Wells Fargo's (NYSE:WFC) president and chief operating officer, Tim Sloan, spoke to analysts at the Bernstein strategic decisions conference last week. One of the topics that he covered was Wells Fargo's decision to wade into investment banking.
Given the regulatory environment, which in many ways penalizes banks with both traditional and investment banking operations, investors would be excused for wondering why the nation's third biggest bank by assets is headed in this direction. Here's a brief overview of Sloan's comments that help to answer this question.
1. Why did Wells Fargo get into investment banking?
For virtually all of its existence, Wells Fargo has focused on traditional banking -- taking deposits and lending money. This changed during the financial crisis, as a result of its acquisition of Wachovia. The deal not only transformed Wells Fargo from a large regional bank into the nation's largest retail banking franchise based on branch count, it also gave the company a turnkey investment bank.
As Sloan explained:
When we put Wells Fargo and Wachovia together we saw a absolutely terrific opportunity to be able to grow that business primarily, one, because of the quality of the people that we inherited when we put Wells Fargo and Wachovia together so it's all about the people and the culture from my perspective, and then two, about a strategy which is not dependent upon using your balance sheet to be able to buy business, but it's dependent upon the broadening of those relationships with your existing customers.
2. How risky is Wells Fargo's investment bank?
One of the problems associated with investment banking, and particularly in today's heightened regulatory environment, is that certain investment banking activities can weigh heavily on the parent company's valuation and profitability. High-risk trading operations are the principal culprit.
It's easy to appreciate why this is when you consider that JPMorgan Chase lost more than $6 billion in one fell swoop four years ago after a London-based trader made a wrong-way bet on derivatives tied to the health of the U.S. economy. Fears that this can happen to any bank with large trading operations weigh on a bank's valuation.
Fortunately, according to Sloan, Wells Fargo isn't interested in taking its investment banking operations too far in this direction. As he explained in a response to a question about the types of investment banking products that it offers:
It's kind of the base level of products and services that you'd imagine. It's bringing folks to market in terms of both investment grade and high yield bonds. It's equities. It's [advising on mergers and acquisitions]. It's just kind of basic and then providing other types of risk management products whether it's interest rate or derivative-type products to our customer base.
3. How is Wells Fargo growing its investment bank?
Although Wells Fargo got into investment banking by way of an acquisition, it disclaims any interest in purchasing additional companies to grow this corner of its business. It's focused instead on organic growth.
One benefit to growing organically is that it allows Wells Fargo to deepen its relationships with existing clients. This has long been one of the $1.9 trillion bank's strengths, as it boasts probably the best cross-sell ratio in the industry -- I say "probably" because most banks don't disclose how many of their products the average customer uses. Another benefit is that growing organically better enables Wells Fargo to control risk, as history is littered with examples of banks that have unwittingly assumed expensive liabilities by acquiring less conservative competitors -- look no further than Bank of America's 2008 purchase of Countrywide Financial.
Sloan was clear that Wells Fargo is focused on avoiding this:
There've been many, many opportunities that we've had post-crisis to look at different acquisition opportunities just given some of the carnage that's gone on in the industry. And that just doesn't make sense for us. Growing our businesses organically is always the number one strategy, particularly in this business because it gets down to the people and you want to make sure that you have the right people that are not only running the businesses that are out there, working with our clients, and also working very well as a team with our corporate bankers, our real estate bankers, and commercial bankers.
In short, Wells Fargo wants to have its cake and eat it too -- that is, to offer its clients the benefits of an investment bank while simultaneously controlling the risk associated with introducing investment banking products into its otherwise traditionally focused business model.
John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.