|Wells Fargo CEO John Stumpf.|
SAN FRANCISCO ( TheStreet) -- While all its big-bank competitors were scrambling to thwart new rules on credit-default swaps, proprietary trading and consumer protection, Wells Fargo's ( WFC) priority was far less sexy: Preemption, which could allow state regulations to take precedence over federal law.
"In my opinion the
biggest risk among current regulatory proposals is losing preemption," CEO John Stumpf said at an investor conference in May. "A wrong decision on this topic would be problematic for our industry and, most of all, the American consumer." The comment was par for the course for Wells Fargo, a San Francisco-based behemoth that ranks as the fourth-largest U.S. bank, but rarely attracts attention. The firm earns its keep by serving individual clients in traditional ways -- loans, deposits, wealth-management -- as well as commercial loans, corporate banking and trust services. Once upon a time, such "boring" bank profits didn't lure investors. But the core earnings generation that Wells Fargo touts now seems much more appealing to those who got burned by subprime and its complex derivatives. With financial reform coming down the pike, banks that rely heavily on core activities represent something of a safe haven. Wells' two divisions that offer loans and other services to individuals and businesses comprised 93% of its profits last year, while its wealth, brokerage and retirement division earned $1 billion, or 7%. As Stumpf put it during a Q&A at a financial conference recently: "If you think about Wells Fargo compared to other companies, we do think of ourselves as Main Street." In fact, since the reform bill turned out to be a lot less harsh on capital markets activities than it could have been, a firm like Wells Fargo is not just safe, but has room to grow. After acquiring Wachovia in 2008, Wells intended to divest most of the troubled bank's brokerage and investment banking operations, but revisited the plan last year . Now it has plans to grow the brokerage business significantly. Though Merrill Lynch was known for its "thundering herd" of brokers, the moniker may better apply to Wells Fargo Advisors in the coming years. Its staff had about 15,000 advisors at the end of 2009, and Wells plans to add another 10,000.
Right now, Wells ranks at No. 3 on the advisor-headcount list, but the addition would place it above Morgan Stanley-Smith Barney ( MS) and the combined Merrill- Bank of America ( BAC) team, though the hiring timeline is uncertain. The other two growth areas for Wells are its geographic reach and the amount of "products" each customer utilizes. Wells's business model places a heavy focus on cross-selling, or wooing one type of customer to enter new banking relationships across the spectrum. An ideal depositor would also be a borrower whose retirement funds and other wealth is managed in-house, and buys insurance from Wells Fargo, too. The strategy has roots in Minnesota, where Wells Fargo's
ancestor , Norwest, was based. Its headquarters, however, are in California, where the original Wells Fargo was based before the two banks merged . As a result, Wells Fargo has had a broad reach across the Western half of the country for some time. But it had relatively little exposure to the East before acquiring Wachovia, whose home base was in North Carolina, and was also established -- though not dominant -- in the Northeast. The advantage of Wells Fargo's countrywide footprint is that the bank can now expand selectively without breaking new ground. There are even more opportunities for cross-selling in Wachovia branches than there are in "legacy" Wells Fargo divisions. The combined franchise has a cross-sell ratio of six products per household. For the standalone Wells Fargo, it's closer to eight, and at Wachovia, it's closer to five. Wells says there's "significant opportunity for growth" as it strives to reach a goal of eight for the combined entity. However, the coast-to-coast presence is also what had Stumpf so concerned about preemption law, which threatened to upend Wells Fargo's plans for profitable expansion. Initial drafts of the reform measure included the change to federal preemption in an attempt to decentralize governance and make the banking landscape more competitive. But there was potential for unintended consequences too: It would complicate national banks' business models, raise costs of compliance and create a situation where customers in one state could be disadvantaged against those in others with "friendlier" financial rules.
Or, as Citigroup analyst Keith Horowitz recently phrased it: "a patchwork of state laws that would add complexity to managing pricing and product offerings across states." Language appears to have been softened in the version of the Dodd-Frank measure that passed through the House. It gives state attorneys general more power to enforce consumer-protection laws, but stops short of giving state regulators more power than federal ones. In response to questions from TheStreet, Wells Fargo spokeswoman Mary Eshet said Stumpf and the executive team are still awaiting the final outcome of finreg and analyzing how it will impact the business and its customers. "We believe Wells Fargo has a distinct advantage because virtually everything we do starts with a customer," said Eshet. Despite the regulatory assault on banks considered "too big to fail" and the massive sell-off in bank stocks, longtime bank-stock analyst Nancy Bush thinks Wells will stand out from the crowd. Bush raised her price target on Wells Fargo stock this week to $36 from $33, citing the firm's potential for growth. "Wells Fargo's stock seems to have been particularly punished, in light of the fact that this company is among the least impacted by Fin Reg," says Bush who runs an independent firm called NAB Research. She adds that the stock slump "also seems to ignore the positives presented by the upcoming integration of the Wachovia network in the Southeast, which we believe will be a game-changer for that region and for the company." Indeed, from mid-April, when the financial-stock selloff began to take hold, through the end of the second quarter, Wells's shares have dropped about 24%. Its decline was slightly greater than JPMorgan Chase ( JPM), which has far more exposure to derivatives, proprietary trading, hedge funds, private equity and interchange fees -- all of which are to be made less viable or less profitable by the reform measure. Other banks that stand to get hit harder than Wells -- Morgan Stanley ( MS), Bank of America ( B) and Goldman Sachs ( GS) -- declined 25% to 29%. Part of the reason for the sell-off in Wells shares may also be the threat of a double-dip recession. The term has been tossed around ever more frequently lately by economists and talking heads. It's true that one of the biggest profit drivers for Wells Fargo -- the mortgage business -- is
coming under stress and is unlikely to return to the heady days of 2009 any time soon. Of Wells Fargo's $1.2 trillion in assets, about $500 billion pertained to residential mortgages. Wells grew that book of business 14% last year, with revenue climbing to $12 billion. It added to the bottom line by hedging on mortgage-servicing rights, with a forward-looking interest-rate strategy that has already started paying off .
Though Wells still beat estimates in the first quarter, its mortgage business slowed. Refinancing activity and new home purchases have declined considerably since then, which indicates that Wells and other big banks will have a hard time relying on housing to boost the bottom line. Still, Bush notes that the firm has more capital and liquidity than ever before. Combine that with the expanded footprint, a skillful management team and a yield curve that makes it hard for banks not to earn money, and Bush considers Wells Fargo a winning bet. "Wells Fargo is at the top of the 'ready, willing and able' list," says Bush. She estimates that Wells will earn nearly twice as much as it did last year once the country enters a more "normal" economic environment, even with a 5% hit from financial regulation factored in. Bush isn't alone, with Wells having a buy or strong buy rating from most analysts who cover the firm, especially now that some of the wind has been knocked out of its share price. Sterne Agee upgraded Wells to buy in late May, citing an "an attractive entry point" and lifting the price target to $37. In a more recent note, KBW analyst David Konrad highlighted Wells as one of the large-cap banks least exposed to reform measures, along with other traditional franchises that are smaller like BB&T ( BBT), PNC ( PNC) and U.S. Bancorp ( USB). KBW counts Wells Fargo among its top-rated outperform stocks. Wells Fargo's stock price does appear cheap, based on price-to-earnings metrics - but then again so are all of the big banks. The industry average for the ratio of stock price to Wall Street's 2010 earnings estimates is 17, according to Thomson Reuters. Wells trades at 12.9, cheaper only than Bank of America, which is at 14.3. Meanwhile, JPMorgan is at 11.5 times earnings, Citigroup is 11.1 and Goldman, the hardest hit, is trading at a measly 7.6 times earnings - even with analysts having lowered estimates in recent weeks to reflect the impact of reform. A more meaningful metric may be price-to-book value. That metric shows Wells -- whose share price tends to be a little more stable than the rest of its big-bank brethren -- being valued a little better than the rest of the pack at 1.23. Goldman -- whose shares also tended to retain value better pre-SEC charges -- trades at 1.04 times estimated book value. More diversified firms like Bank of America, JPMorgan and Citigroup, are all trading below book value, ranging anywhere from 0.6 to 0.9.
Essentially, the bull case for Wells Fargo comes down to this: It's proven an ability to retain a more stable share price and more reliable earnings than competitors. It's got room to grow. And its management is salivating to return its dividend -- cut to 5 cents per share each quarter from 34 cents per share -- closer to Wells Fargo's historic yield. "The toughest decision we made, that I had to make in the last year and a half and that's more so than buying Wachovia and raising capital and accepting TARP and paying TARP off was cutting our dividend because these are our owners," Stumpf said in June. Finally, Wells Fargo is less affected by the regulatory crackdown that has sent shivers of uncertainty through the market over the past few months. Despite his reservations about preemption law, Stumpf may have been the only one of the Big Six to call regulatory reform an "opportunity." "I also consider regulatory reform an opportunity," said Stumpf, "because, if done right, in a way that protects consumers and encourages banks to focus on serving customers, Wells Fargo is in the sweet spot because virtually everything we do starts with the customer." -- Written by Lauren Tara LaCapra in New York.