Circle the Wagons With Wells Fargo
If you had $10 billion to invest, what would you do with the money? Personally, at this point, I would probably look to put it all in U.S. Treasury notes, earn 3.5% a year, happily count my $140 million a year in interest payments, and sit back to enjoy the adoration of my family.
But what if you're a foreigner with currency translation risks, already owned half a trillion dollars in Treasuries and wanted to protect that much larger investment? Well, you might do what the sovereign wealth funds (SWFs) have done: Do your part to prevent the U.S. financial world from collapsing and embark on a new career as the director of a commercial bank.
On one level the SWFs' investments in Citigroup (C) and UBS (UBS) look risky and naïve, in other words, because who in their right minds would want to own companies beset by so many deep-seated and unknown problems? But if you consider that the moves were attempts to bolster the value of much larger investments, then they make some strategic sense.
Moreover from an investment standpoint, the lesson to glean from the SWF investments is that plain-vanilla banking at the likes of Citi and UBS might still be an awesome business. After contending with an inverted yield curve for much of 2006 and 2007, rapidly declining short-term rates, courtesy of the Federal Reserve, are boosting the difference between the amounts banks pay for deposits and the amount they receive for loans. The government is basically rebuilding the banks' balance sheets as we speak, dropping billions of dollars of net interest margin in their laps.Conservative investors may believe it is too early for deep-sea bottom fishing in the financial sector, as credit can still deteriorate faster than net interest margins improve. But as an optimist, I must confess that I see a glint of light at the end of this tunnel. So does veteran industry analyst Richard Bove of Punk, Ziegel & Company. In a recent research note to clients, he pooh-poohs all the obituaries being written for the banking sector. After all, he notes, no other businesses can "borrow hundreds of billions of dollars at prices lower than the United States government and ... reinvest this money to get consistently high returns." In this environment, a case can be made for Wells Fargo (WFC), as it's the only U.S. bank to still receive the highest possible credit ratings from Moody's and Standard & Poors (not that that means much anymore). Based in San Francisco, Wells has the vast majority of its banking branches west of the Mississippi, though it does business in all 50 states. Wells made a ton of mistakes making stupid loans to unworthy borrowers in the days of the credit bubble, but it is finally taking steps to lessen the damage. Last week, the company padded its balance sheet with the addition of $4.5 billion through new debt at reasonable interest rates. Nearly $2 billion was raised for just 0.43 percentage points more than the three-month London interbank offered rate. The low rates were a solid vote of confidence in the bank's future. Over the last seven years, Wells Fargo has grown deposits at nearly an 11% clip. Its net interest margins have actually been declining over this time, as rising short-term interest rates and an inverted yield curve squeezed profitability, but it managed to steer clear of the worst of the securitization and derivatives snafus that have afflicted its larger East Coast peers. The bank just reported its fourth-quarter results, and trends look encouraging. Deposits were up 5%, or $12 billion, even as the rates that it pays on these funds fell. And its loan portfolio grew 9%, or $23 billion. A majority of all this is focused here on the domestic U.S. marketplace -- something that it has been penalized for in the age of international diversification.
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