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Banking

Wells Fargo’s investment bank takes a hit

Clinging on to modest IB ranking; municipalities show their clout over ethics scandals.

tim sloan-600

Tim Sloan, new CEO of Wells Fargo

Compounding all its other woes, Wells Fargo looks set to suffer its third consecutive year of lower investment banking revenues. Last year Wells Fargo made $1.6 billion in investment banking fees, down from 2014, and 2013, but the scandal within its retail arm is going to take further toll on its investment banking business this year. Since September several of the largest municipal issuers in the US have announced they are halting business with Wells Fargo until it is clear that bank has implemented sufficient internal controls. 

California was the first state to drop Wells Fargo from its deal roster. California state treasurer John Chiang said he was suspending Wells Fargo’s “most highly profitable business relationships” with the state for at least a year, including the lucrative business of underwriting certain California municipal bonds. He also suspended any additional investments in Wells Fargo securities and said he would suspend the bank’s work as a broker-dealer hired to buy investments on the treasurer’s behalf. Wells Fargo was the second-largest underwriter of municipal debt in California in the first half of the year behind Citi.

Losses

Even after Wells Fargo said on October 12 that CEO John Stumpf would retire with immediate effect, Chiang reiterated his decision, saying it was still not clear that there was an effective change at the retail bank. He estimates that the loss in fees to Wells Fargo will be in the millions of dollars and points out that there will also be a loss of prestige that comes from doing business with the largest municipal bond issuer in the country. 

Also in October, Illinois Treasurer Michael Frerichs said his office is suspending its annual $30 billion in investment activity with Wells Fargo for at least one year. Frerichs says the loss will be “millions of dollars”. Wells Fargo spokesman Gabriel Boehmer did the bank no favours by reportedly responding that the loss would actually only be $50,000 a year.

The final financial cost to Wells Fargo shareholders is hard to predict. In late October the Los Angeles Times published a search warrant indicating that the California state attorney general has launched a felony investigation into the bank’s creation of unauthorized accounts.

Ohio governor John Kasich is also barring Wells Fargo from “participating in future state debt offerings and financial services contracts initiated by state agencies under his authority”, and is looking to exclude the California-based bank from participating in debt offerings initiated by the Ohio Public Facilities Commission.

The City of Chicago has also jumped on board, stopping its business relationship for a year, and the New York Metropolitan Transportation Authority has similarly taken a stand opting not to include Wells Fargo among banks pre-authorized for underwriting bonds as part of its regular three-year process. Finally New York City mayor Bill de Blasio, and comptroller Scott Stringer say they will review their business dealings with the bank.

Whether it’s millions of dollars that the bank will lose, or as Boehmer suggests, only hundreds of thousands, it comes at a bad time. Wells Fargo has already been struggling in investment banking this year. Its market share of investment banking revenue fees has fallen from 5.77% in 2013 to 4.77%, according to data from Dealogic. In the first six months of this year its investment banking fees were down 16% on the same period last year at $752 million.

A bump in the third quarter put total fees made over the year at $1.172 billion, but it’s unlikely, given the suspensions, that Wells Fargo will beat the $1.6 billion made last year now, even as rivals’ earning pick up. That matters, because retail banking as a business is taking a hit industry-wide as interest rates remain low and loan losses rise. While its peers such as JPMorgan and Citi can lean on investment banking as a buffer, that is not the case for Wells Fargo. 

JPMorgan just had a record third quarter in investment banking and trading. Revenue from merger advice and new securities sales increased 15%, while fixed income and currencies jumped 48%. Citi’s investment bank also performed well, with a 35% increase in bond trading. 

It remains to be seen whether Wells Fargo’s new CEO Tim Sloan will invest in the investment bank or wind it down. He had been overseeing the business for a year, but it’s still a relatively new business as Wells Fargo only decided to enter investment banking after taking on Wachovia in 2008, and it has made little headway in the last four years — the bank has stayed around 8th in the US investment banking fee rankings. 

Effects

Earnings aside however, the shunning of Wells Fargo’s investment bank by municipalities is a warning to other universal banks like JPMorgan, Bank of America Merrill Lynch and Citi that while business lines are meant to provide diversification, malpractice in one area of an institution will affect others

Bank consultant Trent Fleming, says the reactions by municipalities seem ‘knee-jerk’, and likely to have been political. “Given that the retail bank and investment bank have different regulatory and management structures, and don’t really interact, it’s not a natural outcome for a client of the investment bank to extrapolate internal control issues onto the investment banking side,” he says. “Rather, it seems like municipalities are keen to show they are looking out for their constituents.” 

But Fleming concedes that these kinds of reactions could be here to stay. “The US banking supervisory system doesn’t allow banks to publish examination findings or other indicators of financial health or management efficacy, and that gives clients little to go on where they are trying to make business decisions from a socially-conscious viewpoint [as municipalities are increasingly doing],” he says. “The only leverage clients have is to come down hard on all parts of a bank when something fraudulent happens. 

“For banks, reputation risk is far greater than it used to be.”



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