Warren Buffett on Wells Fargo

'Banking is a very good business unless you do dumb things,' says Wells Fargo's largest
shareholder.

Warren Buffett says it's

easy for banks to make
money - as long as they
don't do anything dumb.
Riders on a storm
SAN FRANCISCO (Fortune) -- As the largest shareholder of Wells Fargo through Berkshire
Hathaway (BRKB), Warren Buffett knows the San Francisco bank deeply. He first invested before
Wells Fargo was bought by Norwest, where current Wells Chairman Dick Kovacevich was CEO. As
part of his reporting for his feature on Wells Fargo (WFC, Fortune 500), Fortune Editor at Large
Adam Lashinsky spoke at length with Buffett by telephone on March 26.
Fortune: How is Wells Fargo unique?
Warren Buffett: It's sort of hard to imagine a business that large being unique. You'd think they'd
need to be like any other bank by the time they got to that size. Those guys have gone their own way.
That doesn't mean that everything they've done has been right. But they've never felt compelled to do
anything because other banks were doing it, and that's how banks get in trouble, when they say,
"Everybody else is doing it, why shouldn't I?"
What about all the smart analysts who think no big bank can survive in its present form, including
Wells Fargo?
Almost 20 years ago they were saying the same thing. In the end banking is a very good business
unless you do dumb things. You get your money extraordinarily cheap and you don't have to do
dumb things. But periodically banks do it, and they do it as a flock, like international loans in the
80s. You don't have to be a rocket scientist when your raw material cost is less than 1-1/2%. So I
know that you can have a model that works fine and Wells has come closer to doing that right than
any other big bank by some margin. They get their money cheaper than anybody else. We're the lowcost producer at Geico in auto insurance among big companies. And when you're the low-cost
producer - whether it's copper, or in banking - it's huge.
Then on top of that, they're smart on the asset side. They stayed out of most of the big trouble areas.
Now, even if you're getting 20% down payments on houses, if the other guy did enough dumb things,
the house prices can fall to where you get hurt some. But they were not out there doing option ARMs
and all these crazy things. They're going to have plenty of credit losses. But they will have, after a
couple of quarters of getting Wachovia the way they want it, $40 billion of pre-provision income.

And they do not have all kinds of time bombs around. Wells will lose some money. There's no
question about that. And they'll lose more than the normal amount of money. Now, if they were
getting their money at a percentage point higher, that would be $10 billion of difference there. But
they've got the secret to both growth, low-cost deposits and a lot of ancillary income coming in from
their customer base.
Insurance revenues for example, which had double-digit revenue growth in 2008.
And I would say that most of the critics of Wells don't even know they've got that business. That
business alone is worth many billions of dollars. And their mortgage business, as you can imagine in
this period, I mean, the volume that is poring through there, is huge. The critics have been right on
other big banks, so I think they're inclined to sweep Wells in as well to some extent. And if you've
been right on Citi and you've been right on BofA, it gets easy to say, well, they're all going to go.
We own stock in four banks: USB, Wells, M&T, and SunTrust. SunTrust I don't know about because
South Florida is going to be the last to come back, and they've got a concentration down there. The
other three, they're going to have a lousy year, but they'll come out of it with far more earnings
power. The deposits are flowing in. The spreads are wide. It's a helluva good business.
Dick Kovacevich specifically told me to ask you your views on tangible common equity.
What I pay attention to is earning power. Coca-Cola has no tangible common equity. But they've got
huge earning power. And Wells ... you can't take away Wells' customer base. It grows quarter by
quarter. And what you make money off of is customers. And you make money on customers by
having a helluva spread on assets and not doing anything really dumb. And that's what they do.
Incidentally, they won't lend Berkshire money. They're not interested in national credits or any of
that stuff where the spreads are narrow. We did a big deal about six or seven years ago on Finova,
which we did jointly with Leucadia. And what was then the old First National of Boston sort of
headed the deal up, and people would come in for $500 million or $200 million. Wells wasn't
interested. There wasn't enough money in it, basically. I got a big kick out of that because that was
exactly how they should think. Everybody else wanted to be in it, and they were doing it for 20 basis
points or something of the sort. And they'd make commitments for all kinds of credit for 6 or 8 basis
points, and the ones that were in the underwriting business, they would do it just get the
underwriting.
But back to tangible common equity...
You don't make money on tangible common equity. You make money on the funds that people give
you and the difference between the cost of those funds and what you lend them out on. And that's
where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5
billion go or where'd the 10 billion go that was put in?' That isn't what you make money on. You
make money on that deposit base of $800 billion that they've got now. And that deposit base I
guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money
differently.

They'll have to work through a lot of this stuff that they inherited from Wachovia. Those option
ARMs, they explained exactly how they break them down, and in the end they may lose 3 or 4 billion
more. Nobody knows exactly. But I would say that California residential real estate is not
deteriorating. It hasn't moved up. But it has flattened out with good volume recently. So my guess is
that the option ARMs will work out about as they guessed.
What if the Treasury imposes new capital requirements? Will it hamper their earnings power?
I don't think it'll hamper their earnings. But if you make them sell a lot of common equity it would
kill the common shareholder. It wouldn't increase the earning power in the future, and it would
increase the shares outstanding. Wells, if they want another $10 billion in common equity or
something like that in Wells, they'll have it in a very short period of time at this dividend rate. [In
March, Wells cut its dividend by 85%.] Wells will be piling up the equity while they're paying
nominal dividends. They could afford to pay the old dividend. But since they won't be paying the old
dividend, that's $4 billion a year or something that they'll be adding to equity.
I would have been fine if they had just said, 'Look it, we'll quit paying any common dividend until our
equity has gone up by whatever it might be, 10 or 15 billion.' And they'd get there in no time. Then
they could pay the regular dividend. They elected to do it this other way because everybody seems to
be kind of doing it. The idea of forgoing all or most of the dividend for a year to build the common
equity ratio up, if that's what the government wants, that's fine. But that isn't really the key to the
future of Wells, unless the regulators make it the key to the future of Wells. The key to the future of
Wells is continuing to get the money in at very low costs, selling all kinds of services to their
customer and having spreads like nobody else has.
How is Wells differentiated from the banks you own and the ones you don't?
Wells just has a whole different attitude. That's why Kovacevich calls them retail stores. He doesn't
even like the word banking. I mean, he is looking to have a maximum enduring relationship with
many, many millions of people. Tens of millions. And at the base of it involves getting money in very
cheap. When you do that that's a helluva start in the business. The difference between getting your
money at 1-1/2 % and 2-1/2% on a trillion-dollar asset base is $10 billion a year. It's hard to
overemphasize that. He thinks more like Sam Walton than he thinks like J.P. Morgan. I'm talking
about the individual there. He's a retailer. He's not trying to influence Washington or be the most
important guy on the scene or anything like that. He's just trying to do business with millions of
people every day and make a few bucks off of them.
Now that you mention it, Kovacevich has done a pretty good job of annoying Washington, wouldn't
you say?
That's hard to tell. There's an advantage to being that way too. He's not going to cozy up or be
sycophantic toward his regulator, and I would say most bankers probably are now. They need to be.
But his strong point is retailing not diplomacy. I kind of like that. It's hard for a guy that knows his
institution forward and backwards to have somebody come in that really may be working off a check
list or something and is telling him what to do. And I'm sure that Dick gets antagonized by that
sometimes. In the end, he's got the record. And he's got the business to back up what he's doing.

To the extent that his tangible common equity is low, a) nobody was even talking about that a year
ago. And b) they should be talking about earning power. But it comes about in part because he saved
the FDIC's bacon on Wachovia. I mean they had a deal on Citigroup (C, Fortune 500) that had big
assistance involved in it, and the FDIC moved about what would have been about 5% of the deposits
in the United States without a dime of expense to the taxpayer or the FDIC to Wells. And Wells took
it over. And if they'd gone to Citigroup a) they would have looked like idiots, and within a very short
period considering what happened to Citi. So to penalize them because they solved the FDIC's
problem without cost to the FDIC would be a little crazy. And I imagine that's what gets Dick a little
riled up.
So what is your metric for valuing a bank?
It's earnings on assets, as long as they're being achieved in a conservative way. But you can't say
earnings on assets, because you'll get some guy who's taking all kinds of risks and will look terrific for
a while. And you can have off-balance sheet stuff that contributes to earnings but doesn't show up in
the assets denominator. So it has to be an intelligent view of the quality of the earnings on assets as
well as the quantity of the earnings on assets. But if you're doing it in a sound way, that's what I look
at.
How confident will you be in Wells when Kovacevich retires?
Well, John [Stumpf] is in charge. Dick is a terrific help to John. I play bridge with John on the
Internet. He plays under the name of HTUR. His wife's name is Ruth. My bridge partner, who I
probably play bridge with four times a week, developed online banking for Wells. A woman named
Sharon Osberg. And she's worked with those people. And she told me about John Stumpf ten years
ago. I've had some insight through her on these people. But the real insight you get about a banker is
how they bank. You've got to see what they do and what they don't do. Their speeches don't make any
difference. It's what they do and what they don't do. And what Wells didn't do is what defines their
greatness.
How is John's bridge game?
John is a very good bridge player. But he doesn't play as much as I do. I play all the time. He's smart.
He's a different personality than Dick. Dick is a real sales person. They both subscribe to the same
principles of banking. They just don't think you have to do things that the other guy is doing.
First Published: April 20, 2009: 6:13 AM ET