“Borrow at three, lend at six, be on the golf course by three.”
Banking is a notoriously challenging business, but over the last few decades, the largest banks have increasingly gained market share from smaller competitors. The largest banks, called money centers, have a wide variety of business lines which make them less dependent on traditional retail banking. Retail banking revolves around taking deposits from customers, and then either lending out 90% of those deposits at higher interest rates, or investing in assets which generate income, like Treasury notes or bonds. Banks often borrow sums against the value of those deposits to make more money with the loans that are underwritten. Commercial banking is linked to retail banking, with bank lending going to commercial entities, think businesses and real estate owners or developers. Investment banking is a different business line, involving the underwriting of stocks and bonds, currencies, and commodities (along with options on those assets). They also provide advice to businesses on mergers and acquisitions, or helping hedge funds raise money and invest, called prime brokerage. Over the last fifty years, banks have increasingly added other business lines like payments for debit and credit cards, mortgage lending, auto lending, and asset management. You can see there are a wide range of business activities a bank can have. The one constant with banking is it is potentially a very profitable business, but risk management is the highest priority. Over the last few weeks, as the financial world learned about the blow up at Archegos, the bread crumbs get followed to the banks which financed it’s actions. Let us turn to two entities, Credit Suisse and JP Morgan Chase.
Credit Suisse is one of the largest banks in Europe and does a large amount of business in Asia. It’s primary two lines of business are wealth management and investment banking. Over the last five years, it showed improved performance but the last year has seen multiple errors in risk management wipe out a great deal of capital, along with it’s highly valued Swiss banking reputation. Over the last five days, the head of it’s investment bank and it’s chief risk manager got shown the door only six months after they replaced their predecessors. The Archegos scandal will cost the bank a cool billion for the quarter, only a few short days after revealing a supply chain financing problem as well. From a competitive standpoint, I am sure the leadership at UBS is taking a good hard look at the issues at Credit Suisse to see how they could potentially capitalize. There are probably five other large banking entities doing the same thing. One of them, without question, is JP Morgan Chase. JP Morgan turned down business from Archegos, while Credit Suisse did not. Enough said. Let’s delve a little closer into JP Morgan Chase, shall we?
It is run by the legendary banker and leader, Jamie Dimon. Mr. Dimon released his annual shareholder letter last week, and for any business person, I would highly recommend reading it. Chase is number one or two in every business line, and will generate nearly fifty billion dollars of operating profit on over one hundred and twenty billion dollars of revenue. It is the most profitable bank in the United States and has the highest market value of any bank in the world. Yet, it’s leader emphasized in the letter that banks will be threatened by fin tech companies like Amazon, Google, and Facebook, among others. He discusses a wide variety of business and competitive issues, along with societal challenges and political dysfunction. More importantly, he comes up with ways to attempt solve the problems. In hindsight, one of the great opportunities I missed out on that was right in my wheelhouse was when Mr. Dimon became the CEO at Bank One. I was well aware of how good a leader he is, and did not pull trigger when he took over that entity. Live and learn, and the important lesson I learned is when you know how high quality a leader is and have the chance to invest with them at the ground floor, you are making a big mistake if you do not.
Elsewhere, JNJ had to cut back production of it’s Covid vaccine because of supply chain issues. It could potentially be a setback for the country and world in terms of how long it will take to vaccinate the majority of our citizens. Here in Las Vegas and other parts of the United States, optimism about the recovery seems to be accelerating, at least from my perspective. Las Vegas seems as busy as it ever was and we are only at fifty percent capacity at the hotels. The Caesars CEO made comments emphasizing the hotel chain’s strong bookings here in Vegas. The next few months will be important in terms of maintaining the vaccination progress, and the emerging strains bear continued monitoring, but hopefully there is a good chance by the end of the year the United States will be starting to move past the Covid virus. Next week, the largest banks will be reporting their earnings, and you can bet the investment community will be watching their risk management comments quite closely.
Thank you for reading the blog this week, and if you have any questions about investing, please email me at email@example.com.
Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of ones principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one’s overall financial situation. The fact that Yale Bock has earned the right to use the CFA designation does not mean Y H & C Investments will outperform broad market indexes.