Buffett's Wells Fargo play keys on Bernanke

Berkshire Hathaway's large stake in the bank puts it in the position of fighting the Fed.

By TheStreet Staff Oct 15, 2012 12:14PM

TheStreet.com logoBank sign copyright John Foxx, Stockbyte, Getty ImagesBy Antoine Gara


After Wells Fargo (WFC) posted generally mixed third-quarter earnings and a drop in key interest-rate-based revenue that augurs poorly for 2013, the bank's largest investor, Warren Buffett of Berkshire Hathaway (BRK.A), faces one of his biggest post-crisis investing challenges.


Should the Oracle of Omaha stick it out with Wells Fargo -- the top lender to the recovering U.S. housing market -- and fight the Federal Reserve over the impact of falling interest rates on bank earnings? Or should Buffett begin to cash in his chips on what's been a successful bank stock recovery trade that's outperformed other highly watched financial sector investments?


After announcing a third round of monetary easing -- known as QE3 -- the Fed's efforts to stimulate risk-taking and overall asset prices are creating a quagmire for the nation's largest lenders like Wells Fargo, JPMorgan (JPM) and Bank of America (BAC).


Giving a boost to the economy by way of cheap money and low rates is helping to drive a housing market recovery and a stock market surge that creates big revenue opportunities for large cap banks. However, low interest rates are eating into interest margins, a key driver of bank earnings.


In the third quarter, analysts expected that for Wells Fargo a mortgage lending boom would offset the deleterious impact of low rates. They were wrong.


In Friday trading, Wells Fargo shares fell over 2.5% to $34.25, underperforming the market as investors absorbed an earnings report that showed the bank's overall mortgage lending growth stalled since the second quarter and interest margins fell far more than forecast.


Wells Fargo's revenue rose 8.1% from a year earlier and mortgage banking income rose to $2.81 billion, up 53% from 2011 levels and in line with second quarter numbers. But amid growing optimism on a housing recovery, the bank's $86 million drop in mortgage revenue from the prior quarter failed to impress. Meanwhile, interest margins fell by 25 basis points, a larger amount than the 17 basis point drop Chief Financial Officer Tim Sloan forecast in September.


The San Francisco lender reported third-quarter earnings of $4.94 billion or 88 cents a share, beating estimates of 87 cents, according to analyst forecasts compiled by Bloomberg. Revenue came in at 21.2 billion, slightly beating estimates of $20.9 billion.


Some analysts downplayed Wells Fargo's earnings beat and honed in on what could be a troubling dynamic between slowing mortgage origination growth and falling interest rates. "The beat relative to our expectations was entirely driven by lower loan loss provisioning -- rather than higher mortgage banking income," wrote Stifel Nicolaus analyst Christopher Mutascio in a Friday note to clients.


The analyst stressed the importance of continued loan growth for Wells Fargo's earnings outlook. "More importantly, mortgage banking income is not offsetting the impact of [net interest margin] compression," wrote Mutascio.


For now, the Fed's low rate policies seem to be a negative for earnings expectations on Wells Fargo. Management said on a conference call with analysts that although it is growing mortgage lending sharply in 2012, third quarter loan demand was less than expected.


In fact, Wells Fargo's decision to put some mortgages on its balance sheet instead of selling them for added revenue could be seen as the bank ceding some third quarter earnings in an effort to minimize the blow of falling rates.


The real question for Buffett and Wells Fargo investors is what to expect next? A housing recovery could continue to heat up and, on balance, outweigh the negatives of low rates -- or Wells may continue to disappoint after being a ballast to the banking sector.


Were Buffett to stay with Wells Fargo, he could be seen as fighting the Fed over the impact of its policies on bank earnings. Were he to begin paring a near 8% stake in the lender, it could signal a big switch in his overall investing strategy.


On Friday, KBW analyst Fred Cannon told CNBC that Wells Fargo's weakness can be attributed to the Fed and recommended capital-markets focused players like Citigroup (C), Goldman Sachs (GS) and Morgan Stanley (MS). Such a financial sector rotation would counter Buffett's post-crisis bank investing strategy, which was to put billions behind Main Street lenders like Wells over risky and volatile investment banks.


Since the crisis, Buffett's been one of the most consistently right-minded supporters of a recovery in U.S. stocks and the shares of America's traditional lenders. Meanwhile, amid a big 2012 market rally, he's also been correct to read the Fed's loose policies as reason to be invested in stocks over bonds. With Wells Fargo, Buffett's facing some Fed fire, even if his general view isn't to fight the central bank.


Predicting Warren Buffett's next move is a fun but oftentimes futile effort. However, with a hitch in the Oracle's overall bank investing and 'bet on America' strategy, the biggest change may not come in his holding of Wells Fargo shares. Look for Buffett to take improving earnings per share at Goldman Sachs as reason for him to begin putting money behind the common stock of Wall Street titans.


More from TheStreet.com

Oct 15, 2012 7:09PM

Let me see if I understand the situation.  Banks loan money to people who can't afford to pay it back. People can't pay it back.  Govt. steps in and stabilizes market to the benefit of the banking industry.  Banks triple interest rates, reduce lending and the govt. basically loans them money for free. 


Bank now indicates it can't make money with this senario. 



Oct 15, 2012 3:15PM

QE3 huh


Tell me again how giving those at the top more money so they can start up more buisness overseas is going to help me get a job? Huh ? Whats that ? Move ?.... Oh ok.



Sorry Folks, everytime I see or hear anything about the Fed I get side tracked.

Oct 15, 2012 6:58PM
Whoever wrote this knows next to nothing about Warren Buffett.  It's laughable to think that the Oracle of Omaha would dump his favorite stock, one he's been loading up on of late, just because of the Fed's actions.  Buffett is in all of his stocks for the true long term.  Also, to suggest that Warren is looking for a "fight" with anyone is ridiculous--just read his biography or do some research before writing such things.
Oct 15, 2012 3:29PM

In other words, Buffett is blackmailing the Fed. He is telling them if they don’t align their policies with his profit goals he will dump his shares in WFC and thwart the company’s ability to support the Feds stimulus plans.


And  that folks is how the rich get richer, and the only way anyone makes money in the markets these days. Unless you’ve got the size and power to manipulate prices and those who make the decisions which influence prices of your investments, you will be exposed the unacceptable risk. That’s for suckers and muppets, not Buffetts. That’s capitalism today.


The sad thing is, Buffett himself has never lied about that. He said clear back in the 1990’s that,  “95% of all investors in the stock market shouldn’t be there.” Now we see what he was talking about.

Oct 15, 2012 4:07PM

Rather than fighting Buffett, why not join him? (Come over to the dark side, as it were) Instead of holding your cash in some fraction of a percent savings account, look at where Buffett has invested, his portfolio is available to the public. Then set up an account with a discount broker and buy some shares. Of course, that assumes that you are prudent enough to have saved some cash. If you can't forgo buying toys that bring no return and if you can't budget your money, you have nothing to complain about.


BTW, don't tell me that it's the economy's fault. I've been out of work for over two years, During that time I took some extra cash and followed what Buffett has done and made more money than I ever made working for someone else.

If you haven't the guts to jump in the market, don't chastise those who do. The whole plan of the Fed is to get more people investing. That's why the Fed is driving rates down. So, if you support Obama, jump into the market. If you are a republican you are probably already in the market.

Oct 15, 2012 7:30PM

"You should have studied harder, got better grades, went to a good college and got trained for a high paying job so you could be part of the 1%".



Yeah, just like Bernie Madoff, Jeffrey Skilling, Bernard Ebbers, Sanford and the rest...


C'mon go to Harvard and they will TEACH YOU how to lie, cheat and steal, so you too can become a 1%er.

Oct 15, 2012 4:51PM
Great plan if you can afford to spend MILLIONS at time on investing. As the old saying goes: how do you make a million dollars? Well first you start with a million dollars.
Oct 15, 2012 3:42PM
More money for the BIGGIES! Do they need more of our country's money to INVEST OVERSEAS? They sure as hell aren't spending it here!
The 99% American People have been DRIVEN INTO POVERTY with ONLY 23% of our country's wealth while these ONE-PERCENTERS & their FOREVER VACATIONING CEO'S are LIVING A LIFE OF LUXURY with 77% of our country's wealth!!
This is NOT DEMOCRACY by any stretch of  the imagination! It is NOTHING but BLATANT CRIMINAL HYPOCRISY!!!

Oct 15, 2012 4:00PM
Invest just like what ROMNEY does.  Buy up all the companies here in America and "Out Source" them overseas.  ROMNEY'S idea of investing to make money is the hell with America when you can make more money overseas.
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