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Wells Fargo & Company (WFC) became the nation's largest mortgage lender and the second-largest diversified financial services firm in the United States in term of deposits after acquiring Wachovia (WB) on December 31, 2008.^[1][2] Wells Fargo's bid to buy all of Wachovia (WB) was approved on October 12, 2008 and the company sold $12.6 billion in common stock and $25 billion in preferred stock to the US Government through former U.S. Treasury Secretary Paulson's $700B Troubled Assets Relief Program (TARP).^[3][4][5] The final deal cost WFC $11.7 billion and enlarged its total assets to $1.4 trillion ^[6][7]

For the fourth quarter of 2009, Wells Fargo posted a net income of $2.82 billion, a sharp turnaround from their year ago loss of $2.73 billion.^[8] Wells Fargo had a record $22.7 billion in revenues as Wells Fargo finished the strong in a year in which Wells Fargo generated record net income of $12.3 billion on record revenue of $88.7 billion. Despite these record earnings, there is concern among some analysts about Wells Fargo's credit charge offs, which totaled $5.4 billion in the fourth quarter of 2009.^[8]

On December 15, 2009, Wells Fargo raised $12.25 billion in a stock sale to help repay the $25 billion in Troubled Assets Relief Program (TARP) money that it received from the government during the 2008 Financial Crisis.^[9] Although this diluted Wells Fargo's shares by approximately ten percent, it allows the bank to avoid paying an annual dividend to the government of $1.25 billion and frees it of government oversight.

Company Overview

Wells Fargo & Company is best classified as a diversified financial services company. With over 80 distinct businesses, Wells Fargo offers a full range of financial products and services and targets all types of clients, from individuals to large corporations.

Like virtually all major banks, Wells Fargo has been negatively impacted by the 2007 Credit Crunch and the subsequent economic decline. The company's non interest revenue has fallen by 5% and its profits margins have also fallen from 20.45% in 2007 to 6.33% in 2008. However, these declines should be taken in context, as they are not extraordinarily large compared to other large banks. Furthermore, Wells Fargo has not been forced to write down large losses on its assets.^[10] Despite this, the Standard & Poor's Rating Service downgraded Wells Fargo from its AAA rating to AA+ after its acquisition of Wachovia.^[1] However, in the first quarter of 2009, Berkshire Hathaway (BRK) manager Warren Buffett raised his stake in Wells Fargo by 12 million shares, signaling Buffett believes the company's performance will continue to do well.^[11] During the third quarter of 2009, Buffett further increased his stake in Wells Fargo by more than 10 million shares in another show of support for Wells Fargo.^[12]

On September 25, 2009, Newsweek magazine ranked Wells Fargo the "Greenest Bank" in America, having helped environmentally friendly businesses with over $5.0 billion in financing.^[13] With growing concern about global climate change and other environmental issues, Wells Fargo's initiative and lead among financial companies may give it an advantage in the future among its potential clients.

Business and Financial Metrics

For the second quarter of 2009, Wells Fargo's earned a record $3.17 billion.^[15] Despite the record earnings, there are ongoing concerns about continuing losses related to credit cards and mortgages, including those acquired from Wachovia Bank (WB). Because Wells Fargo's non performing assets increased, it must also increase its provision for loan losses. Holding more of its cash in reserves reduces the amount used for income generating activities such as lending. This in turn negatively impacts future earnings.^[15] On July 22, 2009 Fitch Rating downgraded Wells Fargo's credit rating from AA to AA-, citing concerns about asset quality.^[16]

During the third quarter of 2009, Wells Fargo beat analyst forecasts by posting a $3.2 billion net income, which translates to a $0.56 earnings per share (EPS), up 61% from the same quarter in 2008.^[17] The strong showing was a result of positive growth from multiple divisions, including asset management, wealth management, retirement services, as well as its mortgage business. Deposits increased by 11% while its net interest margins jumped by 0.06% during last quarter.^[17]

Business Segments

Wells Fargo separates its businesses into three main segments for revenue reporting purposes: i) Community Banking, ii) Wholesale Banking, and iii) Wells Fargo Financial.

Community Banking ($2.93 billion net income and 84.8% of 2008)

Wells Fargo's Community Banking business serves small business clients (with up to $20 million in annual sales) as well as retail customers and high-net-worth individuals. Through a variety of channels, including the company's regional banking branches, over 6,700 ATMs, website, and telephone banking service, Community Banking provides products ranging from home mortgages and debit cards to personal trusts. Community Banking also offers Wells Fargo Advantage Funds, a family of mutual funds.

WFC's Community Banking segment earned $2.93 billion in net income in 2008, down 43% from its 2007 level of $5.11 billion.^[18] Net income declined largely as a result of higher provisions for credit losses on bad loans, which increased to $9.56 billion in 2008 from its 2007 level of $3.19 billion.^[18] WFC is one of the largest mortgage originators in the U.S. and also incurred losses stemming from mortgage defaults.

Wholesale Banking ($1.29 billion net income and 37.3% of 2008)

WFC's Wholesale Banking Group serves the company's business clients with annual sales exceeding $10 billion. Wholesale Banking is responsible for a line of corporate, commercial, and real estate banking products and services. Offerings include institutional investments, employee benefit trusts, investment banking, construction loans, and insurance.

Net income for Wholesale Banking fell 48% to $1.29 billion in 2008, a substantial drop from $2.28 billion in 2007.^[18] This decrease is largely attributed to its $1.12 billion provision for credit loss in 2008, which was significantly higher than the $69 million and $16 million losses in 2007 and 2006 respectively.^[18]

Wells Fargo Financial (-$.764B net income and -22.1% of 2008)

Wells Fargo Financial is comprised of the company's auto finance and consumer finance operations. These consist mostly of automobile loans, direct loans, and real estate loans. This division also includes Wells Fargo's substantial credit card business. While WFC's Community Banking division primarily serves small businesses, Wells Fargo Financial caters to individual clients.

In 2008 net income for this division declined to a $764 million loss, continuing a trend from 2007 of declining income. The decline was a result of a $2.38 billion credit loss from increased losses in the credit and auto portfolios. The auto lease industry had slower growth and the credit card industry had an increase in net charge offs, which are loans deemed uncollectible.^[18]

Wells Fargo has issued over 7.7 million credit cards and over 20 million debit cards, making it the second largest debit card issuer in the U.S.^[19] WFC earns revenue from its credit cards through multiple channels. As a credit card issuer, it charges interchange fees (fees charged to merchants who accept credit cards), interest on outstanding customer balances, and a variety of other fees charged to customers, such as late or missing payment fees, exceeding the card's credit limit, and monthly or annual membership fees. Wells Fargo also has costs related to credit cards, such as interest expense (Wells Fargo generally borrows the money that it lends to credit card customers), fraud, and rewards (in order to compete with each other, banks offer cash-back rewards and bonus point systems to lure customers; these generate costs that the credit card issuer must bear).

Trends and Forces

Effects of housing market slowdown

The U.S. housing market had a slowdown that began in 2007, and as it continued into 2008 and 2009, Wells Fargo's mortgage lending business was hit by slow growth and falling residential real estate prices. The economy as a whole experienced the "home equity effect", where homeowners perceive their house values to be lower than they anticipated, and therefore perceive themselves to be relatively less wealthy. As a result, consumers spend and consume less. The number of total housing starts has fallen 63% since peak levels during the end of the housing boom.^[20] During the last quarter of 2008, the nation's banks recorded a total of $26.2 billion in losses and faced a weighted average of 94% fall in profits.^[21] Wells Fargo Home Mortgages have taken a setback, with higher provisions for credit losses offsetting revenue growth in 2008. However, Wells Fargo has been dealing with the mortgage setbacks relatively well due to its wide diversification in product offerings, which allows the company to compensate for poor performance in the home mortgage business.

Subprime bust avoidance

The housing slowdown is often attributed to the collapse of the subprime lending market. Subprime lending, or lending money to customers with poor credit scores (riskier borrowers), can lead to higher loan losses in harsh economic climates or during periods of stagnant or falling housing prices. As customers find themselves unable to make their debt payments, which are higher than average to begin with, defaults rise.

Wells Fargo has fared better than most competitors in the mortgage business, mainly because its mortgages are predominately prime and near-prime. As a result, Wells Fargo has not experienced high rates of default seen in the subprime market. Wells Fargo has avoided much of these losses by deciding not to extend or purchase option adjustable rate mortgages (option ARMs). However, Wachovia Bank, which was acquired by Wells Fargo, took part in Option ARMs and subprime lending. Wachovia has $122 billion in outstanding subprime loans and a loan loss of 29% or $36 billion is expected.^[22] Despite this prediction, the changing economic situation has made existing models unreliable and it is unclear what Wachovia's assets actual default rate will be.

Exposure to U.S. Economic Cycles

Its heavy concentration in the U.S. makes Wells Fargo more dependent on U.S. economic conditions than some of its more internationally diverse peers. Global gross domestic product increased by an estimated 4.9% over the course of 2007, though the U.S. GDP growth rate was notably lower.^[23] As the world economy continues to expand, consumers and firms have more wealth to spend and invest, which translates into increased revenue for Wells Fargo. At the same time, widespread economic weakness that extends beyond the United States can severely impact Wells Fargo's earnings. For instance, the international economic downturn that occurred after the 2007 credit crunch and the 2008 Financial Crisis considerably lowered Wells Fargo's earnings.

U.S. interest rates over time

Interest Rates Sensitivity

The Federal Reserve increased the federal funds rate from 4.25% to 5.25% early in 2006, which put upward pressure on interest rates. This had the effect of slowing economic growth and lowering inflation, which partially offset the effects of strong economic expansion (discussed above). Higher interest rates tend to discourage consumer spending and investment, which impacts Wells Fargo in the form of lower balances charged to credit cards, fewer loans and deposits, and reduced business loans. At the same time, higher general interest rates allow WFC to charge its customers higher interest on their loans, which could increase the company's revenue from the loans that customers do take out.

In late 2007 and early 2008, the Fed implemented a series of interest rate cuts, reducing the rate from 5.25% in September of 2007 to 0-.25% in December 2008.^[24] These measures were largely aimed at stimulating economic activity in the face of a recession caused by fallout in the subprime lending industry and the 2008 Financial Crisis. Wells Fargo will benefit from these cuts if they have the desired effect of stimulating consumer spending and encouraging businesses to expand.

Potential implementation of "Financial Crisis Responsibility Fee"

Obama announced in January of 2010 a plan to tax the largest banks and financial institutions to recover TARP funds that the government used to bailout many of the banks. The proposed plan calls for a 0.15% tax on each firm's liabilities, excluding Tier 1 capital and those already insured by the FDIC, with the goal of raising $90 billion over ten years.^[25] However, the financial institutions subject to this fee are limited to only those with over $50 billion in assets. If this plan gets passed into law, it could represent a substantial cost to Wells Fargo for up to ten years.

Competitors

Wells Fargo competes against a many local and regional banks as well as large international banks. Since Wells Fargo focuses its business operations on the domestic U.S. market, its main nationwide competitors are Bank of America (BAC) and U.S. Bancorp (USB). Wells Fargo's lack of international exposure contrasts with top competitor Bank of America. Although WFC holds assets overseas, its interest in foreign markets does not extend to opening branch offices outside the United States. While this does allow Wells Fargo to focus its resources on gaining greater market share in the U.S., it does make WFC more vulnerable to the U.S. economic cycles, with no foreign markets to buffer domestic performance.

• Bank of America (BAC), with 11.33% of total domestic deposits, is the market leader for domestic banking.^[26] It also has higher revenues and net income compared to Wells Fargo, as in 2008 Bank of America had a net income of $4.00 billion and $72.7 billion in revenues.^[27]
• U.S. Bancorp (USB), the sixth largest bank in the United States, primarily serves the banking needs in the Midwest region of the United States. In 2008, it had total revenues of $19.2 billion in 2008 and $2.83 billion in net income.^[28]

Wells Fargo was originally ranked fourth in market share of total domestic deposits, behind Bank of America (BAC), J P Morgan Chase (JPM), and Wachovia (WB). However, after the acquisition of Wachovia, the bank became the second largest bank in terms of total domestic deposits and surpassed JPMorgan.

WFC has a low loans to deposit ratio, though not the lowest in the industry

Wells Fargo has the highest net interest margin (NIM)

References

1. ↑ ^{1.0 1.1} Trading Markets "Wells Fargo and Wachovia Merger Completed" 1 January 2009
2. ↑ Forbes "Bank of America drops Countrywide name" 27 April 2009
3. ↑ Wachovia Chooses Wells Fargo, Spurns Citi - WSJ.com
4. ↑ Board of Governors of the Federal Reserve System "Press Release" 12 Oct 2008
5. ↑ Forbes: Business Finance "UPDATE 3-Wells Fargo to raise $10 bln to fund Wachovia deal" 5 Nov 2008
6. ↑ Fox Business News "Fed Approves Wells Fargo's Wachovia Acquisition" 13 Oct 2008
7. ↑ Reuters "Wells Fargo completes Wachovia purchase" 1 Jan 2009
8. ↑ ^{8.0 8.1} Wells Fargo turns profit in fourth quarter. Alistair Barr. MarketWatch.
9. ↑ Wells Fargo sells $12.25 billion in stock to exit TARP. Elinor Comlay. Reuters.
10. ↑ ^{10.0 10.1} WFC 10-K 2008 Consolidate Financial Data p.37
11. ↑ Buffett lifted Berkshire stake in Wells Fargo. Alistair Barr. MarketWatch.
12. ↑ Berkshire raised Wal-Mart, Wells stakes in third quarter. Alistair Barr. MarketWatch
13. ↑ Newsweek Ranks Wells Fargo Greenest Bank in U.S. Business Wire.
14. ↑ ^{14.0 14.1 14.2} WFC 10-K 2008 Item 6 Pg. 48
15. ↑ ^{15.0 15.1} Cyrus Sanati. Dealbook. The New York Times.
16. ↑ Sue Change. Fitch cuts Wells Fargo's default rating to 'AA-' . MarketWatch.
17. ↑ ^{17.0 17.1} Lauren Tara LaCapra. Wells Fargo Tops View, Stays Mum on TARP Payback. TheStreet.com
18. ↑ ^{18.0 18.1 18.2 18.3 18.4} WFC 10-K 2008 Item 6 Pg. 52
19. ↑ Wells Fargo Today
20. ↑ Housing Economics "Housing Starts State & Metro Forecasts for 2008-2009"
21. ↑ Star Tribune "FDIC says US banks posted $26.2 billion loss at end of 2008, first quarterly loss since 1990" 26 Feb 2009
22. ↑ Mortgage Statistics "Wells Fargo/Wachovia Option Arms" 28 Dec 2009
23. ↑ IMF World Economic Outlook (WEO) - Housing and the Business Cycle, April 2008
24. ↑ Federal Reserve Board "Open Market Operations" 16 Dec 2008
25. ↑ Obama proposes special fee on financial companies. Rex Nutting & Robert Schroeder. MarketWatch.
26. ↑ ^{26.0 26.1} FDIC Quarterly 2008, Volume 2, No. 4 "Highlights from the 2008 Summary of Deposits Data"
27. ↑ ^{27.0 27.1} BAC 10-K 2008 Consolidated Financial Statements p.102
28. ↑ USB Annual Report 2008 Pg. 3
29. ↑ USB 10-K 2008 Consolidate Financial Statements p.2
30. ↑ FDIC "Summary of Deposits" June 2008