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Pioneering Confidence: Wells Fargo’s New Stage

Richard Kovacevich, chairman and CEO of Wells Fargo, the 5th largest bank in the U.S., shares his views on the state of the U.S. economy and his plans for Puerto Rico in an exclusive CARIBBEAN BUSINESS interview


May 16, 2002
Copyright © 2002 CARIBBEAN BUSINESS. All Rights Reserved.

Wells Fargo: The 150-year-old company is processing $1.5 billion a day in new mortgage applications. The man in the driver’s seat sees it as a sure sign of high consumer confidence and a slow but sure economic recovery.

A publicly traded company that reaches the 150-year mark posting double-digit revenue growth despite a recession deserves taking off one’s hat to.

And the man who heads that company is most certainly worth a hearing.

Recent visit to Puerto Ricoto celebrate the fifteenth anniversary of its Puerto Rico auto loans subsidiary Reliable Financial Services–as well as lend a hand to consumer finance subsidiary Island Finance as it faces a major legislative obstacle–Wells Fargo President and CEO Richard Kovacevich talked about the state of the U.S. economy, doing business in Puerto Rico and the future of the U.S. financial industry.

On the recovery

"I’ve been more optimistic about the U.S. economy after Sept. 11 than the consensus," says Kovacevich, adding that he never bought into last year’s "gloom and doom" economic forecasts.

"It’s not economic models I rely on, but people putting their money down and lenders lending," he says. "$2 billion a day in mortgage applications last November can’t happen in a bad economy–people wouldn’t be taking 30-year out commitments like that if they didn’t think they’d have a job."

He could have added that banks and mortgage companies wouldn’t be granting mortgages to unemployed people, even if they had property for collateral. Wells Fargo is the largest mortgage lender in the country.

According to Kovacevich, the combination of a modest 3% to 3.5% in GNP growth and a sharp 10% decline in the capital goods sector gave us a "blah" feeling of a recession. But he is quick to point out that, unlike in previous recessions, what drove the economic slowdown this time around was the bursting of an artificial technology sector bubble, not a drop in consumer confidence.

Precisely because the recession was unlike previous recessions the ongoing recovery is unlike previous economic recoveries, he says. Consumer spending–which accounts for roughly two-thirds of overall economic activity–remained vigorous throughout the downturn. "We’ve been having record homes sales and record auto sales–through it all the consumer segment of the economy has been going along fine at about a 3% growth clip."

"The recovery isn’t going to be robust because a lot of the elements really have not deteriorated that much, so their recovery is not going to be dramatic," said Kovacevich.

The Wells Fargo chairman takes a jab at the stateside business press for over-blowing the importance of the rising unemployment rate. "If you’re old enough you remember a time 25 years ago when 6% unemployment was considered inflationary [meaning that getting any closer to full employment would automatically cause inflation]. Unemployment stands now at about one half what it was during other recessions. That’s not bad," said Kovacevich, who predicts average unemployment rate on the mainland will peak at 6.5% "if that much."

Further, it feels like a tepid recovery, he says, due to the continued weakness of the capital goods sector. "Capital goods spending still hasn’t come back, but it will," Kovacevich says. "And technology spending will also come back as a result of obsolescent technology needing to be updated--it’s not really a matter of if, but when."

"We’ve reached bottom in the capital goods downturn and inventories are at an all time low. So as soon as new orders start flowing in production will increase. All we need now is for CEOs’ to start having confidence and then they’ll be stimulated to renew expenditures in capital goods," said Kovacevich.

The Wells Fargo Chairman and CEO says until capital spending levels start to pick up again–something that he thinks could be in evidence within the next three to six months–the Fed will not raise interest rates. "I’m very confident that the Fed will not–let me underscore, will NOT–raise interest rates until it becomes crystal clear that the economy is back on track, with no threat of slipping back into a recession." And that will probably not happen before the year is out, he says.

Kovacevich believes the stock market should already be giving healthier signs of recovery. "It appears as if investors actually needed [Federal Reserve Chairman] Alan Greenspan to raise interest rates to know that the economy is already recovered," Kovacevich quips half-jokingly, noting that if Greenspan did raise the rate the market would probably jump 20%. "As soon as investors make the psychological change from uncertainty to confidence that we’ve hit bottom already you are going to see instantaneous change in the stock market."

Continued productivity growth at 4-5% levels and a good number of publicly traded companies experiencing positive surprises for their first quarter 2002 earnings are other signs which signal that the economy is moving along on the road to recovery, Kovacevich said.

One of the elements currently needed to put the recovery on track is congressional passage of a terrorism insurance program, Kovacevich said. "Right now we’ve got $2 billion in commercial construction projects that we can’t sign off on, because the legislation–which everybody agrees is necessary–is being needlessly held up by a distracting debate over tort reform." Among its provisions, the legislation will establish that the government is the insurer of last resort in acts of terrorism.

"I believe that barring externalities such as another major terrorist attack, the U.S. economy is going to come back even better. Time’s on our side if we can keep consumer confidence up," quipped Kovacevich.


Distribution and diversification are key

With the emergence of the modern financial supermarket (in which commercial and mortgage banking are increasingly integrated with investment services and insurance), Wells Fargo is in a privileged position.

Kovacevich, who sits on the board of directors of discount mega-retailer Target, likens Wells Fargo’s distribution system of its integrated financial services to those of other present-day colossal consumer products distributors, such as Wal-Mart and Home Depot.

Like the two retail giants, Wells Fargo, with more than 5,400 stores (they’re not called branches, Kovacevich points out) has its industry’s largest distribution network. It then leverages its massive multi-channel distribution system (including the stores, its 6,500 ATMS and the Internet, among others) in order to establish a competitive advantage when it comes to providing financial products and services in a manner that provides the greatest amount of cost savings, convenience and value to customers.

Last year, the company’s biggest single revenue generator was in mortgage banking. From $76 billion in mortgage originations in 2000, Wells Fargo more than doubled to $194 billion in mortgage originations in 2001. "In early November 2001, we were processing $2 billion of mortgage loan applications a day," Kovacevich says.

In addition to being the U.S.’s number one mortgage originator and servicer (including number one mortgage lender to home builders and number one commercial real estate lender among all banks), Wells Fargo has enjoyed extraordinary success on the World Wide Web. It has become the nation’s number one home equity loan lender through the Internet.

According to SMR Research, Wells Fargo is also the number one home equity portfolio lender overall in the U.S., with $28 billion in home equity loans outstanding, growing 25% faster than the industry as a whole for the past four years.

Kovacevich believes the model of diversification and distribution that has been so successful for both Wells Fargo and mega retailers like Wal-Mart will inevitably prevail and change radically the shape of the financial industry in the U.S. in the next few years.

"The key to success in any business is to figure out a way to drive more revenue through your base. Last year, less than 50% of our profits came from banking, the rest came from our other financial services. Wal Mart, for example, sells more things than anyone else and makes more money than anyone else. Yet it chose to diversify into the worst, lowest margin, most saturated business there is–supermarkets. Why? To drive more revenue through the base. In those stores where they add grocery retail sales, sales in the other departments go up by 26%. If you can do it with groceries, you can do it with annuities and CD’s just the same. This is the direction in which the financial industry is going. After all, most financial products are commodities in the sense that they are not distinguishable one from another. Like the mega retailers, we’re only distributors of commodity products. The key is in the distribution," explains Kovacevich.

For the Wells Fargo chief, consolidation in the financial industry is inevitable and imminent. "This is the best, fastest growing and most fragmented industry. A $2.3 trillion dollar industry where the leader has only 3%! That’s bound to change, and it’s going to be brutal. Some will not be around in five years."


Seeks to out local the nationals, out national the locals

Kovacevich told CARIBBEAN BUSINESS that Wells Fargo’s strategic aim to "out local the nationals and out national the locals" has been the linchpin of its formula for success. "It’s hard to do," Kovacevich admits. "Most big companies don’t get it."

But Puerto Rico, he says, is a prime example of how it works in practice. Local decision-making is an essential part of the equation. Reliable Financial President Jaime Marti and Island Finance President Oriol Segarra and their respective teams exercise the highest degree of local operating autonomy, with the benefit of the capital backing of Wells Fargo.

In the case of Reliable Financial, since joining the Wells Fargo family five years ago, the auto loans firm has more than quadrupled its loans portfolio, from $180 million in 1997 to $720 million today. Reliable currently serves 75% of the island’s auto dealers, and has more than 75,000 active clients throughout the island.

The road has been more rocky, however, for small loans firm Island Finance. Like other small loans institutions in Puerto Rico, Island Finance struggles to turn a profit. As Segarra told CARIBBEAN BUSINESS, nonrecoverable loans in the industry rose from $72 million in 1996 to $211 million in 2000. "The only thing that saved this industry was its deregulation in 1998," he says.

Deregulation is being threatened right now, however, by House bill 1288. The bill–which has yet to be approved by the Senate–sets 19.75% as the maximum interest rate small loan institutions can charge clients with bad credit. The average interest rate charged clients with bad credit currently stands at 27%.

Kovacevich says the threat of House bill 1288 is part of the reason he came down to Puerto Rico. "This issue is much more serious than people might think," Kovacevich warned. "It represents a threat that’s not confined to the consumer finance business."

He stresses the importance investors place on the stability of laws and regulations affecting business, particularly when the proposed changes make the business environment less friendly. "It delivers a terrible message to those who might want to come to invest in Puerto Rico. I feel I’m being told Wells Fargo is not welcome in Puerto Rico."

"If this sector–which has a very hard time making a profit–can be targeted, that means other sectors could be targeted, too." He says he’s hopeful that reason will prevail among government officials and legislators, some of whom he is personally lobbying directly on the matter. "I don’t want to be threatening, just factual–we lost $200 million here three years ago--and we would lose money under this bill."

The bill’s passage into law, Kovacevich and other financial industry leaders agree, would spell the end of the consumer finance industry. The consumers that these institutions currently serve would then likely be at the mercy of loan sharks, he points out. "I’ve seen it happen and it’s not a pretty picture."

An ñ in its future

House bill’s 1288 being put to rest is clearly a prerequisite to further Wells Fargo expansion on the island, particularly when it comes to commercial and mortgage banking.

"I don’t want to give the impression that we would do this--or that it’s imminent--but if we did [expand into commercial or mortgage banking in Puerto Rico] there’s a 99% probability that it would be done by acquisition and it would be done the way we go about it elsewhere, with the input of our local managers, in this case Jaime and Oriol," Kovacevich says.

One frontier that Kovacevich is keen on discussing at the moment is the U.S. mainland Hispanic market. "We think that it will be our fastest growing consumer and small business segment over the next 20-25 years."

Wells Fargo has a work group responsible for the segment that’s tasked with coming up with products and what needs to be done differently for the Latino market. The company is working on implementing its strategy to become "the bank of choice" for the Hispanic market and is increasing its bilingual personnel and affinity marketing initiatives.

Wells Fargo has already positioned itself as the nation’s number one "NAFTA bank"–with more banking stores and assets than any competitor within 60 miles of Mexico and Canada. And the institution’s web site has begun featuring Spanish language promotions for its line of credit cards.

In addition to adapting to changing national demographics, Kovacevich says that as Wells Fargo celebrates its 150th anniversary this year, it’s also staying on the cutting edge of new technology by adding such innovations as web-enabled ATMs to its network. These machines give customers the ability to conduct on-line banking through the ATM machine.

More evidence of the company’s ability to stay ahead is the fact that it is currently ranked the nation’s number one Internet bank. Through its web site, Kovacevich says Wells Fargo now has nearly 3 million Internet banking customers, and is attracting an average of two new customers every minute.

Indeed, Wells Fargo’s chief historian, Dr. Andy Anderson, says that without its continuous ability to adapt to both new technology and customers’ changing needs, Wells Fargo would have invariably gone the way of other companies that fail to keep up with the times and are no longer in existence.

Anderson points to the fact that just 17 years after it’s founding–with the advent of the transcontinental railroad in 1869–Wells Fargo decided to let go of its stagecoaches in favor of moving its business and its customers’ business to the then new technology of the railroad.

"It dawned on Wells Fargo that it wasn’t a stagecoach company anymore, it was, and still is today, a connecting company."

This Caribbean Business article appears courtesy of Casiano Communications.
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