Banking Industry Analysis - of Wells Fargo - Case Study Example

?Wells Fargo is a stable and long term company providing financial products such as banking, mortgages, credit cards, insurance, and investment services to consumers and business clientele. Wells Fargo’s mission, vision, and values have propelled them through rough financial times in the great depression as well as the current economic downturn. Wells Fargo has a proven history of success and overcoming obstacles. Change management and the ability to adapt to new environment will be of the utmost importance to Wells Fargo over the next few years. The financial reform act has made many drastic changes to the way that companies do business in the financial industry which will directly affect the multi-billion dollar financial institution. Wells Fargo must ensure that their upper level management pays close attention to the external environment with emphasis on governmental and legal changes to the industry standard. Wells Fargo has been in business since 1852. Their first office opened in San Francisco during the gold rush. The stage coach was used to transport gold and other valuables. Wells Fargo helped establish the Great Overland Mail service continuing to use the stagecoach but also adding steam ship, rail road, pony rider, and telegraph. From their humble beginnings they expanded from California to the rest of the nation. In 1910 they had 6,000 locations nationwide. Then the federal government took over due to the First World War leaving Wells Fargo with just their initial San Francisco location. Once again Wells Fargo was resistant and expanded again. By 1990 they gained back all of their locations across the nation. In the 1980’s Wells Fargo was the seventh largest bank in the nation. (Wells Fargo, 2011) Wells Fargo continued to expand throughout the Midwest with their merger with Norwest in 1998. The merger combined the largest bank presence on the West coast with the largest presence in the Midwest. After the merger the bank rated first in financial services in the western hemisphere, mortgage origination services, internet banking, agriculture lending, student loans, small business loans, commercial real estate, auto finance, and insurance agency sales. (Wells Fargo, 1998) Wells Fargo merged with Wachovia in 2009 gaining greater presence on the East coast and Southern states. Wells Fargo now had banking presence in 39 states and the District of Columbia. Core Products Banking Online Banking: Online banking includes mobile and text messaging banking. Wells Fargo offers standard online banking as well as applications for mobile devices and text banking. Currently three are 18.3 million active online banking customers. ATM Banking: Wells Fargo currently has 12,196 ATM’s. 8,029 of these ATM’s are envelope free accepting checks and bills directly. We offer email receipts and transactions in seven different on screen language. Our ATM’s also feature voice instructions for visually impaired. The ATM’s are also used to market new products and services to the current customer base. Business Banking: Our business banking serves over 2.5 million businesses with annual revenues up to 20 million. Business banking also includes business lending through capital lines of credit, business credit cards, equipment loans, and commercial real estate loans. We offer merchant services and process $108 billion in annual credit card sales. Business payroll services are available as well as year end tax reporting services. Wholesale Banking: Wholesale banking is comprised of commercial banking, treasury management, receivables solutions, payments solutions, and technology solutions. Commercial banking offers solutions that are tailored to the middle market businesses with annual revenues from $10-$750 million dollars. Government & Institutional Banking: This option provides solutions for government, education, health care, and nonprofit organizations. This can be split into education & nonprofit banking, government banking, health care financial services, public finance investment banking, and sales, trading, and syndicate. Mortgage Home Equity: Wells Fargo is one of the nation’s leading prime home equity originator holding a portfolio of $118 billion serving 2.1 million customers as of December 2010. Mortgage: Wells Fargo is the number one total mortgage producer in the United States. We are also the number one mortgage lender to low-to-moderate income home buyers. Wells Fargo is the number two mortgage servicer in the United States. Wells Fargo currently services 12 million loans totaling $1.8 trillion dollars. Wells Fargo mortgage originations through third quarter of 2010 totaled $262.9 billion dollars. Financial Ratio Analysis Ratio analysis is considered to be a very accurate and reliable tool when it comes to analyzing and interpret the financial outlook and performance of an entity. The main reason for performing a ratio analysis is to quantify the results of the financial operations of an entity and analyze them in the light of financial performance of the prior year(s) in order to assess different aspects of the financial feasibility. [Peavler, R. (2001)] The financial ratios are usually divided into various sub categories such as profitability, gearing and liquidity, each put emphasis on a different area of the financial outlook of the organization. These analyses form an integral part of the financial statement analysis, especially from the investor’s point of view, which are always looking for avenues to invest in countries having strengthened and stabilized financial ratios and representing an upward trend. It is of great significance that the ratios must be benchmarked against a standard in order for them to possess a meaning. Keeping that into account, the comparison is usually conducted between companies portraying same business and financial risks, between industries and between different time periods of the same company. [Investopedia.com (2012] The financial ratio performance of Wells Fargo has been evaluated for the last three years in order to draw attention to various financial trends and significant changes over the period. The analysis is divided into three main categorize namely Profitability, Effeciency and Gearing. Profitability ratios identify how efficiently and effectively a company is utilizing its resources and how successful it has been in generating a desired rate of return for its shareholders and investors. Whereas, the Gearing ratios identifies the extent to which the company is financed through debt and to what degree the operations are being conducted from the finance raised through raising equity capital or otherwise. For the purpose of financial ratio analysis, the financial year from 2008-2012 have been evaluated in order to analyze the financial outlook of Wells Fargo. The information has been extracted from the annual report of the company and the figure utilized in the financial ratio analysis is of the entire group. Profitability Ratios and Efficiency ratios Profitability Ratios 2008-12 2009-12 2010-12 2011-12 2012-12 Operating Margin 7.77 20.29 22.3 29.22 33.07 EBT Margin 7.77 20.29 22.3 29.22 33.07 Net Margin % 5.65 9.01 13.65 18.56 20.91 Asset Turnover (Average) 0.04 0.07 0.07 0.06 0.06 Return on Assets % 0.25 0.63 0.93 1.17 1.32 Return on Invested Capital % -1.74 0.25 1.86 3.31 4.58 Efficiency 2008-12 2009-12 2010-12 2011-12 2012-12 Fixed Assets Turnover 5.11 8.06 8.36 8.44 9.08 Asset Turnover 0.04 0.07 0.07 0.06 0.06 Gross profit margin is an analyzing tool which assists in identifying how effectively and efficiently the company is utilizing its raw materials [1], variable cost related to labor and fixed costs such as rent and depreciation of property plant and equipment. The ratio is calculated by dividing the sales revenue by the gross profit. If we analyze the gross profit margin trend of Wells Fargo it appears that there is considerable change in the percentage over the last four financial years. This presents that fact that the Bank has been able to maintain its markup paid on deposits and made sure that it remains in constant proportion with the revenue. The company has been able to manage the impact of inflation in the cost of administrative expense. Return on capital employed (ROCE) is, according to the analyst, is considered to be the most significant ratio in order to evaluate a company’s performance from an investor’s point of view. ROCE measures a company’s ability to earn a return on all of the capital that is being employed by the company [3]. The ratio is calculated as net income upon total capital employed, which is the sum of debt and equity financings. The return on capital employed is showing a fluctuating pattern as presented in the tabular representation. If we evaluate the tabular information, the ROCE increased sharply from the financial year 2008 to financial year 2012. The net profit of the company increased over this entire period which not only improved the financial outlook but also increased the profitability ratios. Gearing Ratios   2008-12 2009-12 2010-12 2011-12 2012-12 Financial Leverage 19.33 12.04 10.69 10.2 9.84 Debt/Equity 3.94 1.97 1.33 0.97 0.88 The debt ratio represents characteristics which is the opposite to that of the equity ratio. Debt ratio, which calculated by comparing the total liabilities to total assets, is a primary tool in determining the influence the company is under as a result of obtaining finances from sources other than equity. A lower ratio represents that the company is utilizing its equity in order to finance its operations and thus curtailing the financial risk. In order to determine the financial leverage of the company, debt equity ratio is considered to be the most important financial ratio. Financial leverage can be defined as the use of borrowed money in order to finance the operations. It is commonly observed that the banks finance a major portion of their operations through deposits and not through raising equity. The debt equity ratio of the bank has decreased significantly over the year. This shows that the bank has been financing majority of its operations through funds raised through equity and not by acquiring loans and advances from other financial institutions. This has also proved to be beneficial for the income statement as the profitability of the bank has increased owing to the reduced interest charge impact. Banking Industry Analysis Industry Environment The industry environment is comprised of entry barriers, supplier power, buyer power, substitute availability and competitive rivalry. Each category of the industry environment will be reviewed and analyzed below: Entry Barriers “Potential entrants can be a threat to firms already competing in an industry; by entering that industry, new firms can take market share away from current competitors” (R. Ireland, 2009 p.50).Wells Fargo is an established firm that holds the majority of the financial industry along with their major three competitors. New entrants in the financial industry are not considered a threat for Wells Fargo. The financial industry requires a lot of capital and trust. Currently none of the industry has a lot of trust but they do have capital to make investments and decisions that a new entrant to the industry does not have. There is a very high entry barrier in the financial industry. Supplier Power Supplier power is mainly related to capital in the financial industry. With capital being harder and harder to obtain the suppliers do hold a lot of power over the financial industry. Fannie Mae and Freddie Mac as well as FHA and VA have increased their guidelines for mortgages to ensure that they are good investments; they are less willing to back mortgages leaving less business for the financial/mortgage sector. The one thing that Wells Fargo has going for it in this area is that they hold a large amount of capital and have the ability to invest and keep mortgages on their own portfolio. This helps lessen the restrictions that are put in place by other investors. Buyer Power Buyer power is high in the financial industry. Since it is a service based industry if they do not please the consumer they have other options. There are no switching costs to go from one bank to another bank and from a mortgage standpoint there are costs to change but they are often coupled with a lower rate either washing the change or even improving the buyers position. The products available by the financial industry are very similar leaving the buyer lots of other options if they are not happy with the current one. Substitute Availability “Substitute products have the potential to influence an industry’s profitability potential. Substitute products are goods or services that perform functions similar to an existing product” (R.Ireland, 2009 p.53). The financial industry has four major playersthat all offer similar products and services. There is a high degree of substitutes available to the end consumer. Competitive Rivalry Competitive rivalry exists between Wells Fargo, J.P. Morgan Chase, Bank of America and Citigroup. Wells Fargo has done a great deal of work to differentiate their products from that of their competitors allowing them to keep a good reputation in comparison. The problem with this rivalry is that there are very low switching costs in the financial industry. It is the consumer’s money so they are able to take it away and give it to another competitor if they are unhappy. Operating Environment The operating environment includes five segments, competitors, creditors, customers, labor and supplies. These segments are dissected below with relation to the financial industry. Competitors Competition is relatively low; there are only four major choices in the financial industry. This competition has not hindered the performance of Wells Fargo and with the recent acquisition of Wachovia they have gained even more momentum to propel them over the competition. They have a strong foot hold on the banking and mortgage markets. Creditors Credit is extended by Wells Fargo but Wells Fargo has some major investors. Wells Fargo is a publically traded government backed bank. This means that they offer products from Fannie Mae, Freddie Mac, Federal Housing Administration, and Veteran’s Administration. These are the major investors to Wells Fargo’s mortgage business. Customers Customers are a vital part of any financial institution. They must be provided a value based service or they will leave to the competition. Wells Fargo must ensure that they are keeping a competitive advantage and a high level of service delivery to ensure that they keep their current customers. Labor There is no shortage of labor in the industry. With so many other financial institutions closing due to the economy there are a surplus of qualified individuals to fill the needs of the remaining financial institutions. Suppliers Supply is not an issue since there is no product being exchanged. This is a service based industry. Conclusio In order for Wells Fargo to meet their strategic plan there needs to be many pieces in place. Wells Fargo needs to ensure that they have enough diversification to make them stand out from the competition. Being a financial institution the only real way to diversify is to provide the best service delivery and value added options. In order to create excellent service delivery you first need to hire the right people, and then provide constant training. Wells Fargo has a history of being able to maintain and manage change, this skill is critical to the success of the diversification plan. Wells Fargo has a very diverse portfolio so ensuring that all employees that have contact with customers understand the other products and services offered and how they can help the consumer; this will lead to more cross selling opportunities. The main points that need to be focused on are hiring, training, development, sales, and marketing. These items will need constant review and evaluation to ensure a smooth plan implementation. References Investopedia.com (1944) Abnormal Earnings Valuation Model Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/a/abnormal-earnings-valuation-model.asp [Accessed: 11 November 2013]. Investopedia.com (2012) Equity Financing Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/e/equityfinancing.asp [Accessed: 11 November 2013]. Investopedia.com (2012) Free Cash Flow (FCF) Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/f/freecashflow.asp [Accessed: 11 November 2013]. Investopedia.com (2012) Profitability Indicator Ratios: Profit Margin Analysis | Investopedia. [online] Available at: http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp [Accessed: 11 November 2013]. Investopedia.com (2012) Understanding Financial Liquidity. [online] Available at: http://www.investopedia.com/articles/basics/07/liquidity.asp [Accessed: 11 November 2013]. Investopedia.com (2013) Effects of Debt on the Capital Structure – CFA Level 1 | Investopedia. [online] Available at: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/debt-effects-capital-structure.asp [Accessed: 11 November 2013]. Investopedia.com (2013) Modigliani-Miller Theorem (M&M) Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/m/modigliani-millertheorem.asp [Accessed: 11 November 2013]. Read More