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Subject:  Wells Fargo (WFC) Date:  5/23/2013  3:44 PM
Author:  kelbon Number:  137 of 665

Pitch a bank for the portfolio[…]

The most obvious candidate is Wells Fargo (WFC)

In 2008 Wells Fargo doubled its size with the purchase of Wachovia, which makes it one of the four largest banks in the U.S. However, amongst its peers its business model is the simplest.

More than one third of the bank's deposits come from markets where Wells Fargo is top dog, with more than two-thirds coming from markets where WFC is in the top three. Consequently, customers can conveniently find branches and cash machines everywhere.

Once this bank snags a new customer their hope, and strategy, is to cross-sell them other services, snaring them further. Got your checking account at Wells? Why not your mortgage? We have brokerage services and how about a business loan too? This successful strategy deepens its customer relationships and makes it harder for them to jump ship due to switching costs and the inconvenience involved. In other words it gives the bank pricing power. This, and geographic spread and penetration, results is one trillion in low-cost deposit funding, which is around 70% of Well's funding.

Well's was able to fund its assets at an average cost of 1.3% over the last decade, about 20% cheaper than its closest competitor. It's this low cost of funds that has allowed the bank to be more risk adverse than some of its competitors. The company has embarked on an expense-reduction program, which if successful, combined with it's low funding costs, will provide a significant tailwind.

Wells Fargo is not a big derivatives dealer. This activity is only a fraction of J.P. Morgan Chase's. This lessens the likelihood of rogue trading and the consequences of any regulatory changes.

Although their deposit base is substantial they are not overly reliant on net interest income. Non-interest income is nearly 50% of revenues which includes investment related fees and commissions and mortgages. WFC now controls about one third of the country's mortgage market, which of course involves some cleanup due to "missteps" during the housing bubble. All the same, Wells Fargo was not the most aggressive mortgage originator during the bubble so mortgage expenses should be manageable.

Wells Fargo is now in the position to return more capital to shareholders via increased dividends and share buybacks. The bank should be in a good position to increase the dividend going forward and meet its goal of eventually returning 50%—65% of its growing earnings to shareholders.

For what it is worth Morningstar considers WFC's stock slightly undervalued; they peg its fair value $43 a share. And, they give them a credit rating of A+.

One the subject of valuation, WFC's P/E is about 10.5 (Value L