It's unsurprising that Wells Fargo ( WFC) has decided to embrace Wachovia's investment banking business rather than disown it, given Wells' capital position.
Wells Fargo, as reported by TheStreet.com last week, is fusing Wachovia's underwriting, M&A and other securities operations with legacy businesses in what will be called Wells Fargo Securities. Despite earlier indications that it would sell off some of those businesses, Wells is now seeking to expand its presence in the highly profitable investment banking space. Wells CEO John Stumpf struck a fresh tone in a statement on Monday morning, calling Wachovia's investment banking and capital markets platforms "strong" and "one of the great benefits" of the merger. Stumpf had earlier deemed investment banking as "not compatible" with Wells' "vision and values," but now said the company has "an enormous opportunity to become one of the top customer-focused investment banks in the country." Well, duh. Wells earlier this year was told by regulators after government stress tests that it needed to boost Tier 1 capital levels by $13.7 billion -- more than all but one competitor, Bank of America ( BAC). So far, it has explicitly raised relatively little. Wells has tapped the markets for $8.9 billion in fresh capital, whereas BofA, which needed to raise $33.9 billion, has already exceeded that sum through equity offerings, preferred-to-common exchanges and asset sales. Other companies like JPMorgan Chase ( JPM), Goldman Sachs ( GS) and Morgan Stanley ( MS) have already begun to pay off bailout funds. All four firms are also top players in the investment banking space, now that BofA owns Merrill Lynch.
Wells spokeswoman Elise Wilkinson says the firm won't comment on specific plans for growing the investment banking and capital markets business. She cited a mandatory "quiet period" ahead of second-quarter earnings, as well as competitive reasons. Wilkinson says "the branding of the Wells Fargo Securities businesses (which is what our press release was about) is not directly related to" the company's government-mandated capital needs. However, it's clear that the investment banking stands to be a key driver of the earnings the firm is relying on to bail its own way out of the recession. Wells management has stuck to assertions that the company will earn its way out of the downturn and eventually repay the government's $25 billion preferred equity investment made through the Troubled Asset Relief Program. Yet the Federal Reserve is against banks relying heavily on such projections to meet capital needs. Wells Fargo executives have taken a combative stance with regulators, saying repeatedly that the stress tests were overly conservative, or, as Chairman Richard Kovacevich once put it, "asinine." Since investment banking has brought in loads of fresh capital for Wells, as equity and debt underwriting took off this year and markets improved, it would make little sense to divest those businesses at this juncture. Richard Bove, a bank analyst with Rochdale Securities, believes Wachovia is one of the government's primary underwriters. That means big business with the Treasury Department issuing hundreds of billions of dollars worth of bonds each quarter to finance expansive recovery programs.
"There was no question that the underwriting business was making money," Bove says in an interview. "Nothing was as profitable as the capital markets business." Indeed, as TheStreet.com noted
last week, Wachovia contributed 41% of the company's combined first-quarter revenues, over 40% of net interest income and 43% of noninterest income. Trust and investment fees, and trading activities made strong income contributions of $2.2 billion, compared with $802 million at legacy Wells.
The second quarter is likely to show more of the same trends, even if other factors represent significant headwinds going forward. As Wells faces continued deterioration in traditional loans, higher payments to the Federal Deposit Insurance Corp., potential accounting rule changes that might bring more bad assets onto its books, and legal battles in various states, why would it get rid of one business that is boosting the bottom line? "If you were Wells Fargo and you were looking around and saying, 'Where am I making money this quarter?'" says Bove, "If this is the best business we have, we're not going to shut it down, we're going to keep going."