Why Warren Buffett Loves Wells Fargo

I am in the process of putting together a detailed presentation on Wells Fargo (WFC), but I thought it would be useful to understand why Warren Buffett loves Wells Fargo. Wells is the most diversified financial services firm with a leading position in US banking stores, small business lending, mortgage origination, middle market commercial banking, agriculture lending among US banks, commercial real estate brokerage, bank-owned insurance brokerage, banking deposits in the US, debit card issuers, foreign exchange sales, retail brokerage, and wealth management. Wells Fargo has the highest net interest margin, return on assets, and return on equity of all large-cap US banks YTD 2009. Their efficiency ratio is third best in the industry behind only U.S. Bank (USB) and JPMorgan (JPM) (both great banks and great stocks to own as well). Growth opportunities for Wells include investment banking, international growth, and expansion of their business model within the US.

I think it's important to realize that the economy is improving, even though it is a result of easy monetary policies and fiscal stimulus. With unemployment at 10.2% and capacity utilization around 70%, the Federal Reserve will probably not increase interest rates for another six to twelve months. With credit losses peaking for the major commercial banks in 2010, they are set for incredible earnings growth in 2011 and 2012. There is a reason why Warren Buffett owns Wells Fargo, U.S. Bank, and Suntrust (STI) and John Paulson (who has been right throughout the entire financial crisis) is now long Bank of America (BAC), Citi (C), JPMorgan, Suntrust, etc.

All the large-banks capital reserves are much higher than before the financial crisis started. Wells Fargo's stockholders' equity of $122 billion, up $23 billion since year-end 2008 and up $50 billion since pre-Wachovia position at 9/30/08, excluding the U.S. Treasury's $25 billion Capital Purchase Program Investment. Wells Fargo's Tier 1 Capital has increased from 7.8% in 4Q08 to 10.6% in 3Q09 and Tier 1 Common Equity has increased from 3.13% in 4Q08 to 5.18% in 3Q09. Also, Wells Tier 1 Capital and Tier 1 Common Equity ratios would be significantly higher if they did not eliminate $20.1 billion of Wachovia nonaccrual loans at 12/31/2008 through purchase accounting. Wells estimated $40.9 billion losses in their purchased credit-impaired loan portfolio and YTD 3Q09 have taken $13.3 billion in losses, leaving the firm with $27.6 billion in reserves still available (in their credit-impaired loan portfolio). In addition, as the economy improves and these banks earn more money, their capital ratios are increasing. As a result, all large-cap banks are overcapitalized today, especially if you include the government's preferred stock investment.

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