Here’s a $40 billion question: Is Wells Fargo really that much less risky than JPMorgan Chase?
Earlier this week, the Federal Reserve released its rules on how much extra capital big banks had to hold because they are big and obviously dangerous to the broader economy if anything big ever went wrong. Just how dangerous, though, in the Fed’s opinion, depended on the bank. Wells Fargo (WFC), for instance, will only have to hold 2% of its assets, adjusted for risk, in additional capital because of its big badness, the least of any of the big banks. JPMorgan (JPM), on the other hand, will have to hold 4.5% of risk-adjusted assets of additional capital, because presumably of its even bigger and badder-ness.
The higher capital requirement translates to $42.4 billion. That’s how much extra capital JPMorgan will have to hold compared to Wells Fargo. Here’s another way to look at it: When you tack on the new extra big bank capital requirement, which the Fed calls a “surcharge,” Wells Fargo will be required to hold capital equal to 9% of its assets. JPMorgan will be required to hold 11.5%. That means JPMorgan, as least in the minds of the Federal Reserve, is 28% more risky than Wells Fargo.
That wasn’t the case in the 2007-2009 financial crisis. Both companies faired relatively well compared to other banks, which isn’t saying much. Neither lost money. But Wells Fargo’s earnings dropped 71% in 2009. That was more than JPMorgan’s 68% slide. JPMorgan is bigger, though, so it’s earnings did drop more – $10 billion vs. $6 billion for Wells Fargo. JPMorgan’s loan losses were also bigger than Wells Fargo, but it started with a loan losses reserve that was twice as big. The result was that JPMorgan had to put aside an additional $25 billion to cover its bad loans in 2009 and 2010, or just 19% more than Wells Fargo’s $21 billion.
In the most recent stress test, the Federal Reserve estimated that JPMorgan would have nearly $50 billion in loan losses in a severe economic downturn. That’s a lot. But it is only 2% more than the $49 billion that the Fed thinks Wells Fargo would have. Of course, the Fed also estimates that JPMorgan would have an additional $29.8 billion in trading losses, compared to just $15.5 billion for Wells Fargo. The Fed has traditionally been harsh on banks with Wall Street operations. Even added together, though, JPMorgan’s projected losses are only 24% higher than Wells Fargo’s, which is under our 28% bar, though only slightly.
Wells Fargo has long cultivated the image of being less complicated and therefore less risky. It doesn’t have a very large Wall Street investment banking or trading business. The Fed, again, has determined that’s a good thing. But two years ago, though, The Atlantic did a deep dive into Wells Fargo’s finances and found them no less hard to decipher and full of risks than the other large banks. And Wells Fargo’s loan book is significantly larger than JPMorgan’s – $860 billion to $766 billion, respectively.
JPMorgan, on the other hand, has argued it has safety in the fact that it has a diverse set of businesses. It’s trading business could help offset losses in its lending book. JPMorgan’s London Whale portfolio, for instance, was positioned to cover the bank’s lending losses if the world blew up. It didn’t, and that’s in part why the bank ended up with $6 billion in unnecessary losses. But had the world actually blown up history might have been seen JPMorgan’s chief investment office as a buffer, rather than another huge risk.
The market, though, seems to side with the Fed. This week, Wells Fargo became the world’s most valuable bank, worth $40 billion more in market cap than JPMorgan. Wells Fargo’s shares now have a price-to-earnings multiple of 14, vs. 13 for JPMorgan, which is a sign that investors think the former bank is more of a sure thing.
In part, some of that is because of the Fed. The lower capital requirement is likely to make Wells Fargo’s lending operations more profitable then JPMorgan’s. (Higher profits is why the banks wanted to hold so little capital in the run up to the financial crisis.) So it makes sense that investors would value the shares of Wells Fargo’s higher than JPMorgan’s. But if Wells Fargo isn’t much safer than JPMorgan as the Fed thinks, regulators could be driving investors to the wrong bank.