WFC - Wells Fargo

[erdospi]

Despite all the negative things going on with WFC, its net charge off ratio is still the lowest among the 4 big banks and USB, though not as low as much smaller regional banks.

 

Sure, they can’t grow their loans and they committed frauds, but at least the loan they made are still good quality.

 

We’ll see if they are good quality, they are supposedly the most conservative lender and they stopped HELOC, CRE, and independent auto first which is conservative, but they do have CLO exposure and VIE risk.

 

I can live with some of that but I can’t get a normalized earnings power with the NIM that is reasonable. It just looks OK to me here...maybe that’s good enough in this environment.

[sleepydragon]

Thinking on the positive side: my exposure on WFC has reduced by 50% since Jan without I having to do anything  ::)

 

[mcliu]

If lending isn't profitable, can/will banks just slow or stop lending and return capital?

 

Look at the loan to deposit ratio for all banks over the past 50+ years the profitability has been decreasing, they have been returning capital (the buybacks may look bad in hindsight) and the population pyramids for countries are not great although the US is better than most (pretty sure the fed cant print people but maybe with 3D printers and some AI). I wouldn’t bet on them being allowed to return capital if they have to absorb any of these losses from the 12-18 month COVID-19 scenario which is likely optimistic or even if the losses don’t occur why would they allow them to return capital when they are holding rates at 0 for 2 years?

 

Not commenting on big banks specifically, but just in theory, why can't banks stop lending if it's unprofitable? You wouldn't even return the capital, just let past loans run-off and keep the cash on the books, reduce liabilities and stop making new (unprofitable) loans. Wouldn't you eventually end up with cash = TBV?

[erdospi]

If lending isn't profitable, can/will banks just slow or stop lending and return capital?

 

Look at the loan to deposit ratio for all banks over the past 50+ years the profitability has been decreasing, they have been returning capital (the buybacks may look bad in hindsight) and the population pyramids for countries are not great although the US is better than most (pretty sure the fed cant print people but maybe with 3D printers and some AI). I wouldn’t bet on them being allowed to return capital if they have to absorb any of these losses from the 12-18 month COVID-19 scenario which is likely optimistic or even if the losses don’t occur why would they allow them to return capital when they are holding rates at 0 for 2 years?

 

Not commenting on big banks specifically, but just in theory, why can't banks stop lending if it's unprofitable? You wouldn't even return the capital, just let past loans run-off and keep the cash on the books, reduce liabilities and stop making new (unprofitable) loans. Wouldn't you eventually end up with cash = TBV?

 

They can, and they have been lending out at lower ratio of loan to deposits, historically.  That was my point, they have been lending less relative to deposits and returning capital via buybacks and share repurchases.  They can go into runoff on the loan book and hope for the optimistic COVID-19 scenario and maybe get TBV.  I don’t know how many bankers would go for that though.

 

The big banks may have a harder time getting capital return approvals in this environment over the next few years. It may not be horrendous but if WFC equity returns say 7% over the next 10 years is that enough to compensate for current risks. I don’t think so but I’m not that smart.

[mcliu]

If lending isn't profitable, can/will banks just slow or stop lending and return capital?

 

Look at the loan to deposit ratio for all banks over the past 50+ years the profitability has been decreasing, they have been returning capital (the buybacks may look bad in hindsight) and the population pyramids for countries are not great although the US is better than most (pretty sure the fed cant print people but maybe with 3D printers and some AI). I wouldn’t bet on them being allowed to return capital if they have to absorb any of these losses from the 12-18 month COVID-19 scenario which is likely optimistic or even if the losses don’t occur why would they allow them to return capital when they are holding rates at 0 for 2 years?

 

Not commenting on big banks specifically, but just in theory, why can't banks stop lending if it's unprofitable? You wouldn't even return the capital, just let past loans run-off and keep the cash on the books, reduce liabilities and stop making new (unprofitable) loans. Wouldn't you eventually end up with cash = TBV?

 

They can, and they have been lending out at lower ratio of loan to deposits, historically.  That was my point, they have been lending less relative to deposits and returning capital via buybacks and share repurchases.  They can go into runoff on the loan book and hope for the optimistic COVID-19 scenario and maybe get TBV.  I don’t know how many bankers would go for that though.

 

The big banks may have a harder time getting capital return approvals in this environment over the next few years. It may not be horrendous but if WFC equity returns say 7% over the next 10 years is that enough to compensate for current risks. I don’t think so but I’m not that smart.

 

Yeah that's fair, it's not the best environment for a bank. But I think it is difficult/impossible to know how NIMs and rates will trend, especially over 10 years.

There's obviously potential for dire scenarios, but also potential for more optimistic outcomes. US banks have really cleaned up the last 10 years and are pretty well-run and shareholder-friendly.

 

Unless you have extreme loan losses, TBV is likely downside protection, since they can just pull back lending/run-off as mentioned. If they don't return capital through buybacks/dividends, it'll just build on the books. At some point, maybe 3 or 5 years from now, the economy will recover and they'll have too much excess capital, especially if spread is unprofitable.

 

So if you think about risk/reward at a price of 0.5x TBV to 0.7x TBV, the downside seems limited by TBV (unless huge loan losses) and you get potential upside in a case of flat to higher rates.

 

Historically, despite the large decline in rates from 15% in the 80s, US banks have managed around 10% to 15% ROE (with the occasional blowups.)

 

 

[ERICOPOLY]

 

Are saying you want to try to pick a inflection point on rates over almost 40 years? Or are you saying a short term trade on a rate bounce? FED was already cutting rates prior to COVID-19.

 

Rates have been going down, albeit with short term blips, since 1981:

 

https://fred.stlouisfed.org/series/DGS10

 

This has been a long discussion on this board, it's more than a decade old now.  The Fairfax/Hoisington discussions leading up to the collapse of 2008/2009.

 

Then poof and it's gone, and now back again after a few months of a pandemic scare and a forced shutdown.

 

I was bearish on the NIMs prior to COVID-19, I just don’t post much.  Please elaborate on how they are wrong I’ve yet to see a valid argument and over that time period what have NIMs done? And what has happened to interest rates?  The data is what it is rated have gone down since 08/09 with short term blips up and banks NIMs have contracted and currently are continue to contract. So going long here are you not betting on that changing? And if so how/why?

 

I’d love to hear a valid counter argument...I’d love to buy the banks here but I can’t see it. I’m probably just not qualified.

 

I'm saying that the rates were higher before we entered recession.  There will be periods of growth again.  Nobody can say when the NIM will expand.  The stock isn't $50 anymore either. 

 

When is it time to buy the stock given that the future isn't knowable?

[sleepydragon]

Why NIM is so low? My guess is there’s too many none-bank lenders, private equity and the bond market lending money. The none bank lender and private equity guys have lower cost than banks who have high compliance costs.

Small businesses who were bank clients were also acquired by PEs.

And American middle class are poorer since 2008 and they also borrow less.

 

[erdospi]

If lending isn't profitable, can/will banks just slow or stop lending and return capital?

 

Look at the loan to deposit ratio for all banks over the past 50+ years the profitability has been decreasing, they have been returning capital (the buybacks may look bad in hindsight) and the population pyramids for countries are not great although the US is better than most (pretty sure the fed cant print people but maybe with 3D printers and some AI). I wouldn’t bet on them being allowed to return capital if they have to absorb any of these losses from the 12-18 month COVID-19 scenario which is likely optimistic or even if the losses don’t occur why would they allow them to return capital when they are holding rates at 0 for 2 years?

 

Not commenting on big banks specifically, but just in theory, why can't banks stop lending if it's unprofitable? You wouldn't even return the capital, just let past loans run-off and keep the cash on the books, reduce liabilities and stop making new (unprofitable) loans. Wouldn't you eventually end up with cash = TBV?

 

They can, and they have been lending out at lower ratio of loan to deposits, historically.  That was my point, they have been lending less relative to deposits and returning capital via buybacks and share repurchases.  They can go into runoff on the loan book and hope for the optimistic COVID-19 scenario and maybe get TBV.  I don’t know how many bankers would go for that though.

 

The big banks may have a harder time getting capital return approvals in this environment over the next few years. It may not be horrendous but if WFC equity returns say 7% over the next 10 years is that enough to compensate for current risks. I don’t think so but I’m not that smart.

 

Yeah that's fair, it's not the best environment for a bank. But I think it is difficult/impossible to know how NIMs and rates will trend, especially over 10 years.

There's obviously potential for dire scenarios, but also potential for more optimistic outcomes. US banks have really cleaned up the last 10 years and are pretty well-run and shareholder-friendly.

 

Unless you have extreme loan losses, TBV is likely downside protection, since they can just pull back lending/run-off as mentioned. If they don't return capital through buybacks/dividends, it'll just build on the books. At some point, maybe 3 or 5 years from now, the economy will recover and they'll have too much excess capital, especially if spread is unprofitable.

 

So if you think about risk/reward at a price of 0.5x TBV to 0.7x TBV, the downside seems limited by TBV (unless huge loan losses) and you get potential upside in a case of flat to higher rates.

 

Historically, despite the large decline in rates from 15% in the 80s, US banks have managed around 10% to 15% ROE (with the occasional blowups.)

 

 

Higher rates why?  We are going to have a lot of people out levering you?  I get that’s a possibility but it just seems wildly low.  Flat rates will suck their normalized to $5-10B so I don’t think that’s a great outcome.

 

Impossible to know the trend on NIMs? Go look at the chart they have gone almost linearly down with rates since 1981. Japan and Europe didn’t stop there not sure why wee would but if not flat at 1% will not be good. So what changes the rate trend? More demand for capital?  And who is it just PE forms levering to buy businesses I don’t know but it seems a low probability to be able to lend out capital at reasonable rates to compensate for risk.  Also the competition for deposits seems to be getting more expensive.

 

NIMs have declined with rates with some spikes in between since the 80’s. As it gets closer to 0% rates for say 3-5 years it’s hard to make much margin for all the operators in lending. Obviously regulators will likely let ratios and leverage creep up for the banks but look at your chart on ROE they really only sustained 10% and that’s with buybacks and capital returns and better loans. If loans are harder to get, risk adjusted with lower spreads, I don’t see the 10% is really doable.  The US had leverage and population growth which both are now not adding much growth to GDP anymore so where is loan demand going to come from? Baby boomers retiring and deleveraging? 

 

They are on balance levered 10/1 at minimum, so how much in losses does it take to get to .7x TBV?  You think the CRE, auto, credit cards, home loans can’t take hits and put a good dent in a negative scenario for a bit to TBV?  And that doesn’t include the off balance sheet stuff that maybe levered junk.

 

Then, if normalized is low on the NIM which is where they make their returns, which no one seems to think is probable what’s the ROE? Also assuming they are not allowed much in the way of capital returns because why would the FED let them if rates are at 0 and they are potentially bailing out some banks via repos and have the potential for reasonable losses?  What are they going to do grow assets by buying small banks at 1x TBV while the NIM shrinks you issuing stock at .7x TBV? I don’t think Sharf would do that. 

 

I just don’t see the downside protection. the way everyone else does, seems like it’s more mid teens...I don’t know you guys are all smarter and better I just want to understand why everyone thinks rates are going up to protect their lending spreads when the data, including WFC’s NII $3B lower number last week, keep saying otherwise.

 

I’m sure I’m wrong here just having a hard time seen a reasonable probability of what everyone seems to have a consensus view of.

[erdospi]

Why NIM is so low? My guess is there’s too many none-bank lenders, private equity and the bond market lending money. The none bank lender and private equity guys have lower cost than banks who have high compliance costs.

Small businesses who were bank clients were also acquired by PEs.

And American middle class are poorer since 2008 and they also borrow less.

 

The correlation of the NIMs to the 10 year is pretty tight.  Valid point that there have been a lot of loans by non bank entities but don’t think that’s affecting the NIM of the bigger banks as much. They have plenty of stuff in CLOs and VIEs to compensate for that.

[erdospi]

 

Are saying you want to try to pick a inflection point on rates over almost 40 years? Or are you saying a short term trade on a rate bounce? FED was already cutting rates prior to COVID-19.

 

Rates have been going down, albeit with short term blips, since 1981:

 

https://fred.stlouisfed.org/series/DGS10

 

This has been a long discussion on this board, it's more than a decade old now.  The Fairfax/Hoisington discussions leading up to the collapse of 2008/2009.

 

Then poof and it's gone, and now back again after a few months of a pandemic scare and a forced shutdown.

 

I was bearish on the NIMs prior to COVID-19, I just don’t post much.  Please elaborate on how they are wrong I’ve yet to see a valid argument and over that time period what have NIMs done? And what has happened to interest rates?  The data is what it is rated have gone down since 08/09 with short term blips up and banks NIMs have contracted and currently are continue to contract. So going long here are you not betting on that changing? And if so how/why?

 

I’d love to hear a valid counter argument...I’d love to buy the banks here but I can’t see it. I’m probably just not qualified.

 

I'm saying that the rates were higher before we entered recession.  There will be periods of growth again.  Nobody can say when the NIM will expand.  The stock isn't $50 anymore either. 

 

When is it time to buy the stock given that the future isn't knowable?

 

Fair that the economy may grow from a new lower base again next year even, but to do so will likely require lower rates as it did out of the last recession.  Just because they are higher before recession doesn’t imply they’ll go higher out of recession.  Yes the stock isn’t $50 and rates aren’t 3% either and the scenarios of COVID-19 have a wide distribution and the supply/demand shock is pretty extreme here.

 

I’d guess it’s worth in the mid teens under lower rate / NIM scenario. And why do you assume the NIM has to go back up? Europe and Japan haven’t, we have better population pyramid although it isn’t good, so where is the risk adjusted demand going to come from for loans with likely low rates for a sustained time? You know this stuff better than me so I’d love to understand it better. 

[erdospi]

If lending isn't profitable, can/will banks just slow or stop lending and return capital?

 

Look at the loan to deposit ratio for all banks over the past 50+ years the profitability has been decreasing, they have been returning capital (the buybacks may look bad in hindsight) and the population pyramids for countries are not great although the US is better than most (pretty sure the fed cant print people but maybe with 3D printers and some AI). I wouldn’t bet on them being allowed to return capital if they have to absorb any of these losses from the 12-18 month COVID-19 scenario which is likely optimistic or even if the losses don’t occur why would they allow them to return capital when they are holding rates at 0 for 2 years?

 

Not commenting on big banks specifically, but just in theory, why can't banks stop lending if it's unprofitable? You wouldn't even return the capital, just let past loans run-off and keep the cash on the books, reduce liabilities and stop making new (unprofitable) loans. Wouldn't you eventually end up with cash = TBV?

 

They can, and they have been lending out at lower ratio of loan to deposits, historically.  That was my point, they have been lending less relative to deposits and returning capital via buybacks and share repurchases.  They can go into runoff on the loan book and hope for the optimistic COVID-19 scenario and maybe get TBV.  I don’t know how many bankers would go for that though.

 

The big banks may have a harder time getting capital return approvals in this environment over the next few years. It may not be horrendous but if WFC equity returns say 7% over the next 10 years is that enough to compensate for current risks. I don’t think so but I’m not that smart.

 

Yeah that's fair, it's not the best environment for a bank. But I think it is difficult/impossible to know how NIMs and rates will trend, especially over 10 years.

There's obviously potential for dire scenarios, but also potential for more optimistic outcomes. US banks have really cleaned up the last 10 years and are pretty well-run and shareholder-friendly.

 

Unless you have extreme loan losses, TBV is likely downside protection, since they can just pull back lending/run-off as mentioned. If they don't return capital through buybacks/dividends, it'll just build on the books. At some point, maybe 3 or 5 years from now, the economy will recover and they'll have too much excess capital, especially if spread is unprofitable.

 

So if you think about risk/reward at a price of 0.5x TBV to 0.7x TBV, the downside seems limited by TBV (unless huge loan losses) and you get potential upside in a case of flat to higher rates.

 

Historically, despite the large decline in rates from 15% in the 80s, US banks have managed around 10% to 15% ROE (with the occasional blowups.)

 

Also the scale on your chart should just pull the NIM out you can see the constant decline or do it logarithmically.

[CorpRaider]

Declining interest rates to the zero bound and perhaps even following a the eurozone experience, combined with a severe economic recession and attendant loan losses (I would also add in continuing regulatory pressures for wells and pressure from "fintech" at a run rate of current cash burn by vcs) seems to be the consensus view; otherwise you don't get WFC below TBV.

[erdospi]

Declining interest rates to the zero bound and perhaps even following a the eurozone experience, combined with a severe economic recession and attendant loan losses (I would also add in continuing regulatory pressures for wells and pressure from "fintech" at a run rate of current cash burn by vcs) seems to be the consensus view; otherwise you don't get WFC below TBV.

 

Sounds correct, so where is the consensus wrong?  Rates are close enough to the zero bound now, economic recession being severe seems like a reasonable probability, and not sure what you mean by attendant loan losses? I think if all those things continue, plus large losses (maybe that’s what you mean by attendant) it’ll be in the mid teens on intrinsic value. I want to be wrong here and am likely biased but not seeing otherwise. This is not a bearish case.

 

Is anyone short this with a thesis beyond rates going down and regulatory/cultural problems?

[LC]

To your latter question: doubt it. Regulatory oversight prevents a lot of problems within the loan book.

[erdospi]

To your latter question: doubt it. Regulatory oversight prevents a lot of problems within the loan book.

 

So the regulators aren’t doing the same for the other big money center banks? How does the regulatory oversight prevent this? Are they at the loan level overseeing the underwriting?  I’ve heard this before but don’t fully understand how. If they are down to regulating at the underwriting / loan level then the loans may be safer but it will also impair their ability to underwriting higher risk adjusted loans as well.

[CorpRaider]

Declining interest rates to the zero bound and perhaps even following a the eurozone experience, combined with a severe economic recession and attendant loan losses (I would also add in continuing regulatory pressures for wells and pressure from "fintech" at a run rate of current cash burn by vcs) seems to be the consensus view; otherwise you don't get WFC below TBV.

 

Sounds correct, so where is the consensus wrong?  Rates are close enough to the zero bound now, economic recession being severe seems like a reasonable probability, and not sure what you mean by attendant loan losses? I think if all those things continue, plus large losses (maybe that’s what you mean by attendant) it’ll be in the mid teens on intrinsic value. I want to be wrong here and am likely biased but not seeing otherwise. This is not a bearish case.

 

Is anyone short this with a thesis beyond rates going down and regulatory/cultural problems?

 

I think what will happen first is the regulatory outlook will improve, including satisfying consent orders and eventually the asset cap, similar to how BAC played out; either that or the expenses unrelated thereto will come down as distress is used as cover for cuts or otherwise on the back of the recession.  Interest rates?  If you can predict those, get a futures account and a private island shortly thereafter.  But I doubt there's any rush to pile into big banks given the covid.

 

As far as galaxy brain upside: it sounded to me like Charlie Scharf knows they have an opportunity in payments and some other "fintech" areas especially of there is some real distress.

 

As for the credit thing.  The thought process if that if you have an imposed artificial limit on loans you can hold (assets), you have another reason to be more particular about the loans you retain on your books.  We are soon to see about that.  Was very encouraged to hear Scharf's takes on the credit culture.

[erdospi]

Declining interest rates to the zero bound and perhaps even following a the eurozone experience, combined with a severe economic recession and attendant loan losses (I would also add in continuing regulatory pressures for wells and pressure from "fintech" at a run rate of current cash burn by vcs) seems to be the consensus view; otherwise you don't get WFC below TBV.

 

Sounds correct, so where is the consensus wrong?  Rates are close enough to the zero bound now, economic recession being severe seems like a reasonable probability, and not sure what you mean by attendant loan losses? I think if all those things continue, plus large losses (maybe that’s what you mean by attendant) it’ll be in the mid teens on intrinsic value. I want to be wrong here and am likely biased but not seeing otherwise. This is not a bearish case.

 

Is anyone short this with a thesis beyond rates going down and regulatory/cultural problems?

 

I think what will happen first is the regulatory outlook will improve, including satisfying consent orders and eventually the asset cap, similar to how BAC played out; either that or the expenses unrelated thereto will come down as distress is used as cover for cuts or otherwise on the back of the recession.  Interest rates?  If you can predict those, get a futures account and a private island shortly thereafter.  But I doubt there's any rush to pile into big banks given the covid.

 

As far as galaxy brain upside: it sounded to me like Charlie Scharf knows they have an opportunity in payments and some other "fintech" areas especially of there is some real distress.

 

As for the credit thing.  The thought process if that if you have an imposed artificial limit on loans you can hold (assets), you have another reason to be more particular about the loans you retain on your books.  We are soon to see about that.  Was very encouraged to hear Scharf's takes on the credit culture.

 

Agree on the costs and they have other bloat they can cut.

 

You don’t have to predict rates FED has already parked them at 0 for two years.  The short-term vicissitudes would make it hard to handle the futures with any leverage before rates went down or that’s likely a reasonable bet.

 

That would make sense regarding Scharf seeing other opportunities since WFC is a plain vanilla bank. That hopefully is enough with compliance costs coming down and branch closures eventually will right size their efficiency ratio and offset the NIMs but put me down as skeptical.

 

The credit culture is strong but if regulators are at the loan level those returns will be lower. 

[ERICOPOLY]

Fair that the economy may grow from a new lower base again next year even, but to do so will likely require lower rates as it did out of the last recession.  Just because they are higher before recession doesn’t imply they’ll go higher out of recession.  Yes the stock isn’t $50 and rates aren’t 3% either and the scenarios of COVID-19 have a wide distribution and the supply/demand shock is pretty extreme here.

 

I’d guess it’s worth in the mid teens under lower rate / NIM scenario. And why do you assume the NIM has to go back up? Europe and Japan haven’t, we have better population pyramid although it isn’t good, so where is the risk adjusted demand going to come from for loans with likely low rates for a sustained time? You know this stuff better than me so I’d love to understand it better.

 

At mid-teens, you are suggesting a P/E of 10x where the bank is making a 5% return on tangible assets.  Let's say that occurs, and they earn only 5% on tangible. 

 

Suppose further that they plow it all into a combination of buybacks and dividends, and the investor in this hypothetical scenario chooses to reinvest all dividends into more shares at 50% of tangible book.

 

In this situation the investor is making a 10% annualized growth in his share of the bank's tangible assets.

 

One day, our investor wakes up to the news that the economy has righted itself somewhat and other developments on the cost cutting side have yielded some fruit.  Now the bank is earning a 14% return on tangible assets.  Or merely a 10% return if you want to be more conservative.

 

Why is the the right price in the mid-teens if at such a price you make a 10% return while things suck, and then much more later on with all this future upside potential when things just get back to middling?  That's a high return for a deflationary environment, haven't historical market returns been a lot lower than 10% real?

 

Are you expecting significantly less than a 5% return on tangible equity when you say it's worth mid-teens?

 

EDIT:  I am referring to ROTCE above.

[ERICOPOLY]

And why do you assume the NIM has to go back up?

 

To address this other part, here is what I think:  the banks were earning enough to support current stock prices or much higher until COVID hit us.  And that occurred despite Europe and Japan being in worse situation back then just as they are now.  That's pretty much the end of my thought on that. 

 

The other thing I'd add is that each and every time we hit one of these recessions, it takes little time before I see people coming up with complex book-smart justifications for a very long and sustained period of gloom.  It is always backed by the "smart money", and the reasoning looks sound,... and each time when the economy turns around nobody could have expected it.

 

I'm not going to debate you, it just doesn't matter IMO because I'm not going to justify my investment decisions based on this kind of forecasting.  However you should do so if you think it is necessary and I won't talk you out of it, but I may ask questions from time to time.

[LC]

To your latter question: doubt it. Regulatory oversight prevents a lot of problems within the loan book.

 

So the regulators aren’t doing the same for the other big money center banks? How does the regulatory oversight prevent this? Are they at the loan level overseeing the underwriting?  I’ve heard this before but don’t fully understand how. If they are down to regulating at the underwriting / loan level then the loans may be safer but it will also impair their ability to underwriting higher risk adjusted loans as well.

 

Yes they oversee all the major banks.

 

Consider them super-auditors. They can request whatever data they want, and run their own analysis.

 

Banks have a defined risk appetite framework which determines things like underwriting decisions.

[erdospi]

Fair that the economy may grow from a new lower base again next year even, but to do so will likely require lower rates as it did out of the last recession.  Just because they are higher before recession doesn’t imply they’ll go higher out of recession.  Yes the stock isn’t $50 and rates aren’t 3% either and the scenarios of COVID-19 have a wide distribution and the supply/demand shock is pretty extreme here.

 

I’d guess it’s worth in the mid teens under lower rate / NIM scenario. And why do you assume the NIM has to go back up? Europe and Japan haven’t, we have better population pyramid although it isn’t good, so where is the risk adjusted demand going to come from for loans with likely low rates for a sustained time? You know this stuff better than me so I’d love to understand it better.

 

At mid-teens, you are suggesting a P/E of 10x where the bank is making a 5% return on tangible assets.  Let's say that occurs, and they earn only 5% on tangible. 

 

Suppose further that they plow it all into a combination of buybacks and dividends, and the investor in this hypothetical scenario chooses to reinvest all dividends into more shares at 50% of tangible book.

 

In this situation the investor is making a 10% annualized growth in his share of the bank's tangible assets.

 

One day, our investor wakes up to the news that the economy has righted itself somewhat and other developments on the cost cutting side have yielded some fruit.  Now the bank is earning a 14% return on tangible assets.  Or merely a 10% return if you want to be more conservative.

 

Why is the the right price in the mid-teens if at such a price you make a 10% return while things suck, and then much more later on with all this future upside potential when things just get back to middling?  That's a high return for a deflationary environment, haven't historical market returns been a lot lower than 10% real?

 

Are you expecting significantly less than a 5% return on tangible equity when you say it's worth mid-teens?

 

EDIT:  I am referring to ROTCE above.

 

5% is within a range that I think would be reasonable and I get to around 12x’s at that price.  I guess where you see it different is they get back to 10% ROTCE and I have a hard time seeing that over the next 5+ years.

 

I’m also expecting tangible book to likely get clipped further than you it seems, that’s a fair argument as I am not pretending to know their loan book in depth nor the outcomes of tranches, off balance sheet stuff that may or may not be toxic. The upside on $25 or so here is what $40? And the down side is $15 or so and that’s just the intrinsic value estimate no idea where the market would send it in that scenario.  I just don’t see it as a no brainer risk/reward.

 

I want to like WFC but every case I hear made for it sounds like a leap of faith. 

[erdospi]

And why do you assume the NIM has to go back up?

 

To address this other part, here is what I think:  the banks were earning enough to support current stock prices or much higher until COVID hit us.  And that occurred despite Europe and Japan being in worse situation back then just as they are now.  That's pretty much the end of my thought on that. 

 

The other thing I'd add is that each and every time we hit one of these recessions, it takes little time before I see people coming up with complex book-smart justifications for a very long and sustained period of gloom.  It is always backed by the "smart money", and the reasoning looks sound,... and each time when the economy turns around nobody could have expected it.

 

I'm not going to debate you, it just doesn't matter IMO because I'm not going to justify my investment decisions based on this kind of forecasting.  However you should do so if you think it is necessary and I won't talk you out of it, but I may ask questions from time to time.

 

WFC NII was going down YOY for quite some time before covid-19. You are right in that the outcome had been fairly good while the NIMs declined. That just gets significantly more difficult mathematically as you get to the zero bound.

 

I agree with your book smart comment. I’m not book smart and am backed by no money so not sure what applies there. I just want to see how to justify purchasing WFC here makes sense and I don't get a lot of clarity and this board is an intelligent group of investors that has always constructively discussed investments from both sides.

 

Definitely not trying to debate you Eric and I didn’t know you owned the stock and really would not expect anyone to justify ones own investment decision to some random person in a message board. My apologies if that is what you thought I am attempting to do. I really don’t care who does or doesn’t own WFC.  I just want to understand why and how WFC can handle the likely NIM compression and potential deflation or if no one expects that here that’s fine. The banks in the EU all trade at half book or less and have mid single digit ROEs, I know they have zombie loans but hard to see how that is avoided here without the multiplier effect and population growth.

 

I haven’t been able to figure it out before COVID-19 and if I would’ve posted all this prior I would’ve looked like a book smart person backed by smart money but I am neither and it would’ve been total luck because COVID-19 just accelerated what was happening to the NIMs for the past decade. I agree too the economy usually randomly rebounds when no one expects it so I’m probably be a good tell that the bottom is in for banks.

 

I guess I’ll just miss out on this one, because I have yet to see a logical explanation that shows how the big banks, WFC specifically, can not get clipped and still earn a reasonable rate of return from this price. That is unfortunate because there probably is a simple explanation that I’m missing and I’m not intelligent enough to figure it out. I meanI thought someone may have a loan demand growth story or something to offset the NIMs.

 

Either way thanks for your thoughts.

[erdospi]

To your latter question: doubt it. Regulatory oversight prevents a lot of problems within the loan book.

 

So the regulators aren’t doing the same for the other big money center banks? How does the regulatory oversight prevent this? Are they at the loan level overseeing the underwriting?  I’ve heard this before but don’t fully understand how. If they are down to regulating at the underwriting / loan level then the loans may be safer but it will also impair their ability to underwriting higher risk adjusted loans as well.

 

Yes they oversee all the major banks.

 

Consider them super-auditors. They can request whatever data they want, and run their own analysis.

 

Banks have a defined risk appetite framework which determines things like underwriting decisions.

 

Thanks LC. I get that, is that not going to hurt the returns on loans they are underwriting now ?  I like that it will be more conservative and maybe they can deploy more capital in the future if other banks are getting clipped more because the regulators aren’t sitting on the other banks and WFC may have excess capital still to deploy.

 

I just don’t get the NIMs and the spread compression that seems obvious and how they avoid that.

[Spekulatius]

A bank can always get impaired. It is a levered bet on the overall economy after all. If you believe the economy is going to hell, don’t buy bank stocks.

I feel like recent comments from the Fed have made negative interest rates less likely? I think there current near zero interest rates are baked in and the banks have and can live with it.

 

The question for me is if WFC at current prices is indeed a better bet than JPM, BAC or some of the regional banks trading below tangible book as well. BAC around tangible book with its more diverse Business model and still underrated (imo) management strikes me as a better risk reward than WFC if we get another pullback.

[DooDiligence]

And why do you assume the NIM has to go back up?

 

To address this other part, here is what I think:  the banks were earning enough to support current stock prices or much higher until COVID hit us.  And that occurred despite Europe and Japan being in worse situation back then just as they are now.  That's pretty much the end of my thought on that. 

 

The other thing I'd add is that each and every time we hit one of these recessions, it takes little time before I see people coming up with complex book-smart justifications for a very long and sustained period of gloom.  It is always backed by the "smart money", and the reasoning looks sound,... and each time when the economy turns around nobody could have expected it.

 

I'm not going to debate you, it just doesn't matter IMO because I'm not going to justify my investment decisions based on this kind of forecasting.  However you should do so if you think it is necessary and I won't talk you out of it, but I may ask questions from time to time.

 

WFC NII was going down YOY for quite some time before covid-19. You are right in that the outcome had been fairly good while the NIMs declined. That just gets significantly more difficult mathematically as you get to the zero bound.

 

I agree with your book smart comment. I’m not book smart and am backed by no money so not sure what applies there. I just want to see how to justify purchasing WFC here makes sense and I don't get a lot of clarity and this board is an intelligent group of investors that has always constructively discussed investments from both sides.

 

Definitely not trying to debate you Eric and I didn’t know you owned the stock and really would not expect anyone to justify ones own investment decision to some random person in a message board. My apologies if that is what you thought I am attempting to do. I really don’t care who does or doesn’t own WFC.  I just want to understand why and how WFC can handle the likely NIM compression and potential deflation or if no one expects that here that’s fine. The banks in the EU all trade at half book or less and have mid single digit ROEs, I know they have zombie loans but hard to see how that is avoided here without the multiplier effect and population growth.

 

I haven’t been able to figure it out before COVID-19 and if I would’ve posted all this prior I would’ve looked like a book smart person backed by smart money but I am neither and it would’ve been total luck because COVID-19 just accelerated what was happening to the NIMs for the past decade. I agree too the economy usually randomly rebounds when no one expects it so I’m probably be a good tell that the bottom is in for banks.

 

I guess I’ll just miss out on this one, because I have yet to see a logical explanation that shows how the big banks, WFC specifically, can not get clipped and still earn a reasonable rate of return from this price. That is unfortunate because there probably is a simple explanation that I’m missing and I’m not intelligent enough to figure it out. I meanI thought someone may have a loan demand growth story or something to offset the NIMs.

 

Either way thanks for your thoughts.

 

Sounds like you just want someone to talk you into buying.

 

Just out of curiosity, what have you bought lately & why?