Warren Buffett’s love of Wells Fargo (WFC, Financial) is no secret. It’s the second largest holding in Berkshire Hathaway and one of the few that has seen its stake grow of late (when the stock was selling at much lower prices). Buffett had said he could see himself owning the stock for the next 5-10 years. He regularly comments that he only invests in companies where he can project the economics of the industry 10 years out. The economics of the banking industry has changed dramatically in the past couple years. One of the points Buffett mentioned in this weekends’ shareholder conference was that banks have deleveraged significantly, and this will put downward pressure on profitability. Another element of change is the consolidation of the banks. Several large banks have either gone under or been acquired by more robust banks. This naturally favors the remaining banks as it produces a much less competitive environment. Because of this consolidation the top 4-5 banks have grown their share of total deposits to about 40%.
The charts below from Mortgagedaily.com show the dramatic change in the mortgage market. Though they don’t provide hard numbers, it clearly shows Wells Fargo and Bank of America have jumped ahead.
Regulation has also lent some perks to the banks. There exists a quasi interest rate ceiling that is enforced through the Federal Deposit Insurance Act. It forbids banks that are not well capitalized from offering rates higher than the going rate in any given region. Banks like Wells Fargo and U.S. Bank which have generally had a stronger balance sheet would gain an edge because of this provision. Though loan demand is presently close to non-existent, should it improve these banks would have a lever to pull by attracting deposits with higher rates.
Today the Wall Street Journal pointed out a potentially favorable event that may yet provide another blessing to the large banks. The viability of Freddie Mac and Fannie Mae has been a pressing concern of late. The two government sponsored entities which purchase mortgages are incidentally competitors to the large banks.
If the Republicans were to have their way and dismantle the GSEs, the large banks would benefit in two ways. The first is that long-term interest rates on loans would likely go up, helping net interest margins for the banks. The GSEs have a lower cost structure in the form of their low interest rates that are backed by the government. The second is that small lenders which sell their mortgages to the GSE’s for securitization would have to be re-routed to banks like Wells Fargo and JP Morgan for securitization. These banks would consequently see their bargaining power rise and would likely be able to extract higher fees.
Another concern of small lenders is that if they sell to the larger banks their loans, but retain servicing rights, those large banks may try to poach the borrowers by getting them to refinance with them. Wells Fargo noted in their annual report that that is often case in their mortgage servicing business. Wells may be engaged in mortgage servicing (collecting payment and dealing with the mortgagor), but not owning the loan. Because of their higher quality service they find mortgagors sometimes refinance with them effectively importing the loan from the prior lender’s balance sheet to theirs.
Regardless of what happens to the GSEs, the outlook for the banks does look good. Warren Buffett commented that banks like Wells Fargo would simply earn their way out of trouble. That has been the case over the last two years as record profits have padded their capital base. Loan demand, which has been a concern, will eventually return and when it does, borrowers will find their options have dwindled from just a couple years ago.
I wrote two previous articles about Wells Fargo relating more so to what Buffett likes about the particular bank. They can be found here and here.
Disclosure: Long WFC
Josh Zachariah
The charts below from Mortgagedaily.com show the dramatic change in the mortgage market. Though they don’t provide hard numbers, it clearly shows Wells Fargo and Bank of America have jumped ahead.
Regulation has also lent some perks to the banks. There exists a quasi interest rate ceiling that is enforced through the Federal Deposit Insurance Act. It forbids banks that are not well capitalized from offering rates higher than the going rate in any given region. Banks like Wells Fargo and U.S. Bank which have generally had a stronger balance sheet would gain an edge because of this provision. Though loan demand is presently close to non-existent, should it improve these banks would have a lever to pull by attracting deposits with higher rates.
Today the Wall Street Journal pointed out a potentially favorable event that may yet provide another blessing to the large banks. The viability of Freddie Mac and Fannie Mae has been a pressing concern of late. The two government sponsored entities which purchase mortgages are incidentally competitors to the large banks.
If the Republicans were to have their way and dismantle the GSEs, the large banks would benefit in two ways. The first is that long-term interest rates on loans would likely go up, helping net interest margins for the banks. The GSEs have a lower cost structure in the form of their low interest rates that are backed by the government. The second is that small lenders which sell their mortgages to the GSE’s for securitization would have to be re-routed to banks like Wells Fargo and JP Morgan for securitization. These banks would consequently see their bargaining power rise and would likely be able to extract higher fees.
Another concern of small lenders is that if they sell to the larger banks their loans, but retain servicing rights, those large banks may try to poach the borrowers by getting them to refinance with them. Wells Fargo noted in their annual report that that is often case in their mortgage servicing business. Wells may be engaged in mortgage servicing (collecting payment and dealing with the mortgagor), but not owning the loan. Because of their higher quality service they find mortgagors sometimes refinance with them effectively importing the loan from the prior lender’s balance sheet to theirs.
Regardless of what happens to the GSEs, the outlook for the banks does look good. Warren Buffett commented that banks like Wells Fargo would simply earn their way out of trouble. That has been the case over the last two years as record profits have padded their capital base. Loan demand, which has been a concern, will eventually return and when it does, borrowers will find their options have dwindled from just a couple years ago.
I wrote two previous articles about Wells Fargo relating more so to what Buffett likes about the particular bank. They can be found here and here.
Disclosure: Long WFC
Josh Zachariah
