JPMorgan’s results a warning to investment bank shareholders
Shareholders should be as worried by modest returns at the American market leader as by outright losses at Deutsche and other struggling European investment banks.
Shareholders in any financial institution with a large investment bank must have blanched in January when Deutsche Bank issued a profit warning.
It wasn’t so much the large – and hilariously misnamed – “one-off” litigation and restructuring charges in the final quarter of last year that led to Deutsche’s first full-year loss since 2008 that alarmed shareholders. More worrying were the poor underlying results, including an operating loss for the quarter of €600 million, when the analyst consensus had been for a €900 million profit, making for an €1.5 billion miss.
The lead culprit appeared to be far-lower-than-expected revenues in the corporate banking and securities division.
It’s a painful reminder to investors who have pressed banks to restructure and reduce their investment banking divisions just how hard this is to execute and that while customer revenues can evaporate swiftly, fixed costs are harder to shift, shedding them requires more of those pesky supposedly exceptional costs and that risks take longer to manage down than revenues.
The odds on a further dilutive capital raise at Deutsche, something its highly regarded new CEO John Cryan had been trying to avoid, just shortened.
Investors in Barclays, which looks set to continue dismantling its investment banking operations outside the UK and the US, especially in Asia as well as in other emerging markets, should brace themselves.
Investors took rather less notice through results season of the performance of JPMorgan’s investment bank in the last quarter of 2015 and throughout last year, but in some ways it carries an even more troubling message.
It did nothing wrong. The corporate and investment bank division reported net income of $1.7 billion on revenue of $7.1 billion for a return on equity of 10%.
What might give investors pause is that return, which does no more than match cost of equity for a large globally significant bank, comes from the outright market leader in a strong year for large parts of the investment banking business.
According to Dealogic, M&A revenue reached $23.4 billion in 2015, the second highest level on record and while equity underwriting revenues declined from a strong 2014, earnings from the primary market in investment-grade bonds were a record $10.4 billion in 2015.
JPMorgan led the overall investment banking revenue league tables with an 8% market share and close to $6 billion in revenue, being the market share leader in debt capital markets, equity capital markets and syndicated loans, while second only to Goldman Sachs in M&A advisory revenues.
Customer revenues from secondary market trading in fixed income and equities held up well, as investors positioned for the shift in Fed rates.
Profits were boosted by expense-reduction efforts in the CIB division, where JPMorgan has taken out $1.3 billion of costs since 2014. Default risk was low on the relationship loans JPMorgan holds on balance sheet to support its investment banking clients, given low rates. Market risk was also contained in 2015.
If the global market leader can’t make more than a 10% return in a year of strong revenues and low credit and market risk costs, what will the rest do if 2016 sees lower client revenue in the funk period that usually follows bear market falls, default rates rise off their lows and market risks require more capital amid heightened volatility?