Wells Fargo (WFC +0.04%) may be looking at significant opportunity ahead as it rides the banking and housing recovery from the forefront of the industry.
The bank's success is far from a given, though. Even though it's historically been a great bank for investors to own -- particularly as it outshone its peers during the financial crisis -- competition is intense in the industry, and there are plenty of other banks, large and small, gunning for Wells Fargo's customers.
If the bank is going to deliver on its opportunity, it's essential that it executes in these three areas.
Home lending
True to form, Wells Fargo's biggest opportunity is home lending. Its competitive advantage here stems from its previously criticized decision to largely avoid the risky subprime mortgages that have plagued its competitors since the financial crisis. As competitors such as Citigroup (C 0.04%) and Bank of America (BAC +0.22%) have been forced to reduce their exposure to this market, Wells Fargo has stepped in to fill the profitable void left behind.
It overtook Bank of America at the end of last year to become the nation's largest mortgage servicer, with a current residential mortgage servicing portfolio of $1.9 trillion. This provides Wells Fargo with a steady stream of revenue and gives it an inherent advantage in the refinancing business, as homeowners are more likely to refinance with the bank that they're already dealing with. In the most recent quarter, nearly three-quarters of its mortgage applications were refinancings as opposed to first-time home purchases.
Additionally, Wells Fargo is already the nation's largest mortgage originator, controlling roughly one-third of the domestic market. The most immediate advantage of this relates to the mortgage origination fees on the $139 billion of mortgages that it underwrote in the third quarter alone. Beyond that, this position also gives the bank greater flexibility to manipulate its balance sheet. Namely, as the yield on agency mortgage-backed securities fluctuates relative to the underlying mortgages themselves, Wells Fargo's abundant pipeline ensures it has access to whichever is preferable at any one time. During the third quarter, for instance, it chose to retain nearly $10 billion of 1-4 family conforming residential loans as opposed to feeding them into the securitization chain for this very reason.
Taken together, between servicing and originating mortgages, Wells Fargo pocketed at an impressive $2.8 billion in mortgage banking fees during the third quarter -- that figure is above and beyond what it received in interest payments on the loans retained. This revenue stream is only bound to grow as the housing market continues to pick up steam.
Cross-sales
Modern banks look to a variety of revenue streams to maximize shareholder return. Beyond home lending, they offer checking and savings accounts, auto loans, wealth management, and credit cards, to name only a few products and services. In Wells Fargo's case, it makes nearly $5 billion a quarter in noninterest income from service charges on deposit accounts, trust and investment fees, and credit card charges alone. The trick for any bank, in turn, is to capture as much of this business from as many customers as possible.
Wells Fargo has two potent advantages in this regard. First, it already has relationships with one-third of American households through its depository and home lending operations. This gives it a strategic beachhead from which to build upon. Second, its ability to sidestep the most egregious practices fueling the financial crisis -- not to mention that its California headquarters are thousands of miles removed from Wall Street -- minimized the reputational damage that sullied so many of its competitors. Think about all of the bad things you've heard about Bank of America, Citigroup, and Goldman Sachs (GS +0.33%). Now think about all of the bad things you've heard about Wells Fargo. See what I mean?
In the most recent quarter, its household cross-sell ratio reached 6.04 products per household, up from 5.90 last year. Even more telling in terms of future cross-selling potential is the regional difference between the eastern and western United States. In Wells Fargo's traditional western territory, the average household uses 6.40 of its products and/or services. In the east, which Wells Fargo inherited via the Wachovia acquisition, that figure is only 5.56. Accordingly, there remains a lot of room for organic growth.
Investment banking
It may seem odd that I'd identify investment banking as one of Wells Fargo's biggest opportunities. As I noted above, its decision to avoid the riskier trappings of the trade before and during the financial crisis is now arguably one of its biggest competitive advantages because it isn't hobbled by the attendant costs. Not to mention, compared to the likes of JPMorgan Chase (JPM 0.26%), Goldman Sachs, and Bank of America, which dominate the trade virtually across the board, Wells Fargo is largely an afterthought.
But this is a glass-half-empty approach. The more optimistic, and I believe fairer, way to view it is that there's nowhere to go but up. Despite its admittedly nascent state, Wells Fargo has underwritten 5% of all domestic corporate bond sales this year, up from 3.6% in 2009. The $48.3 billion notional value of the offerings makes it the eighth most active underwriter of bonds in 2012, up from 11th place last year. Most recently, it's served as a bookrunner on deals for Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B), Clorox (CLX 2.97%), Dominion Resources (D +1.16%), and Newfield Exploration (NFX +0.00%), among others. With this progress in mind, the sky is truly the limit here.
