Wells Fargo—A Diamond among the Rubble?
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The Fiscal Times
July 16, 2012

You may well decide that you don’t want to own any banking stocks in your portfolio these days – and who would blame you? Barclays  and JPMorgan Chase – two of a handful of institutions to emerge relatively unscathed from the financial crisis and that have gone on to become relatively stronger in the years since – have each been hit by problems that go squarely to their reputation for being skilled risk managers.

The rest of the crowd seems to be subject to at least one of three big sources of risk: Eurozone exposure (all the European banks, and many elsewhere); the Libor scandal (most of the giant global institutions), and a downturn in revenues from investment banking activities amidst growing regulation and uncertain global markets.

But there is always Wells Fargo. When the San Francisco behemoth reported its profits last week, its earnings actually rose by 17 percent (in contrast to the dip in JPMorgan Chase’s profits), and it beat analysts’ earnings estimates by a penny, posting bottom-line earnings of 82 cents a share.

The biggest single reason for the gain seems to be the revival in mortgage applications, which the bank said soared 90 percent from the second quarter of 2011 to $208 billion. That sends an encouraging signal about the health of the housing market – but also sounds a positive note for Wells Fargo, whose gain in mortgage applications was three times that announced by JPMorgan Chase; there’s no question that Wells is gaining market share. 

The good news on mortgages notwithstanding, one of the biggest things that Wells Fargo has going forward for it is that it doesn’t look like any of its giant rivals. Its earnings come from stable kinds of businesses – commercial and retail lending, retail banking, asset management.  It’s relatively unexposed to the turmoil of global capital markets, which ensured that it was one of a handful of major institutions spared when Moody’s last month slashed their ratings on the debt of 15 of its largest competitors.

Wells Fargo doesn’t rely on volatile investment banking earnings, meaning it will be more sheltered from the regulatory storms and the volatility with which firms like Morgan Stanley, Goldman Sachs and Bank of America are grappling with. True, it has had its own woes – most recently, it agreed to pay $175 million in fines to settle a Department of Justice civil suit claiming that it had denied mortgages to qualified Hipanic and African-American homebuyers. But overall, it has stuck to its knitting and steered clear of the kinds of issues now bedeviling its rivals.

Add to the mix the company’s great record for buybacks and dividends, and you’ve got a banking stock that only a curmudgeon could dislike. Heavens, even Warren Buffett is a fan. “I like Wells Fargo better than anything by far,” Buffett told Bloomberg TV recently. “We have been buying Wells Fargo month after month for a lot of years. Among the big banks, I think it is the best.”

But is being the best bank really the “best” kind of company? And will Wells Fargo manage to retain all the qualities that make it so attractive – especially on a relative basis – in the coming years?
 
It may seem too early to speculate on questions like this – today, all the forecasts seem bullish and upbeat, with analysts maintaining positive recommendations on the company’s stock even after its recent outperformance. But Wells Fargo itself is changing – and the question of how that will affect its earnings and its culture remain unanswered.
 
Most notably, the bank is taking steps to boost its presence in capital markets (until it acquired Wachovia Cop. at the height of the financial crisis this wasn’t an area in which it had any expertise). But wealthy individual investors who rely on Wells Fargo’s private bank for investment advice and corporate clients who turn to it for lending want to be able to obtain more services – and Wells doesn’t want to lose them to Citigroup, for instance, simply because the firm doesn’t have the capability to execute stock trades or advise on an acquisition.

Last year, Wells hired two dozen investment bankers from Citadel LLC – perhaps the antithesis of the big bank in terms of corporate style and business focus – to help Wells ramp up its equity underwriting business. Most recently, it snapped up Merlin Securities, a San Francisco-based prime brokerage firm that works with hedge fund clients, lending cash and securities. Analysts expect the bank to be on the lookout for other acquisitions in the capital markets arena, especially as the European debt crisis knocks down valuations.

It’s impossible to tell how much these initatives will end up transforming the bank or making it a more risky investment. But it’s clear that investors buying Wells Fargo stock today, expecting its business to remain stable, may be in for a surprise. That won’t necessarily be a negative surprise, but navigating the choppy waters of global capital markets in the current environment will require skill, luck and good management. It also means that investors will want to keep a keen eye on the bank’s initiatives and its quarterly results.

After all, the recent events at Barclays and JPMorgan Chase have reminded us all just how rapidly a respected financial institution can fall from grace.

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.