I’m mesmerized by this JPMorgan research chart showing that big banks shouldn’t be broken up because they lend so much more to businesses and consumers than small banks do. See:
Basically for every dollar of normalized capital, JPMorgan has extended $12 of credit between March 2010 and September 2012, according to this note by JPM’s Michael Cembalest. Whereas the small banks have loaned out only about $2. Get with the program, small banks!
The trick here – besides “normalized capital”1 – is that “credit extended” means (1) “changes in commercial and consumer loan balances” plus (2) syndicated loan, corporate bond, muni bond, etc. underwriting. That is, if you stand between a company looking for money and the market that provides it, you get, um, credit for extending credit, whether you do that standing-between in traditional banking ways (take deposit, make loans) or in traditional investment banking ways (match bond buyer with bond issuer). “See, we’re lending,” says JPMorgan. “We’re just not lending our money.”2
As a rhetorical move, I say: A+. This is a lovely piece of judo: a popular complaint about big banks is that they combine nice gentle traditional banking services like providing subprime mortgages, with evil risky terrible investment banking services like trading bonds and securitizing ABS. If you point out that underwriting bonds and securitizing ABS provides credit to people and companies, same as lending does, then those things don’t look so bad. In fact they look better than lending, because underwriting doesn’t actually use any balance sheet and so is much more capital efficient. And so you can say things like:
“If you really want to see the capital banks provide, you’ve got to widen your periscope a little,” Cembalest said in an interview Friday. “The point of this is to simply ask, how have different-sized banks been doing, based on their punching weight?”
So, I mean: this is 100% right, right? JPMorgan intermediates a lot more credit to businesses, even controlling for its size, than does, I dunno, Mackinac Bank is one that Cembalest names. No question.
But it’s also totally contingent. Why do that intermediating out of a thing called a “bank”? Goldman Sachs is on that chart, respectably in the middle, and Goldman Sachs is only accidentally a bank – as of last quarter it had about $38 billion in loans, against $65 billion in tier 1 capital, leaving it under 1/3 of the way up to that small-bank green square on lending activity alone.3 The rest, of course, is underwriting. Which is not that surprising? Goldman Sachs is an investment bank? That’s what they do?4
Some people at Jefferies had a good day today – obvs some had a bad day but whatever: its CEO is getting $19 million this year, quite a bit more than, say, JPMorgan’s CEO, and its line bankers are getting their 2012 pay in cash rather than the stew of deferred stock, structured credit, and cold showers that seems de rigueur at bigger banks. If you’re at a big bank, are you jealous? Kevin Roose noted that Jefferies and friends are increasingly trying to compete with the big banks for talent and business, luring bankers with the promise of a place “where they can get paid more, dodge the scrutiny of regulators and the wrath of the Occupy crowd, and generally live a much nimbler, unburdened existence.”
I’ve occasionally thought along related lines. It’s not just comp: with the Volcker Rule and Basel III and G-SIFI and whatnot, surely little banks should be taking over businesses like underwriting and market making where universal banks are becoming increasingly restricted and no-fun, right? Like, if you’re a capital markets banker at BofA: why? Why not go to Jefferies and get paid in cash?
Cembalest’s defense of big banks demonstrates the value of investment banking businesses as a component of the big banks, but it doesn’t demonstrate the value of keeping them there, as opposed to just spinning them off or replacing them with pure-play investment banks.5 You can look at Jefferies through Cembalest’s lens, if you want. By my rough math, looking just at Jefferies’s U.S. bond and syndicated loan league table credit, Jefferies is “extending credit” of 15-20x its “normalized tier 1 capital” – way better than Morgan Stanley, JPMorgan, Wells Fargo, anyone on that chart.6 Which of course makes tons of sense because Jefferies isn’t wasting all that capital by actually lending it to people. Underwriting bonds is a more or less zero-capital business,7 so it’s a super-efficient way for a bank-type-thing to provide credit to businesses.
So if this metric is an argument that JPMorgan is better than Mackinac Bank, it’s also an argument that Jefferies is better than JPMorgan. Shut down JPMorgan’s investment bank and let a million Jefferieses bloom!
And yet … and yet Jefferies, for all that it pays its CEO lavishly, and its peons in cash, and for all that it intermediates credit above its punching weight, is pretty far down the league tables: it underwrites a lot of bonds relative to its capital, but a tiny amount relative to JPMorgan. It’s almost as though the JPMorgans of the world have some advantages over the Jefferieses – as though its size, universality, lending capacity, and too-big-to-failness allow JPMorgan to get business that Jefferies can’t get.
1. That’s not really a trick: normalized capital is just 12.5% of RWAs. As Cembalest puts it, “To avoid unduly influencing the analysis by the different levels of leverage in each bank, we normalized the concept of available capital across all banks. In other words, with this adjustment, more leveraged banks will not benefit from holding less capital relative to other banks.”
2. Of course its not your money in regular banking either, I don’t want to hear it.
- Cembalest is actually talking flows, not stocks – he’s counting increase/decrease in lending, not total loans outstanding – but GS’s current total loans outstanding is obviously a maximum on its increase in lending.
- Loans are page 18, T1C page 81, of the most recent Goldman 10-Q.
4. Obvs I choose GS out of habitual loyalty; Morgan Stanley looks even better.
6. Math is super fake. JEF had $36bn in assets as of November 2012; it doesn’t report Basel RWAs so I just guess they’re about $21bn by comparison to JPM, which had $1.3trn of RWAs on $2.3trn of assets (pages 3 and 59-60 here), or about 60% RWAs:assets. At 12.5% T1C:RWAs, per Cembalest, you get $2.66 billion of normalized tier 1 capital. Ignoring on-balance-sheet loans, ABS, etc., Jefferies has league table credit for underwriting:
- $13.75bn of U.S. bonds in 2012, $9.94bn in 2011, $12.76bn in 2010, and
- $12.08bn of U.S. syndicated loans in 2012, $6.1bn in 2011, and $4.49bn in 2010
Or call it $59 billion over those three years. Cembalest’s numbers run March 2010 to September 2012 so let’s call it $50 billion to be fair. That’s still over 18x “normalized tier 1 capital.”
7. Bought deals! Whatever. That capital recycles quickly.