“Sunlight is said to be the best part of disinfectants; electric light the most efficient policeman.”
- Louis Brandeis in Other People's Money And How The Bankers Use It
I’d like to see Buffett deal with Wells’s can of worms as board chairman for a year or so. Let him crack a few nuts together and change this culture of client exploitation. Let’s reward shareholders with a more generous dividend payout ratio of basic earnings power. Buying back stock helps management more than shareholders, but they never mention that.
This is a to-do if you carry a $20 billion plus investment in Wells, 10% of its market capitalization. The stock, as yet sells at a modest premium to book value but it shrank over 10% of late.
Every decade harbors “the king is naked” surprises. Wells Fargo is just the most recent example of management mufti-pufti that abused clientele and its shareholders, alike. Consider – Wells Fargo is the 14th largest capitalization in the S&P 500 Index at $220 billion.
The stock has traded down close to its 52-week low, off 16% but it sells at 11 times forward 12-month earnings power. This is equivalent to JPMorgan Chase’s valuation so I’d go with Morgan for now. For a recovery spec, Citigroup gets my money at 9 times earnings and below book value.
Berkshire Hathaway holds over 20% of its portfolio in bank stocks, half of which is in Wells Fargo. Actually, Buffett applied to the regulators to add to his position which puzzles me. He's held this position for decades with cost in the mid-twenties, but enough is enough.
The history of financial stocks is spotty, splattered with mud because of unforeseen loan losses and overleveraged balance sheets that take their pound of flesh. Management excesses everywhere get covered up with criminal practices exceeding accounting controls. Enron and WorldCom fitted this template.
I remember looking at WorldCom's income statement and saying sub silentio, it looks too pretty, too close to AT&T's construct. In the eighties, failure of the Continental Bank in Chicago surfaced when oil fell to $9 a barrel. Its oil patch loans proved undercollateralized, some fictitious.
In the sixties, American Express survived its client’s Salad Oil Swindle because its AmEx blue card business was in its takeoff stage, growing 30% per annum. I was there and so was Buffett. Fifty years later he still holds his position, but I'm long gone.
Government Employees Insurance Company was once weeks away from receivership in 1972, but survived with the concurrence of regulators when it relented on overly predatory rate discounting. Buffett was long a shareholder while Geico ticked down to $2. I bought a block and then kicked it out at $8, months later. Its core franchise of policyholders stayed in place and Geico then prospered for the next 40 years.
My capacity to construe Equitable Life Insurance as a potent asset gatherer of variable annuities and not a real estate disaster led to a great recovery play. This was unlike the mortgage backed securities meltdown of 2008. Both Fannie Mae and Freddie Mac claimed they were solvent, but they stood leveraged 100 to 1 and had guaranteed trillions in mortgage paper for a couple of basis points fees. It took $200 billion of government capital to bail them out.
Solomon Brothers was a great case of a dominant house whose raised-finger culture foretold trouble. John Gutfreund was Solly and Solly was John Gutfreund. It's why the Street never chose to pay much of a premium over book value for this franchise.
Subliminally, we understood Solly could get carried away trading Treasuries. Its eyes were too big, with head traders known affectionately as “swinging dicks,” each a serious profit center in 8 figures.
You couldn't pick this up reading the annual report, but there were wild swings of hundreds of millions in trading profits, quarter to quarter. Buffett got sucked into this snake pit, and had to come in later and rationalize operations and instill a code of conduct.
Solly's ultimate rogue play was illegally cornering the Treasury bond auctions in the spring of 1991. Gutfreund’s boys had blown one cigar ring too many in the faces of its competitors and the U.S. Treasury. Operators like Solomon and later Lehman Brothers traded billions in Treasuries on 1% margin and financed same below money market rates. Be right or you're gone.
I won't invest in a company whose headman I don't approve of. Maybe, it's his lifestyle or how he treats people inside or outside the business. In the long run, character and personality govern stats. Mike Milken, a great family man, didn't smoke, drink (not even coffee) or swear. And, yet, his fanatical ambition (and energy) finally toppled him from a position far superior to Gutfreund’s.
Larry Tisch, long gone, was my role model of a frugal operator. Low salaries go with 100% integrity. Buffett’s take is $100,000 and no options. The head man at Dish Network, Charlie Ergen, is famous for corporate frugality. Everyone flies coach. I hear some even doubled up in hotel rooms.
I won't invest in tech houses where there is enormous disparity between GAAP and non-GAAP earnings. Such managements run their companies for themselves with enormous stock grants that dilute shareholders, running as high as 40% of revenues. This construct is as abusive as what Wells Fargo served up to its unsuspecting client base.
Looking back to the mid-nineties, Fannie Mae sold at 3 times book value, considered one of the few unassailable financial franchises. Wrong! The Street had missed management’s personal profit motivation in leveraging their balance sheet. More earnings - higher profit participation and stock grants. When I asked an outside board member at Fannie, who understood their portfolio of credit swaps, the answer was only 2 - the chairman and his chief investment officer.
The Wells Fargo situation stands riddled with ironies. Always a conservatively run bank, its locus of stability rested in single family mortgage paper. It is not heavily committed to Wall Street's undulations as is Citigroup, Bank of America and JPMorgan Chase. I'm sure this is what attracted Warren Buffett, decades ago.
Wells yields 3.3%, nothing to write home about. Want yield? Look at AT&T, Verizon Communications and General Motors. The market wants 5% yielders, but even this paper is wobbly today with Treasuries edging up nearly daily. This bank’s massaging of its clientele base is not a transformingly negative event, but, it does detract luster from the Street image as a conservatively run property unlikely to get into serious trouble in a downturn.
The curse of “bigness” in government and the corporate world dates back to the days of Thomas Jefferson. Wells's case isn't about a big corporation driving farmers off their land, but is comparably invasive and callous. Consider, Wells Fargo earns quarterly $5.6 billion, some 50% more than Citigroup. Its consumer banking staff indulging in pettifoggery with clientele is actionable.
Wells holds 33 million consumer checking accounts and 7.8 million active credit card holders, not exactly a corner luncheonette business. Its market capitalization stands over $220 billion.
There ain’t enough apologies to go around.
Sosnoff and/or Atalanta Sosnoff’s clients own: JPMorgan Chase, Citigroup, AT&T, Bank of America, Verizon Communications and General Motors.
