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Big Banks Do Plenty Of Lending, Though Mostly With Other People's Money

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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.

On banks, size and the recovery in credit markets [JPM via Politico]
JPMorgan Defends Big Banks' Lending Levels [AB]
The Rise of the Little Banks [DI / Kevin Roose]

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.

5."Pure-play" being approximate in the case of JEF, an investment-bank-cum-slaughterhouse.

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:

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."

  • $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

7.Bought deals! Whatever. That capital recycles quickly.


Facebook Will Take Free Money From Banks But Don't Expect It To Show Any Gratitude

The Wall Street Journal today discovered that universal banks that lend money to companies for cheap tend to want investment banking business in return for that lending and I guess that's a scandal: As the market for technology IPOs revs up and the biggest banks seek to capitalize on the size of their balance sheets, the practice of selecting underwriters that also provided loans is coming under focus, spurred by Facebook's IPO process. Critics of the practice say the choices aren't accidental and reflect the "you-scratch-my-back-I-scratch-yours" way that Wall Street works. Bankers, for their part, say they aren't allowed to make loans on the condition that they receive other business, but borrowers can use the loans as a factor in choosing underwriters. Some bankers say that lending is just one of the many services they offer companies. At Facebook, the credit line played a role in the batting order for underwriters, said a banker who worked on an underwriting pitch to the company. When I was young and naive and pitching for underwriting business against banks that did lots of lending, I always thought that banks "aren't allowed to make loans on the condition that they receive other business, but borrowers can use the loans as a factor in choosing underwriters" thing was ripe for a scandal. I still sort of think that: I just do not believe that no client coverage banker has ever said "we'll be in your credit facility but only if you promise us underwriting or M&A business." (Some people agree with me!) And, as the Journal notes, that would be a criminal violation of the antitrust laws, which is unspeakably weird but there you go. But if you ask a banker who has been carefully and recently briefed on anti-tying regulations, he will probably tell you something like "we don't demand underwriting business to provide a loan. Companies demand loans to get underwriting business." And, as the Journal says, that's not illegal.

Banks Prove That They Are Not Too Big To Fail By Saying "We Can Fail" On A Piece Of Paper, Moving On

One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**: (1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank). (2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar. This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.