Wells Fargo (WFC) was founded in 1852 and is the third-largest bank in the country as measured by assets. The bank ended 2017 with about $1.3 trillion in total deposits, and its 90 different business lines collectively generated over $84 billion in revenue from a diversified mix of banking, insurance, investment, mortgage, and consumer and commercial finance services.
Unlike many big banks, Wells Fargo has little exposure to investment banking and trading operations. Instead, the firm focuses on simple lending businesses (e.g. mortgages, auto loans, commercial financing) and fee income.
The company has three operating segments:
- Community banking (57% of net income):Â diversified financial products and services for consumers and small businesses including checking and savings accounts, credit and debit cards, and automobile, student, mortgage, home equity, and small business lending.
- Wholesale banking (33% of net income):Â provides financial solutions to businesses across the U.S. and globally with annual sales generally in excess of $5 million. These include Business Banking, Commercial Real Estate, Corporate Banking, Financial Institutions Group, Government and Institutional Banking, Middle Market Banking, Principal Investments, Treasury Management, Wells Fargo Commercial Capital, and Wells Fargo Securities.
- Wealth & Investment Management (10% of net income):Â provides a full range of personalized wealth management, investment, and retirement products and services to clients across U.S.-based businesses including Wells Fargo Advisors, The Private Bank, Abbot Downing, Wells Fargo Institutional Retirement and Trust, and Wells Fargo Asset Management. Services include financial planning, private banking, credit, investment management and fiduciary services to high-net worth and ultra-high-net worth individuals and families.
In 2017 Wells Fargo’s loan book of $957 billion was rather evenly divided between commercial loans (53%) and consumer (47%). The company serves over 70 million customers through its network of more than 8,300 store locations and 13,000 ATMs, as well as its website and mobile banking application.
Business Analysis
Banks primarily gather deposits and loan them out for interest income. As borrowers, consumers and businesses are most concerned with getting access to dependable financing at the lowest interest rate possible.
In other words, banks are largely commodity businesses, and the lowest-cost operator usually survives the longest in commodity markets. As one of the biggest banks in the country, Wells Fargo enjoys numerous cost advantages, which begin with its track record of gathering low-cost deposits from consumers and businesses that it can lend out at higher interest rates.
According to Wells Fargo’s annual reports, the company’s total deposits have grown from $3.7 billion in 1966 to $1.3 trillion in 2017, representing approximately 12% annual growth over that period. Wells Fargo’s deposits have continued growing at a healthy mid to high-single digit rate in recent years as well.
The company has more retail deposits than any other bank in the country and is ranks in the top five banks in terms of total deposits. When combined with company’s conservative lending practices, which generate a predictable stream of higher-yielding cash flows, it’s no surprise that Wells Fargo is famously Warren Buffett’s favorite bank.
In fact, Berkshire owns nearly $30 billion worth of Wells Fargo stock (over 9% of the company), making it one of Buffett’s largest equity holdings. And in the past, Charlie Munger, Buffett’s right-hand man at Berkshire Hathaway (BRK.B), has called Wells Fargo his favorite company period, against which all others should be measured.
That’s thanks to the bank’s long-term track record of highly conservative and trustworthy banking practices. These have allowed the bank to quickly and consistently grow, while dodging the numerous industry, economic, and global events since its founding in 1852 (see below) that have caused thousands of its rivals to close:Â
- 12 banking crises
- 27 recessions
- Three depressions
- Two world wars
- A global flu pandemic that killed over 3% of the global population
In fact, Wells Fargo’s conservative lending practices have allowed it to remain one of the most consistently profitable large U.S. banks, even during periodic industry crises.
For example, during the financial crisis Wells Fargo’s relatively small exposure to toxic mortgage debt and credit default swaps allowed it to not only survive largely unscathed, but actually remain profitable. That’s because, even at the peak of the crisis, loan losses only amounted to 2.71% of assets. Only JPMorgan Chase (JPM), which also followed a highly conservative banking strategy, was able to repeat this feat.
Basically, Wells Fargo has chosen to largely ignore faster-growing but more volatile businesses, such as investment banking (trading made up just 2% of net income in 2017), in favor of operating like America’s largest regional bank.
However, Wells Fargo’s industry-leading balance sheet was just one part of the company’s strong long-term investment thesis. The other two attractions were its ability to grow faster than its peers (but with lower risk) and achieve some of the top profitability in the industry.
Its edge in terms of profitability was largely due to its advantages against rival regional and community banks. First and foremost, Wells Fargo’s giant scale allowed it to achieve massive operational leverage, thanks to some of the lowest cost capital in the industry.
For example, 20% of the bank’s massive deposit base (which it lends out) bear no interest at all. This is why the bank’s overall interest cost as a percentage of assets is just 0.3%. Thanks to its cheap funding base, Wells Fargo is virtually guaranteed to generate a positive return on its loan portfolio despite today’s low interest rate environment.
