The Best Bank Out There - Part I (WFC)

With the recent and severe decline in bank stock prices, I've been getting the impression that it may be a good buying opportunity. However, as I'm sure you guys already know, there's a lot of risk associated with buying a bank right now (and a lot of potential reward too). Therefore, due diligence is always important, and for today's post, I will go through some of this due diligence for a stock that I already own, and am thinking of buying more of. I will use this blog as a sounding board for my thought process of whether or not to buy stocks in a specific bank. We'll go through the due diligence for a few key banks including:

1. Wells Fargo
2. US Bank
3. JP Morgan Chase
4. Goldman Sachs
5. Morgan Stanley
6. Citi (just to see if there's a hint of light there)

Once I complete the analysis, we'll pick the best one and make a recommendation.

The due diligence I want to perform is really useful information I found in the following article about key performance metrics for banks. I'm basically going to be using the guidance in the article and do some digging to find the metrics for Wells Fargo. Also, since I probably won't be able to describe the metrics better than the article already does, I will be quoting it directly.

http://www.smartmoney.com/Spending/Budgeting/Is-Your-Bank-Healthy-How-to-Diagnose-It-Yourself/?afl=yahoo


Tier 1 Ratio

"The Tier 1 ratio tells you how much capital a bank has set aside to absorb losses. “Essentially, it shows how strong its balance sheet is,” says Chris Fortune, an analyst at investment firm T. Rowe Price who covers regional banks. Generally, a Tier 1 ratio needs to be at least 6% for a bank to be well capitalized, but in today’s environment, banks should have 8% or 9% to be considered healthy, he says. Look for Tier 1 information in the Management Discussion section in 10-K Annual Report forms."

For WFC, the most recent quarterly filing has the (12/08) says the following regarding it's Tier 1 Ratio:

"At December 31, 2008, consolidated Tier 1 regulatory capital was $86.4 billion, after the impact of purchase accounting for credit impairments of loans and write-down ofnegative cumulative other comprehensive income at Wachovia, which, in the aggregate, reduced the Tier 1 capital ratio by approximately 230 basis points to 7.8% at year end,well above regulatory minimums for a well-capitalized bank."

The Nonperforming Asset Ratio

"The nonperforming asset ratio, also known as NPA ratio, tells you how much exposure your bank has to assets that are a potential problem. Loans that are 90 or more days late, for example, are considered nonperforming assets. This ratio is determined by dividing these problem assets by the bank's total assets. “Today, anything below 1% is really good,” says Fortune. “Below 2% is OK. And, as you start to get above 4%, you start to worry.”"

For WFC, the most recent quarterly filing has the (12/08) says the following regarding it's Nonperforming Asset Ratio:

"Total nonperforming assets (NPAs) were $9.01 billion (1.04% of total loans) at December 31, 2008, compared with $3.87 billion (1.01%) at December 31, 2007."

Tangible Common Equity Ratio

"The tangible common equity ratio shows how much of a loss a bank can take, as a percentage of assets, before common shareholders are wiped clean, says Jamie Peters, an equity analyst with financial research firm Morningstar. If a bank’s common equity ratio is 3%, for example, the bank would have to write off 3% of its assets before shareholders lose everything. (As a rule of thumb, anything below 3% is too low, says Peters.)

Figuring this ratio out is tricky, since banks don't generally disclose it in their financial statements. To calculate it, divide your bank’s tangible common equity by its tangible assets. (Tangible common equity is total shareholders’ equity minus preferred stock minus goodwill and intangibles; tangible assets is total assets minus goodwill and intangibles). All of the numbers you need to calculate this are listed in the bank’s balance sheets."

I took a look the balance sheet for WFC (check it out at the end of the post) and did a quick calculation based on the description in the article.

Common Equity = $67,752million

Total Liabilities & Shareholders Equity = $1,309,639million

Dividing the 2 results in a TCER of 5.2%

However, this number has likely dropped since the end of 2008. I would think a more realistic number for this is more like 4.5%

Loan Loss Reserves

"This is the amount a bank has set aside to deal with problem loans. This figure will give you a good idea of the bank's ability to remain healthy in an unhealthy environment. To calculate your bank’s loan loss reserve ratio, simply divide its allowance for loan losses by its total loan portfolio. The higher the percentage, the better your bank’s ability is to cover potential losses. A reserve of 1% or less is considered weak, according to Fortune, while anything over 2% is considered strong."

As is mentioned in the article itself, WFC's LLR is 2.4% - well above the healthy threshold.

Overall Results

So, WFC's numbers breakdown as follows:

• Tier 1 Ratio - 7.8%
• Nonperforming Asset Ratio - 1.01%
• Tangible Common Equity Ratio - 5.2% (but we'll be conservative and say 4.5%)
• Loan Loss Reserves - 2.4%

Overall, I think WFC met my expectations as one of the healthier banks. In none of the above categories does it perform poorly and it's definitely poised to withstand more downside. At the same time, it's strength will definitely enable it to capitalize on future opportunities.

Final Grade: A-


Appendix: Check out WFC numbers and Annual Report here:

Balance Sheet: http://data.cnbc.com/quotes/WFC/tab/7.1
10-K: http://data.cnbc.com/quotes/WFC/tab/7.4


Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.