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Wells Fargo Investor Payoff Requires Warren Buffett-Like Patience

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Investors may need to wait another quarter for interest margins to bottom, and for Wells Fargo's strong fundamental qualities to overshadow short-term headwinds.

Mosby argues that if uncertainties such as interest-earnings and the sustainability of loan demand dissipate, Wells Fargo could outperform the banking sector in 2013 as it has in years past. The analyst notes that while Wells Fargo has doubled earnings since the financial crisis, investors have given the bank little credit.

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Wells Fargo shares currently stand roughly in-line with pre-crisis levels seen in 2007.

" Thiscould be the year where they get a revaluation," says Mosby, who also says the bank might be able to boost its dividend to the 3% range, far ahead of large cap banking peers like JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), and Citigroup (NYSE:C).

Bill Smead, the chief investment officer of Smead Capital Management, expects Wells Fargo's exposure to a housing pickup to more than offset and Fed interest rate policies. "We happen to think a company like Wells Fargo might make more money in the rebound on the value in foreclosed homes than what they will lose on a decline in their interest rate spreads," said Smead, in an interview prior to earnings.

"That will wash out in the long run, which is why you want to increase market share," said Smead of Wells Fargo's increasing presence in the mortgage market and its deposit growth.

Wells Fargo's deposits grew to $928 billion in the fourth quarter, a 7% increase from year-ago levels. Those deposits, however, cut at Wells Fargo's net interest margin by 5 basis points, according to the bank. In a rising rate environment, Smead that margin pressure to reverse.

Smead, who also owns JPMorgan and Bank of America shares, said Wells Fargo's risk reward relationship compares favorably to large cap banking peers in a normal economy.

In addition to a careful eye on interest margins and loan growth, Stifel Nicolaus analyst Christopher Mutascio said the bank's efficiency ratio and reserve releases are an important investor concern. Recently, Wells Fargo abandoned an expense target of $11.25 billion for a ratio of between 55% to 59% of overall revenue as a result of surging housing market and refinancing activity.

Mutascio expected that after reserve releases fell through 2012, the quarterly releases could stabilize at between $150 million and $200 million through 2013 and 2014.

While Wells Fargo released $250 million in reserves, it showed a decline in its efficiency ratio, which rose to 58.8%, at the high end of the bank's guidance, due to a charitable contribution.

Given Wells Fargo's above industry average stock and earnings performance in recent years, some Wall Street analysts recently saw reason to downgrade their outlook for the bank, citing value at competitors Bank of America and Citigroup.

Betsy Graseck, a banking analyst with Morgan Stanley (NYSE:MS) downgraded Wells Fargo from 'Outperform' in late December, citing " less ability to improve its best-in-class expense ratio and already high loan growth."

Such near-term earnings and valuation concerns relative to lenders like Bank of America and Citigroup, who remain far below pre-crisis levels, aren't likely to phase Wells Fargo's largest investor Warren Buffett.

"Nine years from now I would think that Bank of America as well as Wells Fargo and probably the other major banks will be worth considerably more money than they are now,' said Buffett in a Thursday interview on Bloomberg TV.

That perspective might serve Wells Fargo and banking sector investors, in the wake of Friday's earnings.

In the fourth quarter, Wells Fargo recorded took a $644 million charge for a Monday foreclosure settlement agreed with the Federal Reserve and Office of Comptroller of Currency (OCC), which has the bank committing a total cash payment of $766 million and a further $1.2 billion for already provisioned for foreclosure prevention.

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