Q4 2008 13F

[dowfin1]

In 1990 Buffett used a 3% loss stress test, rather than a 10% for WFC.  From the 1990 letter:

 

  Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

 

      None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

 

      A year like that - which we consider only a low-level possibility, not a likelihood - would not distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity. Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices.

[benhacker]

Yeah, I second downfin's comments.  A 10% loss estimate for a lender levered 10:1 is a pretty tough hurdle.  I'll have to dig into Wells' old financials to see if that could have ever been tested. 

 

Prevalou, if you could share your calcs, I'd be interested to see them... doesn't immediately make any sense to me, but I may be thinking about it wrong.

 

These days, Wells can survive a 10% hit (not talking about any recoveries) with minimal capital additions given the massive provisions they have in place, plus the purchase buffer they took with Wachovia + 2 years of Pre Tax, Pre Provision income.

 

The likelihood of a company like Wells getting to a point where they actually have to write off 10% of their assets is pretty astounding to me... like Great Depression type stuff >15% unemployement.

 

Or maybe I've just drank my WFC cool aid too much.

 

Ben

[Mungerish]

I've been in banking for 25 years and Wells is a very well run place IMO.

They are going to have an outstanding Q1 and probably entire year from the mortgage banking/refi perspective. How many of the loans aquired from Wachovia will be refinanced into agency paper?

My guess is quite a few.....

In the sense of full disclosure I should say that I am largely tailcoating WEB here as opposed to doing a month long+ deep dive into WFC. I am very familiar with them on a retail banking level, and that is where my own $.02 comes from.

If you read the transcript of the last conf call, the growth in deposits, loans and market share was just incredible

Ish

[prevalou]

WELLS FARGO M&T BANK US BANCORP

TOTAL ASSETS 1 287 62 266

TOTAL LOANS 864 49 185

TOTL PROVISIONS 21 .788 3.5

Prov%loans 2.4% 1.6% 1.9%

EQUITY 77 3.6 15

EQUITY% actifs 6% 5.8% 5.6%

Equity%loans 8.9% 7.3% 8.1%

CASH FLOW 25 1.1 7.1

Cash flows%loans 2.9% 2.2% 3.8%

(prov+eq+cash flow)/loans 13.2% 11.1% 13.8%

equity/loans 2010 after 10% loan losses 3.2% 1.1% 3.8%

 

I made a rough spreadshit for Wells, M&T and US bancorp

The stress test for me has to consider a hard depression possibility, even if it is remote.

By the way, canadian banks don't pass the test

[Guest ericopoly]

Mungerish,

By the way, thanks for saving me money on NEW and FNM.  I took your advice and owned zero.

 

The conference call transcript is a bit long, so anyone who wants a quick look at Q4 highlights can find it here:

 

https://www.wellsfargo.com/pdf/press/4Q08_Earnings_Presentation.pdf

 

 

 

 

 

 

[prevalou]

In my calculations, I forgot the other assets. For instance Wells has 864 billion$loans and 1300 billion$ assets. But with 10% losses on loans i assume other assets will come clean.

[ShahKhezri]

I think some people are just missing the point here.  You can't talk about asset losses without the implications of depoit growth, it's not one or the other, they are joined at the hip.  If you take the concept of "money flowing to where it is treated best" on a banking level, do you honestly believe other bank-like institutions are going to be able to offer CD's like the Houston outfit that just blew up?  Banks are going to be doing a lot more of what they were created to do.  Now surprisingly, the only CC out there with the most sensible answer to what exactly is going to happen in the intermediate future was from BB&T, here is a great excerpt:

 

Nancy Bush - NAB Research, LLC

 

Yes, my follow-up question is this. And I realized it's probably a little early to be looking to the other side of the thing we're going through right now. But when you're looking at the developments in your credit portfolios, I'm sure you're sort of going through a mental – okay, could we have done this better, what could we have done differently. What are the implications here for the future, particularly as it comes to financing residential real estate development, etcetera?

 

Kelly King

 

Well, I think that's the key question to me that everybody ought to be asking. The way I frame that is, what does the economic engine look like going forward? Here's an interesting thing Nancy, to me, and you may not agree with this. But I think it's rational. I mentioned earlier this 20-plus year period of disintermediation as huge amounts of assets left the banking balance sheet and went into the capital markets.

 

That's gone for a long time; it may be back one day. I think it's gone for a long time. We also, by the way, saw it on the liability side. We saw huge amounts of traditional deposits, CD type deposits leave our system, go into mutual funds and very sadly, nothing wrong with mutual funds; we manufacture them.

 

But very sadly, particularly senior citizens say, well, I would never put my money at risk and put it in the stock market. I'm putting it in mutual funds, and never even understand what they are doing. So now they've lost a lot of their money they were counting on to live on. You are seeing that money come back in the CDs, albeit at lower rates. So we're getting more deposit inflow at lower rates. We're getting more loan inflow at higher rates. Spreads are improving, they will continue to improve. So I think going forward, even with lower aggregate economic activity, which I believe will be the case, good banks will have very good balance sheet growth and very good spreads resulting in very good margins.

 

Now, I don't think any of us ought to be sitting here thinking about going back to the 90s and looking for 15% to 20% growth rates. I don't think that was healthy then. It wouldn't be healthy now and it's not going to happen. But for the first 10 or 15 years of my career, if you could grow loans 6% to 8% deposits in the same kind of category and get good pricing and control your costs, you could make a lot of money. And I believe we are heading into that period.

 

Once we get through this cycle, 12 to 18 months, we are in for 8 to 10 years of really good operating conditions for good spread lending institutions like us. Now, some institutions that had, way over half of their income coming from C businesses, but the kind of C businesses in the capital markets, etcetera, that have evaporated or they had the strategies of buying all their business around the world, those strategies didn't work and they won't work. Our strategy has not changed.

 

And so as the markets slowly improve, the volume will improve. We'll get market share move from this re-intermediation and we specifically will get market share move, for at least two or three years. We have the Wachovia, Wells things. Wells is a good institution, but not as good as us, but they are a good institution and it will take them two or three years to get settled down. We've done enough mergers to know. I mean you just don't do it overnight.

 

Now you have got to be in a bit of [mirror] thing, I mean, and who knows where that's going. But in terms of capital markets business and wealth business, looks to me like a lot of opportunity is out there, not to mention some of our other competitors that certainly have their own challenges. So, I think Nancy, as I look forward and I've tried to be brutally honest with myself about this, I really believe when we get through this, we're going to see some of the best times in basic commercial banking that we've seen in a long time.

 

Nancy Bush - NAB Research, LLC

 

Okay. And get here soon enough.

 

Kelly King

 

Yeah, amen to that.

 

http://seekingalpha.com/article/116009-bb-t-corporation-q4-2008-earnings-call-transcript?page=-1

 

[benhacker]

Thanks for posting this Shah.  I think BB&T is indeed the best managed bank, and his words about Wells are true.  I think 2-3 years to integrate Wachovia is realistic.

 

The core economics of 'good' banks is improving rapidly.  As Mungerish said, Q1 should be good, and there may be some positive credit surprises due to the Refis.

 

Lots of uncertainty here, but if you want to protect against disaster, I'd just buy Wells with a out of the money market put.  Assuming Wells goes under is assuming a depression, period.  and I think that is totally hedgable.

 

Thanks,

 

Ben

[Parsad]

If you own a bank that is in decent shape, or are starting one, the spreads between deposits and loans are fantastic.  Banks that are growing their deposits like Wells, M&T, etc. are going to do very well going forward, even if they do have the occasional hiccup from their loan portfolio.  I think the really tough time was a couple of months ago.  Going forward with the options banks have, the spreads they are getting, the quality of business they are now forced to write, the industry should start to do better.  Cheers!

[benhacker]

So I just glanced at the Wells 1992 financial info, and I really don't see the drastic difference today in term of the ability to withstand losses.

 

Then (Q4 1992):

~$25B in loans

$1.7B in 'buffer' (6.8% of loans)

$2.8B in common equity (11.2% of loans)

 

Today (Q4 2008):

~865B in loans

$21B (+$37B) = $58B in 'buffer' (6.7% of loans)

$68.2 in common equity (8.0% of loans)

 

Big difference is that there is a lot more preferred equity these days at Wells (due to WB acquisition mostly).  I'm not sure how different the numbers would have been for 1991 etc, but I doubt much.

 

I think it's also worth noting that Wells' core business locations have been leading the economic downturn so they are if anything further along the process than many other banks.

 

Just my 2 cents.

[prevalou]

thank you for the info.

If I remember, cash flow in 1992 was about 5% of loans. Then even after 10% losses, shareholders equity would have been largely enough.

Today, it depends if the buffer includes the 37B$ already written off. I prefer to be careful about it and consider the buffer to be 21B$, the 37 B$ written off being very very bad loans (not Wells Fargo standard), but maybe I am wrong.

Another difference versus 1992 is that half the loans were not issued by Wells Fargo but by Wachovia. I am not so sure about their lending criterias.

 

[matjone]

Sanjeev,

Why do you feel so striongly that he has been buying WFC?

I kow he bought it last summer for his personal account, but I believe he sold it based upon the NYT Op Ed piece

Cheers

Ish

 

It's just a no-brainer!  As is GE.  There's two of your twenty life-time punches smacking you in the face right now.  You don't need Buffett, Watsa, Pabrai, or the MPIC Funds.  I haven't had two ideas this cheap since Fairfax was below $100/share, and at that time Fairfax deserved to be cheap.  These are two market leaders that will increase their share for the forseeable future.  They have huge competitive advantages that will not be surpassed over the next decade or two.  Buy it and just put it away! 

 

In regards to WFC, Berkshire filed an amendment a few minutes ago, so that answers that question...they've added shares, and I'm certain they will add considerably more at these prices, as long as they don't face any restrictions.  Virtually every Berkshire subsidiary pension trust now owns Wells Fargo stock! 

 

http://www.sec.gov/Archives/edgar/data/72971/000119312509031272/dsc13ga.htm

 

I bet you will see a filing for GE in the next few months if not sooner.  GE will never be at these prices again in our lifetime!  Absolutely ridiculous!  Cheers!

 

Never say never Parsad ;)

 

No offense, not trying for a jab at you.

[Spekulatius]

Typically, if someone tells you that an investment is a no-brainer, it means you should forget about it. This reaction is correct probably 90% of the time, because there are no investment no-brainers. The only thing there is are investors not using their brain. #punchlinecompleted

[John Hjorth]

I think it's important to read old posts here on CoBF keeping intensively in mind the actual context and - especially - the investment environment at that particular time the post was written. I've done that over the last years a lot, and I think it has been educational to me personally - very!, actually, but it's certainly subject to one being able to keep the actual context back then in clear mind. If you read old stuff on CoBF that way, it - i.e. - beats just about any good book about the GFC. You get the real action going on in real-time, with a time stamp on it, here on CoBF - post by post.

[Gregmal]

Sanjeev's post from 2/09 is like Moses parting the Red Sea and then calmly leading people through it. Cool and collected during times of duress. God like. Sometimes investing is very easy.

 

Ive found the really good investors have no problems maneuvering during the events that your average investor can't handle. Its the long periods of time spent in periods of "fairer value" where they tend to get into trouble.

[Spekulatius]

Sanjeev's post from 2/09 is like Moses parting the Red Sea and then calmly leading people through it. Cool and collected during times of duress. God like. Sometimes investing is very easy.

 

Ive found the really good investors have no problems maneuvering during the events that your average investor can't handle. Its the long periods of time spent in periods of "fairer value" where they tend to get into trouble.

 

Yes, if there ever was a time for no- brainer buys, it was at about the time when Sanjeev posted it. It literally was the best time to put money to work since I started investing (which was early 1980’s).

[Guest]

Sanjeev's post from 2/09 is like Moses parting the Red Sea and then calmly leading people through it. Cool and collected during times of duress. God like. Sometimes investing is very easy.

 

Ive found the really good investors have no problems maneuvering during the events that your average investor can't handle. Its the long periods of time spent in periods of "fairer value" where they tend to get into trouble.

 

Yes, if there ever was a time for no- brainer buys, it was at about the time when Sanjeev posted it. It literally was the best time to put money to work since I started investing (which was early 1980’s).

 

I would have much rather started in the early 80s. You had S&P 500 returns for over 17% for around 1981-1999/2000 time frame.

 

I don't think the returns from 2009-2029 will earn anywhere close to 17%.

 

I'd also say that there was much, much higher risk in 2009 than in the early 80s. There wasn't much talk about a Great Depression. There was a very real chance we could have gone through a second Grand Depression in 2009.

[Spekulatius]

Sanjeev's post from 2/09 is like Moses parting the Red Sea and then calmly leading people through it. Cool and collected during times of duress. God like. Sometimes investing is very easy.

 

Ive found the really good investors have no problems maneuvering during the events that your average investor can't handle. Its the long periods of time spent in periods of "fairer value" where they tend to get into trouble.

 

The 80’s were only great in retrospect. I was investing (little money, since I was student) and it wasn’t all peachy and little did we know that valuation multiples would go up as much as they did. Also keep in mind that inflation and real interest rates were much higher - you could still buy 8% treasury bonds in 1990, with corporate bonds yielding much higher. It was a great time, but it did not always seem so. In 2009, you could smell the fear and desperation. I have seen nothing like this before and likely never will.

 

Yes, if there ever was a time for no- brainer buys, it was at about the time when Sanjeev posted it. It literally was the best time to put money to work since I started investing (which was early 1980’s).

 

I would have much rather started in the early 80s. You had S&P 500 returns for over 17% for around 1981-1999/2000 time frame.

 

I don't think the returns from 2009-2029 will earn anywhere close to 17%.

 

I'd also say that there was much, much higher risk in 2009 than in the early 80s. There wasn't much talk about a Great Depression. There was a very real chance we could have gone through a second Grand Depression in 2009.

[MarioP]

Sanjeev's post from 2/09 is like Moses parting the Red Sea and then calmly leading people through it. Cool and collected during times of duress. God like. Sometimes investing is very easy.

 

Ive found the really good investors have no problems maneuvering during the events that your average investor can't handle. Its the long periods of time spent in periods of "fairer value" where they tend to get into trouble.

 

Yes, if there ever was a time for no- brainer buys, it was at about the time when Sanjeev posted it. It literally was the best time to put money to work since I started investing (which was early 1980’s).

 

I would have much rather started in the early 80s. You had S&P 500 returns for over 17% for around 1981-1999/2000 time frame.

 

I don't think the returns from 2009-2029 will earn anywhere close to 17%.

 

I'd also say that there was much, much higher risk in 2009 than in the early 80s. There wasn't much talk about a Great Depression. There was a very real chance we could have gone through a second Grand Depression in 2009.

 

If you think that there is no risk when inflation is at 14% and interest rate at 16% then you wasn’t managing money at the begining of the 80.

 

There is never a period with no risk.

[Guest]

Sanjeev's post from 2/09 is like Moses parting the Red Sea and then calmly leading people through it. Cool and collected during times of duress. God like. Sometimes investing is very easy.

 

Ive found the really good investors have no problems maneuvering during the events that your average investor can't handle. Its the long periods of time spent in periods of "fairer value" where they tend to get into trouble.

 

Yes, if there ever was a time for no- brainer buys, it was at about the time when Sanjeev posted it. It literally was the best time to put money to work since I started investing (which was early 1980’s).

 

I would have much rather started in the early 80s. You had S&P 500 returns for over 17% for around 1981-1999/2000 time frame.

 

I don't think the returns from 2009-2029 will earn anywhere close to 17%.

 

I'd also say that there was much, much higher risk in 2009 than in the early 80s. There wasn't much talk about a Great Depression. There was a very real chance we could have gone through a second Grand Depression in 2009.

 

If you think that there is no risk when inflation is at 14% and interest rate at 16% then you wasn’t managing money at the begining of the 80.

 

There is never a period with no risk.

 

When did I say there was "no risk"?

 

Do you really think the risk was as high of another Great Depression was 1980 as it was in 2008? What would have spurred an 80% drop in the market when valuations were as cheap as there were then? Valuations were far higher in 2008 that they were in the late 70s and very early 80s.

 

Jan 1st 2008 P/E on S&P 500: 21.46

 

Jan 1st 1980 P/E on S&P 500: 7.39

 

But you're right, I was not managing money in 1980 but I fail to see how that impacts the topic of conversation?

[MarioP]

You said :I'd also say that there was much, much higher risk in 2009 than in the early 80s. There wasn't much talk about a Great Depression.

 

I was just saying that if you were in the market in 1980 there was a big risk. It wasn't a depression risk it was hyperinflation that can make your real return negative even if you made 15% on your stock. I just want to tell that when you were in the market in 1980 or in 2009 it was not easy to convince you that everything will work well in long term.

 

Ten years after it is easy to tell how easy it should have been. For a great opportunity to exist you have to have a lots of peoples exiting the market. If this happen it is because the perception of a high risk is the sentiment of the majority. You have to be able to ignore it to invest heavily during these period.

[John Hjorth]

Thank you for the elaboration here, Mario,

 

Please don't be a stranger here on CoBF.

[omagh]

Adjusting for inflation (the early years were horrible), were the real returns much larger?  Gaudy headline numbers may dazzle but inflation took up a large number as well.

I would have much rather started in the early 80s. You had S&P 500 returns for over 17% for around 1981-1999/2000 time frame.

 

I don't think the returns from 2009-2029 will earn anywhere close to 17%.

 

I'd also say that there was much, much higher risk in 2009 than in the early 80s. There wasn't much talk about a Great Depression. There was a very real chance we could have gone through a second Grand Depression in 2009.

[Dynamic]

Although it does not appear to be a Total Return S&P500 Index adjusted for inflation, this one of many charts on the same site (including Shiller PE and many more), may help somewhat:

 

https://www.multpl.com/inflation-adjusted-s-p-500

 

It's plotted on a logarithmic vertical axis, so the same slope represents the same percentage capital growth in 'real terms'.

 

The late 1980s up to Black Monday (1987) are about as steep as anywhere on the graph, including the late 1950s boom, though you can see that, ignoring dividends, by 1987 the S&P had only almost regained the purchasing power it had at the peak around 1969-1970. Today in late Aug 2019 it has about 4x the purchasing power of the Black Monday peak.

 

Of course, interest rates go hand in hand with inflation rates and stock prices tend to go inversely with interest rates, so one might link some of the rise in various periods to interest rate reductions when those occurred, which is not plotted on that graph..

[Cigarbutt]

Although it does not appear to be a Total Return S&P500 Index adjusted for inflation, this one of many charts on the same site (including Shiller PE and many more), may help somewhat:

 

https://www.multpl.com/inflation-adjusted-s-p-500

 

It's plotted on a logarithmic vertical axis, so the same slope represents the same percentage capital growth in 'real terms'.

 

The late 1980s up to Black Monday (1987) are about as steep as anywhere on the graph, including the late 1950s boom, though you can see that, ignoring dividends, by 1987 the S&P had only almost regained the purchasing power it had at the peak around 1969-1970. Today in late Aug 2019 it has about 4x the purchasing power of the Black Monday peak.

 

Of course, interest rates go hand in hand with inflation rates and stock prices tend to go inversely with interest rates, so one might link some of the rise in various periods to interest rate reductions when those occurred, which is not plotted on that graph..

It seems like the graph does not account for dividends or reinvested dividends. Dividend yields have been coming down and this made quite a large difference in the 30's and the 70's. I think dividends in the 70's accounted for something like 75% of the total return.

In terms of comparing the 2009 period to the early 80's and keeping in mind the "perception of risk" which MarioP alluded to, investors coming out of the 70's had realized (real loss of 1.4% per year, not audited) the worst ever decade of real returns when it was felt that equities were likely the best of the swindlers of the asset classes. So investors had to deal with a morose period in general and a recent broken promise about stocks being an adequate vehicle to maintain purchasing power (equities recently pronounced dead). From a retrospective point of view, the risk and reward profile was amazing, it just wasn't probably appreciated then by the majority.

The institutional imperative is very strong and behavioral reasons often win over rational analysis (in low and high markets). Mr. Buffett had published, in 1979, a very interesting article about pension funds sub-par investing behavior and how "difficult" it was for the pseudo-passive investing crowd to invest in equities for the long term. I guess the real risk was reputational.

https://d2wsh2n0xua73e.cloudfront.net/wp-content/uploads/2016/05/docslide.us_31752060-forbes-on-buffett.pdf

pages 8-9 of the pdf document.