Drip
Portfolio Report
Norwest and Wells Fargo
by Dale Wettlaufer ([email protected])
Alexandria, VA (July 17, 1998) --Before we finish up with Norwest, a note on yesterday's piece.
The appendix on securitization was certainly not offered in hopes that everyone can understand it. I know there are CPAs that find this stuff perplexing, and I know I think it's one of the Byzantine rules of all the Generally Accepted Accounting Procedures (GAAP).
I gave a brief explanation of "securitization" in our financial services glossary earlier this year. I also explained "mortgage servicing" in the glossary. To review, mortgage servicing is collecting principle and interest and passing it on to those who own the mortgage. If you have a mortgage, it's very likely that your bank doesn't own it. They probably sold it to their master trust, which packaged it with a bunch of other mortgages into asset-backed securities. An insurance company in Iowa could have bought securities giving it claim to all principal paid in the first five years of the mortgage while another bank could have bought a security which gives it the right to receive all interest paid in the first five years of the mortgage, while a hedge fund in New York might have bought securities representing the right to collect all principal in years 6 through 10. These interest-only (IO) and principal-only (PO) strips are the things that have gotten some companies into trouble over the last year or so.
The IO strips are really the culprits for the companies that had them on the balance sheet. Since they represent estimates the companies have made as to the timing and amount of interest that they would be paid on the mortgages that underlie them, when there is a shift in interest rates and mortgage prepayment activity that doesn't fall within the parameters of the original estimates, things can go bad.
Intuitively, this should make sense. When interest rates go down and everybody is refinancing their mortgages, the holders of securities that entitle them to interest payments on those mortgages aren't going to be happy. Because when a mortgage gets prepaid, it's the principal that gets returned, not interest. This is one way to hedge a portfolio in an environment of falling interest rates. PO securities will increase in value, because the principal that will come to holders of these securities will materialize faster as more people prepay their mortgages. IO strips, on the other hand, decline in value.
Back to Norwest.
In addition to the company's banks with 930 locations in 16 states, the company is the 14th largest insurance agency in the country. It's not mainly an underwriter of insurance (although the company does do that), but a broker of insurance. The company also is a securities broker with 366 offices, most of which you will find in bank branches.
Of more import to me, though, is the company's consumer finance unit, which has 1,447 stores (as of year-end) throughout the U.S., Canada, the Caribbean, and Latin America. This unit makes personal loans, such as auto loans, direct installment loans, and purchases finance contracts from retailers such as furniture stores. For instance, when you go in and buy a sofa with "no money down and no interest until 1999," it's usually not the retailer that finances it. It's AT&T Finance, GE Financial Services, or Norwest, for example. This is a predictable, commodity-like business that offers pretty stable, if unspectacular, returns on capital. Given Norwest's size, it can do these things at low cost.
As I wrote earlier this year when we first looked at the company (Part 1, Part 2, Part 3), I very much appreciate CEO Kovacevich's approach to serving the consumer. I think he allows the customer to drive the business rather than trying to herd the customer to whatever channel the company thinks is the lower-cost distribution platform. It would be fine and dandy if all consumers wanted to bank over the Internet, but that's not going to happen tomorrow. I personally think that Wells Fargo's strategy, while looking OK on paper, has alienated much of its customer base and has done some damage to marketshare and possibly even mindshare.
Mindshare is less tangible than market share and represents goodwill and recall of a consumer brand in the market. On the other hand, Norwest's mindshare is excellent, as far as I can tell. I have received only raves about the company from its customers and perceive that it has something of a Nordstrom-like attitude of going out of its way to please customers. I think that's great and hope that this attitude is brought to Wells Fargo territory. That's part of the investment thesis here, in addition to the geographic coverage the company will have in some great areas such as the Mountain and Western states.
What we get out of the two is a company that has a high asset turnover (or velocity) with good margins and a highly diversified distribution strategy. Bringing more of a full-service, cross-selling approach to Wells Fargo's low-cost distribution approach will improve Wells Fargo. Meanwhile, Norwest will learn from Wells Fargo what it needs to know to widen its distribution strategy. I think there's tons of room for Norwest to grow and feel good about the long term for this company, despite the uncertainty of the merger. The two companies are taking things slowly, to make sure the merger is done right, however. I think that approach is fine. Don't be surprised if this is where the Drip Port ends up investing, even given the fees of this company's DRIP program. NationsBank, you might recall, is a second strong possibility.
Touchstone Friday. This week we began the review of our finalists, looking to eliminate the contenders down to our Number One Pick. On Monday, we looked at the earnings report from NationsBank (NYSE: NB), and Tuesday we wrapped up and concluded that it was a strong possibility -- sharing why.
On Wednesday, Jeff came in and took a closer look at Johnson & Johnson's (NYSE: JNJ) and Intel's (Nasdaq: INTC) quarterly earnings from the night before. Intel's conference call summary will be available tonight in the Fool's Conference Call area. He also touched on the Drip Port's performance numbers.
On Thursday, we addressed Norwest (NYSE: NOB), our second finalist, and today you see the results of that -- it's a very likely possibility. Next week, the search continues to narrow. Have a good weekend.
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