My Best Investments Of The Decade P1-3 (Wells Fargo preferred shares during the financial crisis)

In the previous article, I described the worst investments (investment decisions) that I have made within the past decade.  The best investments will be broken into a 3 part series, as the selections were very close.  I want to illustrate in detail the original circumstances/context/situations of the time, the thought processes, why I think they were the best, and also the key investment aspects of each. In this manner, I hope that my readers can improve their own investing skills & knowledge from my experiences.

 

Comparison Evaluation:

In evaluating which investments/decisions I think have been the best, I did not measure/compare them based solely on yearly performance numbers, and instead took an overall evaluation approach.  Why? Yearly performance numbers don’t mean anything in particular, because it blindly calculates the change in prices between one calendar date and another.  This type of metric is highly misleading for determining performance, as we don’t make investments or sell them based on arbitrary calendar dates.  We base investments on the role they play in the overall investment plan, on their individual valuation/price, in addition to other criteria.

For example, some investments we would not sell for capital gains at all, because they act as income components.  Another example are investments that have a very long time horizon (based on company milestones), and therefore may not impact the portfolio’s numbers until years later.  However, the mutual fund industry & media focus very heavily (to the point of brainwashing) on the use of yearly performance numbers.  When reviewing your own investments (and even your portfolio), remember that its more useful to evaluate them based on total return, as well as the other important aspects.

I will start the series with my top selection, followed by the second in the next, and the third in the last article of the series. Please keep in mind that NONE of my selections are to be taken as investment recommendations. And although some may still be below their intrinsic value, PLEASE do not rush out and blindly acquire the investments that I mention without any planning, research, analysis, or having an overall plan.

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Wells Fargo Capital XII 7.874% Pfd

The Investment:

I purchased WELLS FARGO CAPITAL XII 7.874% PFD preferred shares, at the end of February 2009, for about $14 a share, yielding roughly 13% in preferred dividend payments.

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Circumstances:

– The investment was purchased during one of the most panic stricken times of the financial crisis.  Mass panic in the financial industry had spread across the globe.  One year earlier, investors saw the collapse of Bear Stearns through the $2 per share acquisition by JPMorganChase in a fire sale (3/16/2008). Its stock price in January of 2007 was $172, and $93 in February 2008 just before its failure. The deal was backed by $30 Billion from the Federal Reserve to cover Bear Stearn losses.  In September of 2008, a string of giant failures produced fears of a liquidity crisis that hasn’t been seen since the Great Depression.  Massive institutions, Fannie May and Freddie Mac were seized by the government (9/7/2008).  Together they owned about half of the $12 trillion mortgage market in the US.  England’s first run on a bank in over a century created a wave of panic with customers lining up to withdrawal deposits, when Northern Rock was given emergency funding by the Bank Of England (9/13/2008). Merrill Lynch, the world’s largest brokerage was sold to Bank of America (9/14/2008) after losses, and client withdrawals sparked liquidity problems. Lehman Brothers filed for bankruptcy protection after incredible asset losses (9/15/2008). People in Canada will remember that the Lehman bankruptcy (Bazis International’s partner) had affected the massive condo development One Bloor tower, which was subsequently canceled and then purchased by Great Gulf. The US Federal Reserve lent $85 Billion to AIG (American International Group) to avoid sudden insolvency (9/17/2008). The FDIC (Federal Deposit Insurance Corporation) seized Washington Mutual, with banking assets sold to JP MorganChase for $1.9 billion (9/26/2008). The FDIC decided that the banking operations of Wachovia would be sold to Citigroup Inc (9/29/2008), with government support to cover billions in Wachovia losses.

That was followed by Wells Fargo’s purchase bid for Wachovia (10/3/2008), where they expected Wachovia to lose $71.4 billion on its $482 billion loan portfolio.  Wells Fargo’s 2008 3Q profit (10/15/2008) decreased but remained in positive territory at $1.64 billion, compared to its peers who have had continued quarterly losses.  In October 2008, the US government forced major banks to take billions in TARP money to prevent insolvency and a liquidity crisis.   The US policy makers and the FDIC (Federal Deposit Insurance Corp) talked about government nationalization (once unthinkable) of troubled banks.  Banks continued to expose billions in writedowns and losses through into 2009. Across the globe Asian, South American, and other European banks were bailed out by other banks and the governments.  Investors feared that Wells Fargo had not done enough due diligence and losses would sky rocket as well, from its Wachovia unit.  Citigroup was earlier on the brink of defaulting on its bond payments (corporate debt similar in nature to preferred shares) before government protection.  Wells Fargo’s posted a net loss of $2.73 billion in 2008 4Q (1/28/2009) as it set aside $8.5 billion to offset future losses.  It was the bank’s first quarterly deficit in 7 years.

The mindset was if it was a bank, people were expecting it to be in trouble. If it was a bank in the US, it was expected to go under & be seized by the government (wiping out common shareholders).  No one wanted anything to do with investments related to an American bank.  Wells Fargo, which was an American bank that had recently purchased troubled Wachovia and saw its common share price plunge.  All corporate debt instruments from bonds to preferred shares belonging to banks in the US plunged by the end of February of 2009.  Wells Fargo’s preferred share price declined roughly 25% to the mid teens, from the low twenty / high teen level.  The drop caused the preferred dividend yield to go into double digit territory, with the terms “junk bonds” being tossed around the sector.  However, the bank was known for its prudent and conservative approach, and did not get involved in the sub-prime mess.  The opportunity to get solid corporate debt at such a low price (making the yield so high), was very rare and it had to come before making other investments.  I had been waiting for such an opportunity for several years.  The usual research & analysis was performed. Both Wells Fargo’s & Wachovia’s losses, as well as possible impacts on the preferred dividend were estimated.  From the results, management had likely performed proper due diligence on Wachovia.  I purchased the preferred shares despite its massive decline in price from the public’s loss of confidence.  The loss of confidence was also attributed to the professional analysts which stated management had not performed proper due diligence.

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What Happened:

After the purchase the preferred shares rose back close to the $20 level for a short period of time.  On March 3 2009, at the peak of the crisis, billionaire super investor Warren Buffett gave his opinion of the financial crisis and the bank itself.  He stated that it would emerge from the nation’s credit crisis “better than ever”, and that the “prospects three years out have been better than ever”.  However, even in the days that followed, the price dropped to its lowest level in recent history for a few days (slightly below my purchase price).

Since I had already spent the full amount of money that was set aside for such a deal, no more shares were to be purchased.  I had already restricted myself by purchasing the full amount the first time, and that meant foregoing any opportunities for better pricing that would possibly follow.  In this case better pricing did follow.  I call this the classic Shopper Problem, that all investors face.  When we see an item that goes on sale (whether regularly or rarely), do we buy it?  Or do we wait and see if it goes on clearance for an even better price?  What if demand suddenly spikes and they raise the price or the price returns to normal (discount is reduced or eliminated)?   Unlike shopping, there are no refunds or price matching.  Buying something on sale uses money from our wallet.  But at the same time we give up the chance to buy something else on sale using the same money, or buy more of the same thing at a lower price.  However, passing up the sale completely means we risk losing the opportunity to get the item at a good price (if the price returns to normal or is raised).  The same problem exists even if we spend only a portion of our allocated cash.  If the opportunity for better pricing never occurs, the unused cash now must be used on a similar item that fits the role.  Losing the opportunity means that we would have to look at other alternatives.  The alternatives may be of poorer quality, have significant defects, or may not be a good fit.  Sticking with only high quality and safety (low risk) means our choices are more narrow as well. Like shoppers, investors cannot predict the level of the lowest price, or the direction of pricing, and must make this decision each time investment capital is to be used.

By mid March the preferred shares had returned to the high teen price level.  By April it had risen to the low $20 level, and then the $24 level in June 2009.  The window of opportunity was extremely short-lived.  The attractive yield at the low price was no longer available. .

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Impact & Additional Thoughts:

This investment serves as a reminder how critical proper research & analysis is to the investment process.  It lead to the selection of this particular bank’s preferred shares rather than one such as Citigroup’s (lower price and even more attractive yield) who almost defaulted on its bond payment before government aid stepped in.  In addition to performing research & analysis, it is equally important to trust in what the results tell you.  Investment decisions should not be based upon the comments or behavior of the media, analysts, and other investors in the market.  Many times I have found my analysis to be contrary to the statements made by professional analysts, and fund managers.  An investor needs to be able to go in the direction that the analysis points to, rather than with the herd.  It also reinforces the importance of prioritizing possible investment opportunities ahead of time, so the investor can be ready to act if the situation appears.  Sometimes the situation never does appear.  For example, the Canadian preferred shares that I wished to acquire never actually reached my acquisition price level.  At the time there was an abundance of excellent common share opportunities in the market, which looking back now, was during the peak of the crisis (we can never predict at what level the lowest will be, or when it will reach it).  Those opportunities could have easily taken attention away from looking out for this type of investment, as well as the necessary capital.  There were fixed income roles in the investment plan and specific strategies for filling them. As a result, the acquisition of this type of investment was placed above the others.  The window of opportunity was much more narrow than expected, and an investor had to purposely be waiting for it in order to acquire such shares before the price discount disappeared. This was not only true for the Wells Fargo preferred, but across the board.

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How Is The Investment Doing Today?

Wells Fargo did not default and achieved consecutive record setting profits in the quarters that followed.  Wells Fargo’s 2009 Q1 (4/22/2009) profit was a record $3.05 billion. 2009 Q2 (7/22/2009) profit was a record $3.17 billion.  Wells Fargo again set a new record profit in 2009 Q3 (10/21/2009) at $3.2 billion. They remain one of the strongest/dominant banks in the US today and continue to do much better than their peers. At the end of January 2010, they repaid the government TARP funds that they were unwillingly forced to take. The preferred share price has remained slightly above its $25 face value in the $25.50 range for several months.  However, its common that most preferred shares across all industries remain slightly below their face value. I expect that the price will not change significantly for several years, with no significant opportunities in the short term.

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Why Was It One Of The Best?

Its no surprise that market downturns give us some of the best opportunities, and this time there was many.   I consider this the best investment / investment decision that I’ve made this decade.  Why would I consider this a better investment move than the acquisition of a stock that has a return of over 700%?  One reason is because the opportunity only comes around once every few years, and this time there was a very small window of opportunity (a few weeks).  Another reason is because a stock that has a 700% return would be cashed out (likely within a few years).  That would then require searching for a new investment that would give double digit returns to re-deploy the capital.  However, this investment would continue to pay as long as the company is able to, or until the shares mature in 2068, or until the next crash where they can be traded for newer issues (payouts/pricing adjusted for the inflation).   I strongly believe Wells Fargo can continue to pay, considering they were able to withstand the financial meltdown & purchase Wachovia.

A rock solid double digit yield, padding a portion of the portfolio’s foundation is a must have. The preferred status & rights of these shares (that come before those of common shareholders) is added protection. And the share price increase above its face value is just an added bonus.  Although its not as good as Warren Buffett’s investment in the specially made Goldman Sach’s preferred (with a 10% dividend yield), because of the warrants associated with them. I would still say that this is pretty close.

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I hope you have enjoyed reading this article, and that you were able to gain some knowledge to take back with you!  In the next article I will discuss my second selection for the best investment / investment decision that I have made this decade.

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Here is a list of books that will help you make better investment choices:

The Intelligent Investor (Benjamin Graham)
Amazon.com Amazon.ca Chapters.ca
[Amazon.com version includes preface by Warren Buffett]

The Snowball: Warren Buffett & The Business of Life (by Alice Schroeder)
Amazon.com Amazon.ca Chapters.ca

The Warren Buffett Way (Robert G. Hagstrom)
Amazon.com Amazon.ca

Securities Analysis: 6th Edition (Benjamin Graham)
Amazon.com
[Not available at Amazon.ca ]

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Thanks & Happy Investing! — The Investment Blogger © 2010

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