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Warren Buffett was optimistic about Wells Fargo’s prospects in 1989/90. He was so optimistic that he spent $289m of Berkshire Hathaway’s money buying almost 10% of Wells Fargo’s shares. But we have to ask: Was Warren correct to be greedy when others were fearful? There are two parts to answering this question.
First, did the facts from the recent past support the idea that it was unlikely Wells Fargo would suffer significant losses in the Californian recession?
Second, does the evidence in the period after 1990 show a successful recovery after the dip?
I’ll tackle the first element today and the second tomorrow. (This case study shows the main metrics used to evaluate banking shares today)
How strong was Wells Fargo in the 1980s?
Carl Reichardt, having joined the company in 1970, became chairman and CEO of Wells Fargo in December 1982, so we’ll trace its performance from then. Reichardt, ably assisted by vice chairman Paul Hazen, built a well-deserved reputation for controlling costs. Even once expenses were well under the norm for the banking industry he refused to relent.
A key measure in this area is non-interest expense, such as employment and property costs, as a percentage of total revenue. Revenue is net interest plus non-interest income such as fees for managing investments and bank account charges.
It is clear from a comparison of Figure 1.1 and Figure 1.2 that Wells Fargo ran a much tighter ship than the average US bank. The average bank in the mid- to late-1980s tended to stay within the range of spending 66 – 69c of every dollar it received in revenue on running costs. At Wells Fargo Reichardt and Hazen managed to reduce the spend from over 70c per dollar of revenue in 1983 to a mere 53.6c in 1989.
Figure 1.1. US commercial banks’ noninterest expense as a percentage of total revenue 1985 – 1997
Figure 1.2 Wells Fargo noninterest expense as a percentage of total revenue 1983 – 1989
Source: Wells Fargo Annual Reports and Accounts
When revenue is measured in billions a percentage point saving can make a huge difference to profits. This is reflected in the returns on common shareholders’ equity and the return on asset numbers. Whereas the US banking sector as a whole achieved returns on equity of roughly 10% – 11% in the period 1983 -89 (excepting the bad year of 1987) – see Figure 1.3 – the Wells Fargo team generated between 12.51% and 14.81% returns for shareholders in the mid-1980s, and then raised their game dramatically in the last two years of the 1980s to RoE’s of 23.99% and 24.49%, far above the industry averages – see Figure 1.4.
A similar profitability superiority is shown in the returns on total assets (assets being all those loans and other rights held by Wells Fargo) in Figure 1.5. Whereas the commercial banking sector made profits of around 0.6% – 0.7% as a percentage of assets in the 1980s Wells Fargo lifted its RoA to 1.14% in 1988 and 1.26% in 1989.
Figure 1.3. US commercial banks’ average return on equity and average return on assets 1970 – 1997
Figure 1.4 Wells Fargo return on equity, %, 1983 -89
Source: Wells Fargo Annual Reports
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