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By Erik Kobayashi-Solomon | 09-30-2010 08:56 AM

Wells Fargo Succeeds by Keeping It Simple

Wells Fargo does a good job of executing the old banking mantra: pay depositors 3%, lend at 6%, and be on the golf course by 3 p.m.

Erik Kobayashi-Solomon: Hi. I'm Erik Kobayashi-Solomon, co-editor of Morningstar OptionInvestor, and today it's my great pleasure to welcome Jaime Peters, who is senior analyst in charge of banks here at Morningstar.

Jaime, thanks for coming.

Jaime Peters: Hello.

Kobayashi-Solomon: So, just recently I did an option strategy on Wells Fargo, a company that you cover. And I want to ask you more about Wells Fargo. But before we get into that, what I'd like you to do is just at a 30,000-foot level talk about the relative quality between these big four banks: Wells Fargo, Bank of America, J.P. Morgan, and Citi.

Peters: It's actually pretty interesting because that has changed over time from beginning of the credit crisis to what is going on now. So, really, we should just focus on what's going on now.

Top of the hierarchy is going to be either Wells Fargo or J.P. Morgan, depending on your point of view. Both have really benefited from this crisis. They've grown quite a bit and they've grown profitably. If you compare their amount of asset growth and their potential for earnings compared to their share count growth, both of them have done a very good job of growing that asset base, that earnings potential, but keeping the share count growth under control.

That is in stark contrast to Bank of America, who, like J.P. Morgan, also tried to play the hero by buying Countrywide and Merrill Lynch, but paying way too much, having to issue a lot more equity because of poor underwriting themselves. And as a result, you're probably going to see them come out at equal or probably even less earnings per share than when they went into the crisis. Citigroup is just the disaster. They have seen their share count go from 5 billion to about 28 billion.

Kobayashi-Solomon: The government is now trying to get rid of some of these 20 billion shares I think, correct?

Peters: Yes. They've been selling quite a bit of it actually. They still have other things like trust preferreds at the government that they are going to have to work out over time. And even while their share count has just exploded, the amount of assets they have to earn off of it has actually shrunk and they are continuing to shrink. So, if you want to put the bottom of the pile, you're going to look at Citigroup as the bottom. You're going to look at Wells Fargo, J.P. Morgan at the top, and you're going to see Bank of America in between them--closer to the bottom than the top, though.

Kobayashi-Solomon: So, one of the things that you've said before, one of the reasons that you like Wells Fargo is something called net interest margin. This is, of course, the difference between the costs of the borrowing that they have to do versus the money that they receive in interest for lending. Can you explain a little bit about what's the secret sauce about Wells Fargo's net interest margin?

Peters: What's great about Wells Fargo is they stick to the old banking mantra, which is lend at 6, borrow at 3, on the golf course at 3. If you can go on to the golf course and not worry about what's in your bank and you have that ability, that's really where you are going to have a great bank.

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