Description

Wells Financial Corp (WEFC) is a small, midwestern thrift that trades at $18.55, has $29.55 of cash on its balance sheet, trades at 88% of book, 6.6X trailing earnings, has an ROE of over 14% on a conservative balance sheet, has a current dividend yield of 3.88%, has consistently repurchased its own shares and has an above average performance on its loan portfolio.

What’s wrong with Wells? I can’t seem to find much wrong at all. For many, it is too small, with a market cap of just $22 million or maybe it is too conservative with its underwriting (they just aren’t fond of loan losses). Nothing exciting here, no turnaround situation, no need to change their business plan, they just need to execute as they have for 68 years and investors will be rewarded.

Wells Financial Corp is a unitary savings and loan holding company for Wells Federal Bank, fsb. Wells has eight full service offices and one additional loan origination office, all located primarily southwest of Minneapolis, Minnesota. Their expertise is lending on farm real estate as well as one-to-four family properties. To state they know their customers is an understatement and you can’t seem to find anyone at the bank that can ever remember having a loan loss on a farm real estate loan (which typically makes up about 20 - 25% of their total loans). Their loan portfolio is made up of about 49% owner occupied residential, 25% commercial (primarily farm real estate), 16% home equity lines, and the remaining being various consumer and commercial loans.

Wells is a traditional thrift and when rates are too low, they tend to sell to the secondary market and in a higher interest rate environment, they retain a greater percentage of loans in their portfolio. Wells retains the servicing on virtually all of its loans while currently selling conventional fixed rate one-to-four family residential loans to the secondary market. Its portfolio consists primarily of its farm real estate loans, adjustable conventional loans and consumer loans. Because it services all of its loans and it literally does know its customers, Wells is able to maintain a very low non-performing loan to assets ratio of 0.32%, which is significantly below industry averages. They are able to write farm real estate loans at higher yields and lower terms. Wells can typically generate an additional 200 basis points higher on farm real estate loans than typical residential loans and have not had a loan loss on their farm real estate loan portfolio in recent history. Their low loan loss history is directly attributable to their conservative underwriting on residential, farm real estate and consumer loans which is aided by their servicing abilities.

Wells Federal has two wholly owned subsidiaries in Wells Insurance Agency, Inc. and Greater Minnesota Mortgage, Inc. (“GMM”). The insurance subsidiary offers various health, life casualty and business insurance to its customers. WMM was founded in 1997 for the primary purpose of originating residential loans from sources where their current branches may not service. GMM has begun to add to the origination volume of loans for Wells and has provided a growing stream of earnings.

Wells has an enviable balance sheet, including $29.55 in cash and very low amounts of borrowed funds. Its core capital ratio is 8.65% and even with such a conservative balance sheet, it has a ROA of 1.61%. In 2001, with interest rates falling to levels that management felt were not adequate to portfolio, Wells significantly expanded its cash position by selling a significant amount of its loan portfolio to the secondary market. Over the past year, it has found itself flush with cash and evaluating various alternatives to deploy this cash. If there is one attribute that the management of Wells has, it is to only act when such action will generate long-term profitable outcomes. Wells is clearly not interested in growing for the sake of growing. Should they be able to identify a source of profitable growth, they will act, if not they will be patient.

Alternatives for the excess cash

In March 2002, after 38 years of service, the president and CEO retired and a new president and CEO was named. The new CEO has a background in the commercial lending area and management has stated they expect to increase their commercial loans in the future. However, management has been very clear that they are not interested in changing their conservative underwriting approach, regardless of the lending that takes place. Additional commercial loans will primarily be real estate based and again they will be able to obtain higher yields and shorter terms than comparable one-to-four family residential. Thus, one option for some of the excess cash is to deploy it into commercial lending and fulfill their current customers’ needs that have not been previously met.

Also look for Wells to continue to use excess cash to repurchase shares. Over the past 4 years, they have purchased over 800,000 shares of their own stock and currently have a float of about 1,214,000 shares. Given their significant portion of cash available, a continued significant repurchase of shares would not be out of the question, especially when the stock is trading at a discount to book. Given their strong tendency in the past to repurchase shares, the stock is becoming less liquid, which may dissuade them from purchasing significant shares, at least without a stock split. Although, a dutch auction would have the potential for an interesting scenario.

With most thrifts being purchased at a multiple to book, or at least at a strong premium to book, Wells is clearly an undervalued company and should they be purchased in the near future, it would certainly be a significant premium to what the company is currently valued in the market today.

Summary

Should Wells be able to grow earnings at a minimum of 10% annually, this will be a very profitable investment for years to come. With a current stock price of $18.55, a current dividend yield of 3.88%, cash of $29.55, a book value of $21.05, trading at 6.6X trailing earnings, this small, conservative thrift is a bargain with any type of valuation method.

Catalyst

I’d love to say there is a potential buyout or some big news on the horizon, but quite frankly the catalyst will be the continued good operation from Wells and the profitable deployment of their excess cash. With cash per share at $29.55 on a share price of $18.55, they have many alternatives to create additional shareholder value.