"Bank stocks are still so cheap!"
That's something we're hearing more and more often, and also how there is good reason to believe their profits will grow in a big way. The housing market is recovering, more people are saving money, and the cost of borrowing money to lend to customers is ridiculously cheap -- and should remain so for at least a few years longer.
However, there's one aspect of the financial sector the market seems to have forgotten about: investment banking.
Started from the bottom...
Wells Fargo (NYSE: WFC ) has significantly grown its investment banking business. Since 2009, when the company acquired Wachovia (Wells got the majority of it investment banking business from Wachovia), Wells' investment banking market share has increased from 4.1% to 5.7%. That makes the bank eighth overall in investment banking revenue in the U.S., and it has captured the No. 1 spot in asset-based lending, a title that formerly belonged to Bank of America (NYSE: BAC ) .
This is welcome news, as one of the complaints about Wells Fargo from an investment perspective is that the bank is getting too reliant on the housing recovery for revenue growth, being that Wells is the largest mortgage provider in the U.S.
Additional promising data for Wells' investment banking efforts indicated that the bank's profits from advising clients on investments and financial planning increased by 40% since last year. This is particularly impressive because the total assets and deposits of the division only grew by 11%, which indicates this aspect of Wells' business is doing a great job of growing its margins.
How are the other banks' investment divisions doing?
The investment banking divisions of other big banks are doing very well also. Bank of America just reported fantastic results for the fourth quarter, with revenue from its investment banking division increasing by 34% from the third quarter and by 9% on a year-over-year basis. The company also sees increased revenues in the near future, fueled by an M&A market that seems to be picking up.
However, the numbers aren't great for everyone. JPMorgan Chase (NYSE: JPM ) , the investment banking giant, reported a 3% drop in investment banking fees for the most recent quarter. The bank saw much lower debt underwriting revenues, and saw its merger advisory fees drop by 7%. Of course, this could rebound fairly quickly if Bank of America's prediction of increased M&A volume in 2014 proves to be accurate.
What it could mean for shareholders
The impact investment banking revenue growth will have depends on the particular company and just how much of its income is dependent on investment banking.
In Wells Fargo's case, we see that Wells earned a profit of slightly more than $20 billion for fiscal year 2013, around $2 billion of which came from investment banking, so for our sake, let's say that 10% of Wells Fargo's profits come from investment banking. So, a 10% increase in investment banking revenue would mean about a 1% increase in the overall profits of the bank.
The impact would be much greater for a company like JPMorgan, because over 35% of the company's revenues come from investment banking. Therefore, JPMorgan is much more sensitive to a gain (or loss) in investment banking revenues.
Foolish final thought
Although Wells Fargo isn't tremendously dependent on the investment banking business, the bank is doing incredibly well in its operations. Wells Fargo's success in the field is especially impressive when you consider that this aspect of its business was virtually nonexistent five years ago.
In addition to its thriving investment banking business, Wells Fargo has a well-diversified business and fantastic management that should keep the company among the best performers in the financial sector for years to come.
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