Quick Take
- Private equity (PE) deals contribute to a sizable part of
Wells Fargo's revenues and are managed by the bank's Norwest
business division
- Unlike the global investment banks that pool investors'
money along with their own to run their PE business, Wells
Fargo uses its own cash
- Incidentally, the Volcker Rule exempts such transactions
(classified as 'merchant banking' rather than 'private equity')
from restrictions
- This will allow Wells Fargo to actually grow its private
equity business in the near future, even as investment banks
are scaling down theirs
Like the Goldman Sachs (
GS
), the risk-averse and traditional-banking focused
Wells Fargo
(
WFC
) has also figured out loopholes in the Volcker Rule, to ensure
that cash continues flowing into its coffers (see
Goldman's Volcker Rule Policy: Creative And Profitable
Compliance
). Wells Fargo has also done its research on the fine print of this
restrictive rule, and the bank plans to not only sustain, but also
grow
its private equity (PE) business. Ironically, the fact that Wells
Fargo's PE business is
funded 100% by its own cash
is what will allow it to go around the
3% limit
imposed by the Volcker Rule, on a bank's use of its own cash in a
private equity fund. The law states that by keeping external
investors out, Wells Fargo is actually indulging in 'merchant
banking' - an activity specifically exempted under the current
format of the Volcker Rule.
We maintain a
$38 price estimate for Wells Fargo's stock
, which is about 5% ahead of current market prices.
See our complete analysis of Wells Fargo here
Wells Fargo's Private Equity Business At A
Glance
One of the lesser known businesses of Wells Fargo's diversified
business model is its private equity business - something it
acquired as a part of its merger with the Norwest Bank in 1998. The
two business units Norwest Equity Partners (NEP) and Norwest
Venture Partners (
NVP
), look for suitable investment opportunities in small companies
and manage capital worth $5 billion and $3.7 billion
respectively.
So how much does the business affect bottom line figures for the
country's fourth biggest bank? To put things in perspective,
Norwest Equity Partners sold off Becker Underwood to Germany-based
chemical firm BASF last November for a tidy sum of $1.02 billion,
booking a pre-tax gain of $715 million on the deal. That's nearly
10% of Wells Fargo's $7.2 billion pre-tax income for Q4 2012.
Wells Fargo reports its PE revenue under the "net gains from
equity investments" head in its income statement. For our analysis
of the bank, we include these revenues as part of "other revenues,"
represented in the chart below.
But Despite The Risks, The Business Is Set To Grow In The
Future
The Volcker Rule has a clear reasoning for clamping down on
banks' PE activity - the business offers high returns, but comes
with very high risk, and the rule understands that bank customers
would definitely be better off without this risk. For example,
Wells Fargo's PE business lost $1.27 billion over the 2008-2009
period. And deals like the Becker Underwood sell-off can only be
materialized once every couple of years, if at all.
Wells Fargo is not Goldman Sachs. While the former has just a
fraction of its assets set aside for the Norwest funds,
private-equity and merchant banking assets for Goldman form at
least a quarter of the investment bank's assets. So we can safely
say that as far as Wells Fargo is concerned, the risks of the
private equity business are largely contained, and it does look
like a good option for the bank to continue growing this business
in light of the stable economic outlook for the future.
Submit a Post at Trefis Powered by Data and Interactive
Charts |
Understand What
Drives a Stock at Trefis