On Monday, the ratings agency Moody's Corporation (NYSE:MCO) Investors Service expressed concern about the move into the new business and away from its usual comfort of consumer lending. Moody’s criticized the bank for moving into that new direction and said that its recent purchase of Merlinn was "credit negative.”
Wells Fargo & Company (NYSE:WFC) purchased Merlin in April but didn't disclose the transaction figure. The acquisition enables them to step up against its big bank competitors in the lucrative prime brokerage area. The prime brokers help to manage cash, execute trades and lend securities for short sales.
The deal is expected to close in the third quarter.
In a note, Moody’s expressed concern about the Merlin acquisition because it “signals that Wells Fargo intends to expand its” investment banking business. It added, “Though Merlin is small and has a limited balance sheet, we expect that Wells Fargo will build this business and seek to expand its products and services."
Moody’s also pointed out that prime brokerage wasn't exactly business as usual for Wells Fargo. It said, “We do not believe that this is a traditional area of expertise for Wells Fargo’s management.”
Wells Fargo has challenged Moody's review and responded with, "This is a modest acquisition and a measured approach to entering the prime services market. We have successfully grown our investment banking and capital markets business into a meaningful platform through thoughtful and measured expansion that is based on serving our customers’ needs and by continuing our longstanding record of prudent risk management.”
Fellow credit ratings agency, Fitch also expressed criticism last week but it was less harsh. It said that while Wells Fargo “may use Merlin as a platform for further expansion, the transaction is still viewed as relatively small in nature."
Wells Fargo and Home Mortgage Lending
As Wells has grown to one of the nation’s biggest home mortgage lenders, its investment bank has stayed small. It has avoided a large exposure to volatile business, which has helped the bank outperform some of its big rivals, including Bank of America Corp (NYSE:BAC) and Wells Fargo made 33.9% of the $385 billion of mortgages originated in the first quarter. By compassion, JPMorgan Chase & Co. (NYSE:JPM), which is the number two player only made 10.9% of loans. Bank of America Corp made up 5.2% of loan origination.
Moody's noted this with “Wells Fargo’s proven expertise is running a large consumer and commercial bank with a sizable mortgage business, which contributes the great majority of the bank’s earnings.”
With the move into this new business, Wells Fargo will see some advantages. Merlin will bring about 500 hedge fund clients--focusing mainly on the equity markets. It will provide a new revenue stream and add some diversity to its business. Wells Fargo is also looking to expand its services to fixed-income and commodities trading, according to The New York Times.
Wells Fargo said in a statement, “It is a natural extension of the capital markets solutions we currently provide to our corporate and institutional customers. It added that the Merlin “does not represent a material change to the risk profile.”