As most US-based securities financing professionals now know, Wells Fargo announced a week ago Friday that it was buying Merlin Securities, a mini-prime broker that has built a successful book of business with smaller hedge funds and low leverage trading clients. The move makes good sense in hindsight. An odd release by Moody’s however continues to show what we think is ignorance about particular balance sheet issues not only in general but also at very important ratings agencies. Here’s our take on the deal and on the Moody’s commentary.
In our Asset Ops and Strategy blog last week, we noted that “For Wells Fargo, acquiring Merlin’s technology and its lower leverage client base is a double win. On the one hand, the firm gains a prime brokerage technology base where it had nothing before. On the other, Wells Fargo can now be an official prime broker but will not be concerned about potentially acquiring hedge fund clients that are balance sheet intensive. Merlin Securities was prime brokerage light as compared to Morgan Stanley or Credit Suisse. The new Wells Fargo prime brokerage will start off the same way, then could become more balance sheet intensive (and hence riskier but more profitable) as time goes on in a steady, stable way.”
The New York Times today cited Moody’s review of the deal this way: “Moody’s Investors Service, the rating agency, raised concerns on Monday about the bank’s recent move outside its comfort zone of consumer lending. Moody’s directed criticism at the bank for stepping into prime brokerage, calling the bank’s recent acquisition of the midsize company Merlin Securities “credit negative…. Moody’s expressed concern the Merlin takeover “signals that Wells Fargo intends to expand its” investment banking business. “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 said in the report.” Fitch’s review was much less concerned.
We agree with Moody’s on one thing at least: the acquisition of Merlin gives Wells Fargo more clients for its distribution (corporate debt anyone?) but we end there. As Merlin is a mini-prime, the whole point is that Wells isn’t taking on any balance sheet risk today – all of that risk is carried by Merlin’s clearing brokers who we understand to be JPMorgan and Goldman Sachs. Wells could opt to take on the clearing business and might indeed to align with their other business goals, but all of that business would be CCP, not balance sheet activity. Wells also has its own securities lending business that has been doing fine. Merlin’s small hedge funds and low leverage borrowers could take advantage of this desk but we aren’t talking huge volumes here.
So is Moody’s saying that they see any build-out of clearing services as credit negative? Clearing on a CCP carries a 2% risk weighting, and that was meant as a token, not as a real statement about a CCP’s actual risk. Or is this just commentary wanting Wells Fargo to stay as an “untarnished” retail bank and not sully itself with corporate clients. Sorry to say, that boat has left the harbor: Wells Fargo has a huge investment banking and lending business. On the OTC derivatives side, its big enough that it’s a member of LCH.Clearnet’s SwapClear, for goodness sakes!
Change comes hard, and risk has many levels. We think that the Moody’s release overestimates the risk of Wells Fargo getting into trouble in prime brokerage; rather we see the move as “credit neutral” – the purchase adds technology and expands distribution with a free option for Wells Fargo to take on clearing clients in the future.