dividend increase is more likely within 1-2 years. management.

 

Same math with buyback or dividend, aside from taxes (assuming your dividend purchases more shares).

 

If it weren't for this f'ing divorce I would buy WFC.  I'm not allowed to buy anything without her consent.

[rb]

Some disruptor. Failed to talk to their regulator. And oh yea, they're not a bank.

 

https://www.marketwatch.com/story/robinhoods-new-checking-accounts-may-not-be-insured-after-all-2018-12-14

[fareastwarriors]

Some disruptor. Failed to talk to their regulator. And oh yea, they're not a bank.

 

https://www.marketwatch.com/story/robinhoods-new-checking-accounts-may-not-be-insured-after-all-2018-12-14

 

I think it is non-news. They will figure it out and make it work.  Or just move on from, it.

 

Silicon Valley right? Move fast and break things?

[rb]

Some disruptor. Failed to talk to their regulator. And oh yea, they're not a bank.

 

https://www.marketwatch.com/story/robinhoods-new-checking-accounts-may-not-be-insured-after-all-2018-12-14

 

I think it is non-news. They will figure it out and make it work.  Or just move on from, it.

 

Silicon Valley right? Move fast and break things?

Banking regulators tend not to get very enthused about the breaking things part.

[Viking]

I have a small bone to pick in the dividends vs. buyback section. They're the same is you think that markets are efficient and MV=IV always. They're also the same if you MV actually equals IV (excluding tax issues). They're also the same if you take your dividends and promptly reinvest them in the stock.

 

But... If for example WFC gets to hypothetically buy back 50 billion at 67% of IV (1/3 of IV) then they create an extra $25 billion for their shareholders. Hello an extra 11% return! If a company buys back $50 billion at 33% (1/3) over IV then that company is GE and goes from industry titan to people wondering whether Chapter 11 is a possibility. So yea, this stuff matters.

 

One on the things i look at before investing in a company is what they do with earnings over many years. Are they making decisions that are shareholder friendly (with how they spend earnings)? The company can do three basic things: re-invest in the business (organic growth), aquire another company or return cash to shareholders (dividends or buybacks).

 

Many companies spend their earnings on expensive aquisitions, many of whick do not work out. GE is the current poster child. There are lots of other big misses like Microsoft’s $8 billion purchase of Nokia (hope i got the total $ correct).

 

The big banks today are overcapitalized (too much capital). They are cash machines right now. They cannot make aquisitions (of deposit taking institutions) and they look unlikely to make any foreign aquisitions so growth by aquisition looks unlikely. There are some opportunities for organic growth and JPM looks to be most aggressive on this front; BAC looks to be getting a tad more aggressive.

 

However it is clear that the big banks have decided return of capital to shareholders is the best use of excess cash. This does not bother me for the simple reason that i like the certainty of knowing they are not going to waste it by overpaying for a big aquisition (and destroying shareholder value).

 

It terms of whether to buy back stock or pay a big dividend the biggest factor to me is how expensive the shares are. Obviously, if shares are cheap (like they appear now for the big banks) i would prefer bigger share repurchases. If shares were trading at 2 x TBV i would want a bid dividend (and perhaps a special dividend of the remainder instead of share repurchases).

 

The good news is the shares of the big banks are so cheap (and likely to remain cheapish the next little while) that dividend or share repurchases are both a very good option for current shareholders. A 9% to 10% yield looks pretty good to me :-)

[Cigarbutt]

^Hi John,

Hoping all is good with you.

In the past, in these and other pages, I have also enjoyed the discussion we had about personal responsibility and such.

 

Investment in US banks requires following the official regulatory-mandated stress tests.

 

WFC and USB are the banks that I know most about and both are likely to survive, no matter what. On a relative basis, interesting features for WFC are 1-being curtailed at a time it has not chosen to in this part of the cycle and 2-clearly belonging in the too-big-to-fail category while having the least exposure, relatively among the big banks, to derivatives products.

 

But the ultimate test with investments in banks is to meet one’s own internally defined stress test.

 

[John Hjorth]

... Investment in US banks requires following the official regulatory-mandated stress tests.

 

WFC and USB are the banks that I know most about and both are likely to survive, no matter what. On a relative basis, interesting features for WFC are 1-being curtailed at a time it has not chosen to in this part of the cycle and 2-clearly belonging in the too-big-to-fail category while having the least exposure, relatively among the big banks, to derivatives products.

 

But the ultimate test with investments in banks is to meet one’s own internally defined stress test.

 

Hi Cigarbutt,

 

I still consider myself a newbie in the banking space, after starting investing in the major US banks seriously about 19 months ago. [fairly small positions in some of them before that - for quite some years [bAC & WFC].

 

I sold WFC in April this year, because I was dissatisfied with the speed of progress in cleaning up the issues WFC then had, and still has.

 

I still think there is from a managerial angle right now a material aspect, that divides WFC from the three other major US banks. The WFC CEO Mr. Sloan hasen't been around at that level for long enough to possess "the long term memory" of the GFC and the clean-up afterwards. Mr. Dimon ran JPM into, during and out of the GFC without any quarterly loss. Mr. Moynihan has cleaned up at BAC, and he will never forget about it. Mr. Corbat has cleaned up at C, and he will never forget about it.

 

- - - o 0 o - - -

 

The idea of WFC moving the right foot from the gas pedal to the brake pedal at this moment [somewhat a bit forced right now] has a lot of appeal to me. Making higher demands on quality on new lending is to me nothing less than brilliant in the situation. [That one, I'll give to Mr. Sloan.]

 

Every challenge contains an opportunity. It'll be interesting to see how WFC plays the next CCAR cycle in June 2019. It could plan to return more capital, or just become the lender of last resort to next time all things turn sour, by chosing to live a life as "eternal overcapitalized", getting smoked by competitors in the end of each cycle, smoking every competitor going out of every downturn, like Svenska Handelsbanken AB.

[cmlber]

If WFC is over-capitalized and can't grow, they should be returning 100%+ of earnings. They can't. They will remain over-capitalized until the ceiling is eliminated.

 

They can, and they are... YTD they've distributed $19B through buybacks & dividends on earnings of $15B, and Q3 they distributed $9B on earnings of $6B. 

 

At the Q3 pace it would take them ~20 months to distribute out all the excess capital.

[nkp007]

If WFC is over-capitalized and can't grow, they should be returning 100%+ of earnings. They can't. They will remain over-capitalized until the ceiling is eliminated.

 

They can, and they are... YTD they've distributed $19B through buybacks & dividends on earnings of $15B, and Q3 they distributed $9B on earnings of $6B. 

 

At the Q3 pace it would take them ~20 months to distribute out all the excess capital.

 

Great point. This is clear from past transcripts / earnings presentations.

[John Hjorth]

...We're 6 months in. Of course it hasn't yet. If WFC is over-capitalized and can't grow, they should be returning 100%+ of earnings. They can't. They will remain over-capitalized until the ceiling is eliminated.

 

Schwab,

 

Why? [if you look at WFC beyond June 30^th 2019.]

[Guest Schwab711]

If WFC is over-capitalized and can't grow, they should be returning 100%+ of earnings. They can't. They will remain over-capitalized until the ceiling is eliminated.

 

They can, and they are... YTD they've distributed $19B through buybacks & dividends on earnings of $15B, and Q3 they distributed $9B on earnings of $6B. 

 

At the Q3 pace it would take them ~20 months to distribute out all the excess capital.

 

I may be falling too far in to devil's advocate territory in some sense with my posts. But by "they can't" I mean 'I don't think regulators will let them'. Their loan book is a bit more risky then is generally associated with their reputation. They have a meaningful amount of high-priced condo loans, PE exposure, leverage loan exposure, auto, ect. They also have high CRE exposure (higher than I expected them to be associated with). This gets to why I think it will be hard to grow NIM without rate tailwinds. None of that exposure is going to dent them long-term (which is why I'm trying to say all this in such a way that is short-term cautious as opposed to my views on OZK, for instance) but it makes me wonder how they will grade in future stress tests as they distribute excess cash + can't grow (see earlier post on consequences of that) + any additional concern around the exposures WFC has. Finally, depending on the trajectory of rates in 1 year or so, additional issues may pop up. That's where I'm coming from when I say "they can't". I should have said, I think there's a good chance they won't be allowed to.

 

As I said, mid-$40's is not a bad price. I'm just wondering if the asset ceiling is a bigger deal then everyone thought. The concerns around the asset ceiling would make more sense at $60 then <$50 since some of those concerns are somewhat baked in. I should have thought this through and posted this awhile ago. It's hard to say anything bad about WFC but they do have a lot of work to do.