We chat with Willie Keng, our co-founder. Willie talked about one of his favourite investment ideas at the moment: Wells Fargo (NYSE:WFC).

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Disclosure: Stanley owns Bank of China. Willie owns Wells Fargo and Bank of China at the time of recording.


Stanley: Alright! Welcome to another episode of investing ideas. This week, we have a very special guest which is my co-founder Willie Keng; hello! Willie Keng.

Willie Keng: Hello!

Interlude: * Music* from valueinvestasia.com; this is Investing Ideas. Where we talk to investors from all walks of life, learn from them and find out some of their favorite investment ideas. *Music*

Stanley: Before we even begin talking about your great idea for today, why don’t you introduce yourself a little bit, and you know more specifically, what type of investors are you, why don’t you share with everyone your own investments now?

Willie Keng: Sure! Thanks Stanley. So, everyone my name is Willie, I’m also co-founder of Value Invest Asia. My investment strategy is a lot on dividends; what I do is, I like to buy stocks which have a very high dividend yield, and they pay a steady cash flow of dividend stream. So, there’s really largely my strategy, I look mostly in US, Hong Kong and Singapore, so a lot of my stocks are dividend based stocks. So, you can find me looking at sectors in financials, some industrial names, REITs, some property names as well. So, a little bit about myself, I currently run a consulting practice; an investment consulting practice, where I help my clients, family officers to make money through fixed income bond investments. I also help set up their operations as well, so it sort of resonates with dividend yielding stocks, because for bonds it also creates a steady cash flow from their coupons, so as you all know that bonds are basically like your IOU, you don’t really get to participate in the upside of a bond, but you get a nice regular cash flow stream from the coupon payout, usually paid out semi-annually or quarterly.

Stanley: Right! Okay! Well, there’s a great introduction, and thank you so much, and you know without further ado, I think let’s dive in into your investment ideas for today, it’s a very interesting company, and I think not many people is actually looking at it, although is such a large tech company, why don’t you introduce the company, and let us know more about it?

Willie Keng: Yeah! Sure. So, for today, what I’m going to introduce to you is, a stock which I have; which is called Wells Fargo, I believe if people have followed Warren Buffett and his portfolio, they will be very familiar. So, Wells Fargo is one of the largest commercial banks in the US. It has a market capitalization of more than slightly more than 200 billion US dollar; it’s listed on the New York Stock Exchange. Currently, it has a dividend yield of about 4.2 %, a Price to Earnings of 10.5 times and a Price to Book of 1.27 times. So, a bit about Wells Fargo here; how I chanced upon this stock was because of the scandal, one or two years back where the bank itself was implicated in creating fraudulent checking and savings accounts. So, there was a huge increase in the number of accounts being opened, but all these accounts are actually non-approved, they’re unapproved by the customers of the bank. So, as a result, there was actually a slight correction in the stock itself, and I happened to chance upon it, I was looking at it, and this actually came across my watch list, and is actually part of my portfolio right now.

Stanley: Okay! So, you bought it during the scandal you know, can you just give a sense, how much has it appreciated since then?

Willie Keng: I think it has roughly increased not much about eight, nine percent, ten percent like this.

Stanley: Okay! Still quite in reasonable range, this is a stock that you still like even today right?

Willie Keng: Yes of course.

Stanley: Okay! Can you go through – you know, why is that the case?

Willie Keng: Okay! So, maybe before I get into the why, I can just – let me talk about what Wells Fargo is; Wells Fargo, I think we all know it has roughly about 1.9 trillion dollars in assets, and it’s basically a commercial bank, I mentioned, it’s very different from the other US banks. Wells Fargo is very focused in commercial banking; meaning they divert traditional savings and loans business, where they take in deposits from the US population; the US citizens, and then they disperse their loans be it for mortgages, be it for companies, for corporates, for SMEs. So, this is a very basic bread-and-butter business which I kind of like, when I look at financials. So, it can simply be split up into various segments, as you can see, they have Consumer Banking, Wholesale Banking, and they’re also trying to go into Digital Banking these days, I mean that’s a lot of the trend for the Financial Industry right now. Wells Fargo also has Wealth and Investment Management; which is not as big a business, even though it’s complementary to their commercial banking business. So, largely, they are still very much in the Wholesale Consumer Banking business where they lend out whatever deposits they have to their corporate clients, to their retail clients; who are seeking for mortgages, who are looking at credit card or –

Stanley: So, they’re truly the OCBC of US kind of. do you have the break down as to like how much of their revenue is coming from each segment, just a rough idea, because you say that the wealth and investment is still not a very big business for them, I guess in conjunction to you know other banks like Goldman Sachs or JP Morgan, but do you have a sense of what they are break down in segments?

Willie Keng: Yeah! I do. So, as of 2018; if I will give a full annual year picture: Largely, about 44% of their revenue, which is the interest and non-interest income combined is 44 percent. So, loans take up 44 percent, another large part of their Revenue income is also coming from what I call your debt securities. So, they actually make some investments as well, but that’s not a very large portion of their pipe that’s only about 14%. They also do a bit of trust services as well, that’s another 14%. So, a large proportion of their banking business is still related to loans as you can see from the chart.

Stanley: Okay! That’s interesting. So, they’re still more traditional bank in a sense, maybe that’s why in a sense they are not too affected during the global financial crisis right?

Willie Keng: Yeah! Exactly

Stanley: Okay! and is this the main reason – I know you bought it during the crisis, but you know is it the bank that you prefer over all the other American banks, mainly because it is to a more traditional bank?

Willie Keng: So, typically when I look out for banks in the US. I pay more closely to what they are really doing; banks in the US have two different spectrums: So, maybe just to give a little flavor of it. So, banking you know it’s basically split in the US, it’s basically split; either investment banking or commercial banking, Wells Fargo happens to sit right at a spectrum of commercial banking, and they’re sort of the king of the king when it comes to commercial banking, and if you compare to the other US banks, since the financial crisis, or before the financial crisis; a lot of US banks, they started adding investment banking units to their business, and that creates a very lumpy, a very volatile revenue business for them, because what happens if – let’s say, if there’s a crash in the financial markets; investment banking activities will definite drop, but commercial banking tends to be very stable, even though it might not be a – it might not sound as sexy as investment banks, nor the fees which they can get from commercial banking might be very high, but it provides a very steady flow of the business. So, think of, for example your savings and loans; where Wells Fargo, or any other commercial banks lend out their money to financial property, to finance mortgages for example; the mortgage typically is set out, or lent out over very long period of time, say for example, 25 years to 30 years, so that allows the bank to receive a steady income every year.

Stanley: Right!

Willie Keng: And then something which I really look out for, and Wells Fargo; you know, like I’ve mentioned, is the king of King in commercial banking, and that’s the reason why I’d like to look at it. of course, when it comes to other investment banks, it’s a different set of analysis, which I employ myself, but for Wells Fargo in this case, what really strikes me is; it has a very dominant position in the US when it comes to deposits, when it comes to its loans.

Stanley: Right! Okay, and why don’t you do you – you mentioned a little bit about when you look at investment banks, you use a different lens to look at them; why don’t you share a little bit about that, why do you think investment bank is different, and maybe one or two things that you see them differently, and how do you analyze the investment bank compared to a traditional consumer bank?

Willie Keng: Yeah! Sure. So, when it comes to investment banking, what I typically look out for is the relationship with some of the top companies, say for example JP Morgan and Goldman Sachs, they happen to sit right at the top of the investment banking arena. So, when we look at these two banks, and we compare them to the other investment banks in the US, including the blue chip investment banks; what you’ll find is that this top of top players, they typically have very strong relationship with the companies, which they typically bring these companies to the market, often they have this intangible value, or this franchise value, where the relationship with the companies or the clients are very strong; and on top of that, they also have their reputation; the reputation of being able to bring companies into the market, through say for example IPOs, true debt raising, or M&A activities. So, how I will look at it, I mean just to give a flavor is that these banks, you don’t really need to have a strong Network or strong branch network within the country, and on top of that, you don’t really have a very strong deposit base, but what you do have is the relationship; which you have with the companies, and you can see based on their annual report you know, who they’ve have worked with over the past years you know, which are the huge IPOs they are involved in; which sectors they are very strong in. So, when you see all the very high-profile IPOs coming into the market, a good telltale sign that the investment is good, is that they always appear as one of the key underwriters for some of these IPOs. So, this is basically what I look out for investment banks. Another thing is also they are their trading activities that mean these banks; they usually have a good complementary, in terms of the trading segments, that means their market making activities. So, what happens let’s say if Goldman Sachs they bring a company to IPO, and post listing, post IPO, they usually have the market makers to actually create market, or create volume or liquidity for their clients, or to be able to generate volume in a secondary marking.

Stanley: Okay! Yeah, but going back to Wells Fargo, you mentioned that it had a strong network, and a good relationship with all its customers, how does that translate into his business, or why do you like the business?

Willie Keng: I like Wells Fargo because it has a very strong reputation, it is actually one of the largest deposit holders in the US, even though you know they stood at scandal, the CEO also just resigned, because of this scandal itself, but even then Wells Fargo has already established its name in the country. so it had very deep relationships with its retail customers, he has a very reputable franchise, and because of this; it’s able to provide this what you call a ‘flight to safety’ capability, meaning that you know, in times of financial stress, or if let’s say if there’s a bank run, what’s going to happen is that; depositors or the local population would definitely put money into the safest bank, because in this period of time, it’s not about how much interest rate, or how much deposit they can stand to earn, but they want to see their money being kept safe. So, that’s where Wells Fargo actually really come in, and because of this very large deposit base, its able to expand itself in terms of the loads, so it gives the bank more firepower to increase their loans, because gives the bank’s the capability, or the advantage to capitalize on the last deposit base, by charging a very low deposit rate, because you don’t really need to charge very high deposit rate to attract depositors Wells Fargo already has its own name, that’s why depositors can just put in money, or deposit the money into the bank itself, without the money on very high deposit rate, and of course for Wells Fargo, I mean if we see in the US, it is still predominantly offline bank, banking businesses. So, they have the best, or one of the best branch network in the US, so a lot of its core group of business units, they have very loyal longtime customers.

Stanley: Cool! I guess, you know when you see the US, being such a big country; Wells Fargo being like almost a National Bank, whereas definitely have that stamp of, as a most safe bank compared to maybe a just a state bank in the sense; how does that translate to their business, you know how has they been doing after the financial crisis, can you give us you know some indication of how well they are doing right now?

Willie Keng: Yeah! I mean if we can look on to the next slide, where we basically see the return on equity. So, ROE is one of the measures which I use for banks, it is one of the easiest indicators to calculate, and typically you can find them; either on the website, on their annual reports, or some of the top party research services, which can be provided. So, you can see, what I usually look out for, for ROE is, for banks you know, you can either use ROA; which is Return on Assets, or ROE; Return on Equity, shareholders equity. So, I typically look at over the past say five to ten years, and as long as the ROE is well above say 10%, and hovering around 12%, I think this is a fairly decent indicator, I mean coming from a company which have been around for a few centuries, and you can see since 2010, just after Wells Fargo came up from the crisis, the ROE had started to increase again, from you know, 10 plus percent all the way at one point was 14 percent, and then after that it starts to average out between 11 to 12 percent in this case. So, this is something which I draw a lot of comfort in, many at times when we look at banks, there tends to be a lot of numbers, there tends to be a lot of very technical terms, which we have to do with, or which we may not understand, but coming from myself where I’ve been looking at financials for a very long time, I realized that a lot of things, a lot of ratios which we don’t really need to look at, we just have to pay attention to a very few key important criteria, or few key important ratios; such as, the ROE and the ROA, then we can really get a sense of whether these banks are good, whether they are strong, whether they are weak, whether they are doing well or not. So, ROE is one of the indicators, and this is something we should I draw love comfort in, when I was looking at Wells Fargo.

Stanley: Okay! Why don’t we discuss a little bit about the risk you know, everything you mentioned is quite rosy at the moment, but if I can be the devil’s advocate right? So, number one; I guess you assume that the crisis is just a one-off, and you don’t see any long-term impact for them, well why do you think so?

Willie Keng: So, let’s talk about the crisis, and also talk about the scandal itself. So, for the crisis, back in the JFC, if you’re to track Wells Fargo, all the way you know. Pre-crisis and even during 08 to 09, between this period; what you see is that, even though that they have drop in their profitability, and they were able to rebound back really fast after the crisis, and they are one of the few banks, where they didn’t need to have huge liquidity injection, what this means is that they don’t have to knock on the government’s door, and say: Hey! I need to get some money from you guys; I do need to get a huge amount of money from you guys to retain my business, because for a simple fact is that, a lot of the liabilities are mostly deposits, means that they don’t really have to borrow too much from other banks to finance their business. So, this creates stability for them, that’s why if you’re going forward, banks which typically borrow a lot, they tend to find themselves in need of cash during the crisis, because during crisis the amount of money or amount of capital which is available to companies, or to the market, typically gets withdrawn back. So, you have to rely – for banks, you really have to rely on your deposits, and on top of that, you have to ensure that the deposits don’t decrease during this period.

Stanley: Okay, and also on the most recent crisis on their reputation, you don’t see any impact on that as well?

Willie Keng: I mean you, if you look at it, Wells Fargo they’ve been talked about, whether this fraudulent accounts will actually impact the bottom line, and there were a lot of speculations saying that this could very well affect all the numbers which have been reported you know, over the past five to seven years or even up to ten years, but if we see so far you know, since the scandal was announced, it has been close to two years, they’ve been fine about a hundred and eighty million dollars, which is not which is not really a huge amount with respect to the amount of assets which they hold, and on top of that, we have seen that their profitability, their earnings you can see you know, just by observation from the day to day, that their banking business is still very strong, I mean there have been some shake-up in the senior management themselves, but this is a business where you don’t really need to rely on just one key man, you know if you have a very strong CEO, or if you have a very strong senior manager, typically the bank is able to run by itself, and of course, because of the reputation that it has built over the years, over several years, this really creates that safety, it creates that comfort, and that assurance, in spite of the scandal.

Stanley: Okay! Yeah! Sure, that’s good to know, but what about some of the more macro risks, we have seen reports saying that now the US yield curve has inverted, and also there’s a lot of disruption in the FinTech area, why don’t we go talking about yield curve first, what is the inverted yield curve, and why does it matter to a bank, is it good or bad for a bank?

Willie Keng: So, when it comes to an inverted yield curve; theoretically speaking, or you know, if you base on academics, what this means is that the interest rates, the long-term interest rates, that means interest rates at which the mortgages, or if there are any loans, or if they’re any debts, which have let’s say 15 years, 20 years or 30 years in maturity, is actually priced lower than the short-term interest rate, and short-term interest rate could be your federal fund rates in Singapore, it could be your swap rate, you know your one-year swap rate, it could be your US LIBOR, or your SIBOR in Singapore’s case. So, an inverted yield curve means that, interest rates is actually much higher right now in a short-term basis, let’s say between a few months can be from a few months to one to three years, and interest rates in a long term, or the long end on of the yield curve, is much lower than that, and what this means is that, because banks you know, there is this quote saying; that you know, they usually borrow short, that means they borrow from depositors, the deposits, and then they lend out these deposits in a form of loans in a long term. So, when you think about the yield curve, it just means that the interest rates, which are charging for companies is actually much lower than the deposits which you are paying up to the depositors. So, directly this is what it means, and it isn’t very good for the banks. However, you know, even though this might happen, but the mortgage rates or the interest which the banks can charge, they can actually increase the credit risk pricing of some of these loans. Meaning that, if let’s say right now, the 10-year Treasury is roughly about two percent, it doesn’t mean that Wells Fargo would be lending out their 10 year loans at 2%. They could be charging much higher, say they can increase by another 0.5%, 0.7%, one percent, and so on and so forth. Such that, they are able to cover their cost of borrowing, and this cost of borrowing, comes from paying their depositors, the depositing rate. So, in this case, the banks are able to do it, they will be able to ride through the inverted yield curve wave, and if we see you know, during all the different crises; if you track from the global financial crisis, the Asian financial crisis, the 1987 crisis, what precedes that crisis is usually an inverted yield curve, but the inverted yield curve is short lived. So, it typically lasts for maybe two to three years before the crisis hits, and then the yield curve will revert back to its original shape. So, it will uninvent itself.

Stanley: So, it seems that that’s not good news right?

Willie Keng: I mean, I wouldn’t necessarily focus on the inversion of the yield curve, just so because when we see ourselves as investors, we are definitely looking long term, especially for myself, I am a pretty much an incumbent investor where I focus a lot on the dividends. So, as much as I like everyone else, when we look at some of the indicators, by moving a long term, these are just temporary, when I look at dividends, I definitely look at the fundamentals of the business, whether if it’s affected by your yield curve or not, because I feel that these are mostly noises or distraction, which keeps us away from looking at the real thing, which is really looking at the underlying fundamentals of a business.

Stanley: Fair enough, in the sense then you know, yield curve might be just a temporary issue, but what about the technological disruption you know, the rise of FinTech; we see that very dominantly – especially in China, that’s happening. I’m not very sure what’s happening in the US, but can you share like what is Wells Fargo doing in this field, do you think that they will be alright?

Willie Keng: So, when it comes to FinTech in the US; for Wells Fargo, specifically what they are doing it’s more of a compliment treat, so people think that FinTech, it’s like a direct hit on to compete against the banks, but for Wells Fargo and a large part of the banks, they usually use it as a compliment, what this means is that; for example, Wells Fargo is transitioning into online mortgage application. So, rather than going to one of the bank branches to apply for a mortgage, Wells Fargo is moving into online mortgage application. So, I mean if compared to say, for example, when maybe you apply for a mortgage in Singapore, we are already doing it online, but you know Wells Fargo is starting to catch up in this case, so they are using FinTech to be able to track some of these. Another thing is also the payments, to improve their payment processes, so that’s where FinTech really comes in. For example, when they have their own credit cards, it’s more facilitating the payment systems. So, these are some of the things which Wells Fargo is capitalizing on the revolution of the FinTech right now, where they’re really trying to look at it. So, I wouldn’t really see FinTech as much of a risk I will see it, more as a compliment, and I find that the risk might be focused in the investments side of things; meaning Investment Management or Wealth Management, which Wells Fargo doesn’t really have a huge exposure to. So, don’t forget they still operate as a very traditional bread and butter commercial banking business, they borrow from depositors, and they just lend it out as loans.

Stanley: Okay! Cool! I’ll take that argument [Laughter] Going back to Wells Fargo, and I guess the most important thing is valuation; how do you value this company, and why do you still think that it is attractive right now?

Willie Keng: Okay! So, I bought this quite a while back, right now for in terms of their Price To Earnings, I find that this is actually relatively attractive, it’s about ten about ten eleven times. Dividend yield is something which I still like, it’s roughly about four point two percent, this has actually increased compared to historically they have been using about two to three percent in terms of their dividend yield, so it has actually increased in the recent months. Of course, because of the scandal as well, this is in spite of the relatively high Price to Book rate which is approximately 1.2, 1.3 times Book value. When I look for banks I typically like it around one times price to book value, or side yield. This is an exception which I make for Wells Fargo, because I’m willing to pay a slight premium on its book value, because I find that its franchise value is still unmatched, it is still one of the largest commercial banking business, and I will say is the strongest, at least one of the strongest in the US. So, this is something which I’m going to pay for, and at the same time, paying four point one seven percent dividend yield for this stock is something which is relatively, it fits the strategy of my portfolio, and this is something which I’m happy to actually include in my portfolio.

Stanley: Okay! Cool. Okay, but you know as investors, we can invest anywhere in the world right, we can invest anywhere in the world and if I look at this on the valuation standpoint; Wells Fargo’s looks interesting, but if you look at the Chinese banks, they are trading at 0.6, some are 0.5 plus times Book value, and they’re giving dividends around 6%, five, six percent. Why do you still choose Wells Fargo over these Chinese banks, what are some of your concerns?

Willie Keng: Actually, I do own the Chinese banks as well. Okay! but the reason why I want to share Wells Fargo is because, I think at the end of the day; a US bank is still pretty much located in a developed market, and these banks; they have survived crisis after crisis, especially for Wells Fargo, and there has to be a price tag for being able to survive for so long. Versus Chinese banks; the Chinese banks only came up you know, over the past decade, they have only been listed in the past decade. So, we don’t know that they’re – potentially they’re actually one of the largest, if not even larger than some of the US banks, but a track record of course cannot match to the US banks which have survived for so long. On top of that, I also wish to point out that for Wells Fargo, they have very conservative Loans to Deposit ratio. So, if we look at Wells Fargo itself, their loans to deposit ratio has; over the past five, six years never exceeded 100 percent, what this means is that, they don’t lend out more than what they receive, in terms of the deposits. So, they are very conservative in this nature, it also means that they’re able to increase the firepower for lending up their loans. Compared to the Chinese banks, we also understand that the Chinese banks loans to deposit also comes below a hundred percent, but these are considered state banks, meaning that they are loans to deposit ratio actually tightly controlled by the state. So, to improve their profitability, to increase their profitability, it’s not as easy as compared to say Wells Fargo, and this is something which I do enjoy, that flexibility the ability to increase the firepower.

Stanley: Okay! Wow! Okay! Fascinating! So, you’re paying slightly a premium price, but of course, you are paying for quality as well. I absolutely love this idea, and definitely it will be a stock added on to my watch list right now. Thank you so much again Willie for sharing this wonderful stock with us, if you guys want to check more with Willie regarding Wells Fargo, or you just have some questions on bonds or dividend stocks, he is the man to go to, you can email him at willie@williekeng.com. I’ll provide his contact, on the show notes below, and of course you see that he has a presentation PDF for you guys, you’ll be able to download that on our show notes as well. I’ll provide the link for you guys down below. So, thank you once again Willie. I’ll see you.

Willie Keng: Thank You, thank you Stan.

Stanley: Yeah! Bye.

Willie Keng: Bye, bye.

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