First quarter results have elevated questions again about whether the mixture of structural and cyclical factors has ended the long reign of the global investment banking institutions. This seems to be the full case for the weakest in the herd, but what about the most powerful? Most analysts agree that the two strongest among the very best dozen banking institutions are JP Morgan (JPM) and Goldman Sachs (GS), who positioned 1 and 2 in Dealogic’s 2015 investment banking revenues league table with 15% of all earnings between them.
34 billion in earnings from investment bank fees, sales, and trading and principal investing. Darwin’s idea of the survival of the fittest didn’t rest on the fittest being the strongest – he claimed that the fittest would be the ones that adapted best to changes in their environment. The last five years have certainly proven that a lot of environmental change is going on in the investment banking industry that will continue for quite a while. As I’ve expressed often in previous content, the effect of the changes has most visibly appeared in results on collateral (ROE) being persistently less than the banks’ cost of equity capital.
For the most powerful, this differential is relatively modest now, but for the weakest the differential is in double-digit negative percentages. Within the industry, the capability to adapt this percentage into a positive place, more than anything, will determine fitness, and survival therefore. For some, adaptation may need to stop wasting time and substantial, perhaps dramatic. But GS and JPM have avoided the dramatic for a reliable, well-aimed series of small changes they wish best will continue to work.
The two companies will be the only ones in their industry led by long-experienced main executives set up prior to the 2007-2008 crisis; both CEOs have laid out plans to re-engineer their firms than shake them up significantly rather. 6 billion trading mishaps, which brought immediate attention to the need for risk accountability and management for errors. But, behind the scenes, GS has been adapting to its new environment steadily. GS’s most visible adaptation over the past five years is the reduction of its trading-related businesses (Institutional Services, and Lending and Investment) to a mixed 61% of online revenues from 75%, and in increasing its global reach.
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GS prides itself in having transitioned into an company (25% of its workforce). However, for almost all their success in adapting to the near future, both GS and JPM are lagging well behind where they want to be in conditions of shareholder returns. 23 billion less than Wells Fargo, which is 30% smaller in terms of assets.
JPM now deals at 104% of reserve value (WFC is at 150%), and in December 2015 had a ROE only 0.10% higher than its cost of equity capital (WFC was 5.70% higher). GS has done much better than most also but not as well as JPM. Darwin never said it was easy. Adaptation to radically different environments does take time and it is painful and uncertain. But someone has to emerge as the fittest, and capture the advantages of survival. JPM and GS are betting it will be them.