Tickers in this Article: WFC, C, BAC, RF, RY, STI, UBS
Wall Street is certainly down on banks once again. Given how weak the economy is and how much debris is still left to clean up from the housing crunch, maybe it's not so surprising. Nevertheless, Wells Fargo (NYSE:WFC) is looking more and more like a bargain as this goes on. The company still has to clean up its balance sheet and the Wachovia integration is going to take time, but this looks like a quality bank that is trading well below its true long run potential.

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A Disappointing Third Quarter
Although investors seemed reasonably happy with the results posted by Citigroup (NYSE:C), the news was not as encouraging for Wells Fargo. The company actually missed on the top line, and the bottom line results were not so impressive either. Revenue fell 4% sequentially, with net interest income down 5% and non-interest income down 7%. Wells Fargo actually did pretty well on controlling operating expenses (down 5%), but that's not going to encourage investors enough.

Persistently low interest rates and sluggish lending activity are taking something of a toll on net interest margin. Wells Fargo still compares favorably when its comes to rivals like Citigroup, PNC (NYSE:PNC) and Bank of America (NYSE:BAC), but this is a "worry first" market and lower lending activity, coupled with lower fee income, is just not a helpful environment.

A Good Long Run Plan
Today is rough, but Wells Fargo has a proven formula that should pay dividends in the future. Few banks are as good at cross-selling, and management now has a large roster of Wachovia customers to target. That will make for a challenging environment for other rivals in the Southeast, like PNC (which is acquiring Royal Bank of Canada's (NYSE:RY) regional U.S. ops), SunTrust (NYSE:STI) or Regions Financial (NYSE:RF). By the same token, Wells Fargo's relatively higher reliance on mortgage banking could be tricky in a still-weak housing market.

Another Deal?
Wells Fargo is now the second-largest bank in the country, in terms of deposits. What that means is that another deal for a deposit-based institution is pretty much out of the question, without the government's explicit cooperation. There are certainly still areas where Wells Fargo could boost its presence, but that will likely have to come via the expensive "ground and pound" way of branch-building and share capture.

That's not to say that Wells Fargo is done dealing. Wells Fargo doesn't have the large trading and securities business of Citigroup or Bank of America, but it has a wealth management business that could be even larger, particularly with this company's cross-selling proficiency.

Morgan Keegan would be an obvious target, as Regions needs to sell and doesn't have the leverage to demand a rich price. By the same token, Raymond James (NYSE:RJF) or Stifel (NSYE:SF) could make some sense. More likely, though, is for Wells Fargo to go for a large captive business at a conglomerate that needs to raise capital from asset sales; that could point to something like UBS' (NYSE:UBS) U.S. asset and wealth management businesses.

The Bottom Line
Given the probable earnings power of Wells Fargo's assets, the stock looks too cheap. Although Wells Fargo still has elevated loan losses, that won't last forever and it could hide the real quality of this operation. It may very well prove to be true that U.S. banks won't ever boast the same returns on equity, that they had during the housing bubble. That said, Wells Fargo should be able to go back to low-to-mid teen returns on equity, and that makes the stock a compelling long-term buy at today's prices. This is not a stock for the nervous, nor for those who need immediate returns, but patient value-oriented investors should find a lot to like here. (For additional reading, take a look at Analyzing A Bank's Financial Statements.)

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