The Stocks of Warren Buffett - Wells Fargo Part II
Richard Kovacevich, the former CEO who stepped down in 2009, had shown exception in abstaining from growing the bank by acquisitions and instead grew it organically. One of the few acquisitions Wells Fargo did was of a Minnesota bank and was hailed as a masterful integration of the two banks. It was the poor acquisitions that pushed the Charlotte banks over the edge; Bank of America with Merrill Lynch and Wachovia with Golden West. The acquisition of Wachovia by Wells was a meticulous one. Initially the bank held out allowing a much more financially battered Citigroup to jump in and secure an exclusivity agreement. However, a new law that allowed acquiring banks to use the target bank’s losses against their own profits was passed the same week. With the passage of the law the acquisition turned favorable for Wells and a $7 a share bid was offered well above the $1 a share Citi was offering.
In the years leading up to the crisis Wells Fargo was particularly absent from the subprime scene. Warren Buffett wrote of Wells in a Fortune piece, “You'd think they'd need to be like any other bank by the time they got to that size. Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, ‘Everybody else is doing it, why shouldn't I?’" In 2003 the company left the subprime market after growing wary of the excesses in the market. It came with losses in revenue in the short-run, but would later pay off in the long-run.
Wachovia had also refrained from diving into the subprime market up until their purchase of Golden West in 2006. Golden West was a subprime lender heavily exposed to real estate in Inland Empire and other parts of southern California. The management of Wachovia cleverly referred to Golden West’s subprime portfolio as nonprime. Of course prime refers to the highest quality borrowers, anything otherwise is inherently subordinate to those borrowers. Wachovia, though being a large national lender, was notably absent from the California mortgage market and understandably the CEO wanted a piece of the feverish market. It would come at a price as upwards of 30% of the $120 billion Golden West portfolio would have to be written off.
As Buffett has written, with a leveraged institution like a bank, the quality of management becomes increasingly magnified. In the period of 2 years Wachovia went from a well managed bank to near bankrupt just on one poor decision by the CEO. As I mentioned earlier Richard Kovacevich who is credited with growing Wells Fargo to what it is today had stepped down as CEO and was replaced by John Stumpf. Unlike many of his peers, Kovacevich had shown the discipline to avoid costly acquisitions and maintain prudent lending throughout the bank. So will Stumpf prove as disciplined as his predecessor? Perhaps it will be best to keep an eye to Buffett’s holdings of Wells Fargo. Incidentally, Buffett plays Bridge with Stumpf and knows him quite personally. If there’s a better method to getting to know the innards of a bank, I’d like to know.
Disclosure: Holding shares in Wells Fargo