In the first quarter of 2022, Warren Buffett's company Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) ended its decades-long relationship with the large bank Wells Fargo (WFC -0.03%). The move could be seen coming several quarters prior when Berkshire sold large chunks of its position in Wells Fargo. There had also been speculation that Buffett had lost his patience with the bank after moves Wells Fargo made following its phony accounts scandal, which came to light in 2016.
But just a year later, another prominent investor, Michael Burry, who got famous by placing short bets against the U.S. housing market right before the Great Recession, along with his fund Scion Asset Management purchased 125,000 shares of Wells Fargo in the first quarter of 2023.
While Burry loaded up on banks in the first quarter, Wells Fargo is the only too-big-to-fail bank that Burry bought. Let's take a look at what Burry might see in Wells Fargo.
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Taking the contrarian view
Berkshire first purchased Wells Fargo in 1989, and for many years, it was believed to be one of Buffett's favorite stocks. But in 2016, Wells Fargo was rocked by the phony accounts scandal in which employees were found to have opened millions of credit card and bank accounts on behalf of customers without their consent.
Since then, the bank has been trying to move past the scandal, but it is still dealing with the fallout. Wells Fargo paid billions in fines, cleaned house among its senior management team and board of directors, and continues to operate under an asset cap imposed by the Federal Reserve which prevents the bank from growing its balance sheet. Buffett was not happy about the scandal and also reportedly didn't like the bank's hiring of CEO Charlie Scharf in 2019 because he was a Wall Street insider.
As a long-term investor, Buffett had clearly had enough of the bank. But as a contrarian, Burry is investing in the bank because it looks to be executing a turnaround.
Despite Buffett's rumored objection to the hire, Scharf seems to have done a good job restructuring the bank, completely overhauling the senior management team and Wells Fargo's regulatory infrastructure. Scharf has also made a lot of moves to improve the operational efficiency of the overall franchise. Since he became CEO, Scharf has exited businesses outside of Wells Fargo's core U.S. franchise and has also been in the midst of a huge efficiency initiative that involves significantly cutting expenses. The bank has already shown that it can generate a 10% return on tangible common equity (ROTCE), and Scharf expressed confidence in the bank's ability to get to a 15% ROTCE over a medium-term time horizon.
Keep in mind that Wells Fargo is doing this with the asset cap having now been in place for five years. Growing the balance sheet is a key way banks make money, and the asset cap is arguably one of the most punitive punishments to a bank in history.
While an end to the asset cap is still unknown, there's reason to believe that most of the bank's regulatory issues related to the asset cap may now be resolved. At the end of last year, the bank paid a whopping $3.7 billion to the Consumer Financial Protection Bureau (CFPB) for historical matters related to Wells Fargo's management of mortgages, auto loans, and deposit accounts.
Burry may have a point
I think Burry's new position highlights what many investors have been saying for a while now. Wells Fargo has a clear path to a 15% ROTCE with the asset cap still in place.
The bank got leaner and also bulked up in some new revenue areas, such as credit card lending and investment banking, while continuing to focus on what has always been a very strong U.S. commercial and consumer banking franchise.
There is also reason to believe that the asset cap is going to be removed at some point over the next few years, which would really allow the bank to go on the offensive. Trading at 122% of its tangible book value or net worth and at less than 9 times forward earnings, I think Burry's position in this ex-Buffett stock makes a lot of sense right now.
