Money Stuff: It’s Not All Bad for Banks

Money Stuff

Programming note: Money Stuff will be off tomorrow, back on Thursday.

Bank earnings

The bad news, for JPMorgan Chase & Co., is that it is mostly a giant bank that is in the business of lending money to people and companies, and now lots of people have lost their jobs and lots of companies have lost their revenue, and so they will have a hard time paying JPMorgan back. It is early in that process, but the bad news looks pretty bad:

JPMorgan Chase & Co. said first-quarter profit tumbled 69% to the lowest in more than six years as credit costs surged, giving investors a first glimpse at the extent of the damage Covid-19 is wreaking on bank results.

The company set aside $8.29 billion for bad loans, the biggest provision in at least a decade and more than double what some analysts expected, as it grappled with the effects of the coronavirus pandemic on the economy. That prompted JPMorgan's first drop in profit since the fourth quarter of 2017.

Here are the earnings release and financial supplement. Among the bad news: JPMorgan set aside $4.5 billion of extra reserves for losses in its consumer bank, mainly on credit cards, and marked down its bridge loan positions by $896 million. If you lend money to people and the economy collapses, they stop paying their credit card bills; if you lend companies money briefly before re-funding in the capital markets, and the capital markets collapse, you are left holding some number of bags.

The good news, for JPMorgan, is that it is also a giant trading firm that is in the business of buying stocks and bonds that customers want to sell and selling stocks and bonds that customers want to buy, and when stocks go up a lot, and then down a lot, and then up a lot again, that tends to be a good business to be in, for reasons we discussed last month. Banks' trading operations are supposed to do well when markets are volatile: Banks are in the business of providing liquidity, when markets are crazy liquidity is very valuable, and so banks can charge a lot for it. That tends to make banks safer in a crisis; as I wrote: "Trading operations are a hedge, an insurance policy against losing money in regular banking. If you just run a regular bank and lend a lot of money to businesses that now can't pay it back, this crisis is unmitigated bad news. If you run a universal bank with a big trading business that is minting money, this crisis is, you know, mitigated bad news." And here you go:

Some of the declines at JPMorgan were offset by gains in the bank's trading operation, which benefited from record volatility during the quarter as investors moved in and out of positions in response to the unfolding crisis. The bank generated $7.23 billion from trading stocks and bonds, the most on record, according to data compiled by Bloomberg.

The trading gains came off a wild three months for the markets, with stocks reaching record highs in January only to suffer the biggest decline since the 1987 crash as the extent of the pandemic started to become clear.

Equities traders generated a record $2.24 billion in the quarter, 28% more than a year earlier, driven by derivatives. Bond-trading revenue rose 34% to $4.99 billion, the highest in nine years.

Another bit of good news is—well, you know how the stereotype of financial crises is that when things get bad people rush to withdraw their money from banks? In this actual crisis, people are rushing to deposit more money at JPMorgan. Deposits were up 23% for the quarter, and grew in every line of business. In the 2020 financial crisis, as you would expect, there has been a rush for cash, but "cash" in the modern world means mostly "deposits at big stable banks." Customers have drawn down their credit lines and sold their stocks and bonds and Treasury bonds so they can get as much cash as possible, and then parked it at JPMorgan. (And regulation has responded by reducing restrictions on JPMorgan's ability to take their cash and park it in boring places like Fed reserves or Treasury bonds.) JPMorgan is a safe harbor in a financial crisis. That's kind of what you want, from your banks.

Trading desks

One reason that JPMorgan had a good quarter in its trading businesses is that market meltdowns are often good for bank trading desks. But another reason that JPMorgan had a good trading quarter might be that it dragged a lot of traders into the office to trade, despite the coronavirus lockdowns and the risk to their health. The theory behind dragging them into the office was pretty explicitly that markets were nuts, it was a good time to make money, and it's a lot easier to make money if you're in the office. "With the amount of issuance trading we can really separate ourselves and do a great job for customers by being in the office," a senior credit trader told his team.

JPMorgan's earnings report is among the earliest of the big banks but it will be interesting to see if other banks that were less gung-ho about coming into the office will also have good trading quarters. Obviously physical presence at the office is not the only variable here, and every bank seems to have had some traders in the office and others working from home, and we're unlikely ever to get total clarity. Still I am rooting for some other banks to announce even better quarters in their trading businesses, and to add "oh by the way we sent everyone home early on and kept them home, they made us all this money safely." It will be a little unsettling if the takeaway from this crisis is "we risked our employees' health to make some extra money, and it worked great."

Along with JPMorgan, Bank of America Corp. also seems to have been especially gung-ho about going into the office. "The reason why it's called critical function is because we have a critical requirement by senior-ups to provide proper and orderly markets," one senior trader told his team to get them back into the office. Here is a New York Times story about "the hard-driving culture that has come to dominate Bank of America's global markets division since Thomas K. Montag, now the bank's president, joined the firm 12 years ago," and how that played out in the coronavirus crisis. It features these anecdotes from the pre-coronavirus times:

Mr. Montag has been known to monitor the comings and goings of his trading team, sometimes leaving notes on their desks noting the time — usually after 5 p.m. — and asking where they had gone, since he was still there, according to two former executives. Once, during a presentation to his top lieutenants at an off-site meeting in Barcelona, Mr. Montag put up a slide showing the number of attendees who had taken the redeye flight to Europe and those who had flown during the day, on what is pejoratively known in financial circles as "the chairman's flight." The move was widely seen as an attempt to chide those who spent the extra day traveling rather than flying all night to avoid losing productivity, say two people who were there.

Honestly that's amazing? The stakes were way lower then, of course, back when being hardcore about being in the office all the time was funny rather than dangerous.

Stakeholder capitalism

We talked yesterday, as we do from time to time, about the Business Roundtable's big announcement last year that from now on the purpose of the corporation is not going to be making money for shareholders, but rather serving the interests of all stakeholders. One possible interpretation of that announcement is that the Business Roundtable, a group of chief executive officers of big companies, really cares about the environment and workers, and intends to make changes to protect the environment and empower workers. Another possible interpretation is that the CEOs in the Business Roundtable do not like having to answer to shareholders for their performance, and would prefer to have a good excuse for brushing shareholders off. "Oh you greedy shareholders, always telling us to make more money," CEOs can say when activists complain about the lack of money; "don't you know that money is no longer the most important thing?"

When the Business Roundtable statement came out, I went with the second interpretation; as I put it yesterday, "'stakeholder capitalism,' as endorsed by CEOs, always means reducing CEOs' responsibility to shareholders, not increasing their responsibility to workers or society or anyone else."

But your choice of interpretation implies some empirical predictions. If you think that the Business Roundtable cares about workers or the environment, you might predict that the companies whose CEOs signed the statement (1) would have better environmental records and treat workers better than companies whose CEOs didn't, but (2) would have worse financial performance for shareholders. If you think that the Business Roundtable mostly cares about averting shareholder pressure, you might predict that (1) they wouldn't have better environmental or labor records but (2) they would still have worse financial performance for shareholders. In the cynical interpretation, "stakeholder capitalism" means only worse returns shareholders, not better treatment of any other stakeholders.

There is of course a literature. Here is "Do the Socially Responsible Walk the Talk," from February, by Aneesh Raghunandan at the London School of Economics and Shiva Rajgopal at Columbia Business School:

Relative to within-industry peer firms, signatories of the BRT statement have higher rates of environmental and labor-related compliance violations (and pay more in compliance penalties as a result), despite the BRT statement's specific reference to employees and the environment. These compliance violations do not just reflect trivial matters; BRT signatories are also more likely to have paid a settlement in lawsuits alleging workplace discrimination or wage theft. Signatory firms have higher market shares, suggesting that they may be more likely to face scrutiny in future mergers and acquisitions (M&A) transactions. Consistent with the idea that BRT signatories attempt to head off potential regulatory scrutiny, they spend more on lobbying policy makers than their nonsignatory counterparts. Moreover, our findings on market shares and lobbying are unlikely to reflect superior business performance because signatory firms report lower stock returns alphas and worse operating margins. Despite this underperformance, we find that BRT signatories' CEOs are paid more relative to peer firms; this may be associated with the finding that BRT signatories' boards contain a lower percentage of independent directors, relative to non-signatory firms.

There are other ways to measure these things. And we are still pretty early in the Business Roundtable's new paradigm of "companies are for everyone, not just for shareholders," so perhaps they are still figuring out how to treat stakeholders better; one can't be entirely cynical. But so far the basic stylized facts are what you'd expect from the cynical interpretation: Companies that signed on to the Business Roundtable's statement do worse for shareholders, sure, but they also do worse for employees and the environment. They pay their CEOs more, though, which is perhaps the real point.

The Ackman trade

Last month, after Bill Ackman disclosed more details of the gigantic credit hedge trade that his Pershing Square Capital Managment fund put on to hedge against the coronavirus, I gave a stylized rundown of the numbers. Basically I assumed that he put on a five-year credit default swap trade on about $60 billion notional amount of investment-grade credit, paying $27 million for the first month's protection, and cancelling it after a month for a $2.6 billion profit. An amazing trade, though not quite as amazing as I (and others) had first thought: It's not exactly that Ackman bet $27 million to win $2.6 billion; it's more that he bet $27 million per month—and ran the risk of losing billions—and happened to win the $2.6 billion after the very first month.

Anyway now the Financial Times has the real numbers:

Mr Ackman quietly scooped up a set of huge insurance policies linked to $71bn of corporate debt — ten times Pershing Square's assets under management. By the time he exited the position, he had paid only $27m in premiums. …

According to a person familiar with the trades, Pershing Square built up CDS on $50bn of US investment grade debt, a $18.5bn position in the equivalent European index, and a $2.5bn notional exposure to Europe's high-yield debt.

Such policies typically last for five years, but Pershing Square paid less than the first month's $40m premium. By early March, investors were waking up to the implication that stopping the spread of Covid 19 meant entire industries, including airlines, travel and hospitality, would essentially shut down for an unknown period. 

In short order the cost of insuring debt quadrupled. "In the first couple of weeks of March there were a lot of buyers and very few sellers", said David Riley, a partner at BlueBay Asset Management. 

Mr Ackman had to stomach huge swings in the value of the firm's CDS position as US markets leapt and plunged as well as an enormous $485m yearly premium if he was forced to hold on to it for longer than anticipated. 

On March 13, for example, the S&P 500 rose 10 per cent in a day and the value of Pershing Square's contracts dropped by $800m, a person familiar with the firm said. This was a hair-raising amount of volatility for a position that had come to represent about 40 per cent of the firm's assets at its peak. 

Mr Ackman began to sell as fast as he could without alarming the market and after offloading the insurance policies, he had booked a $2.6bn profit.

Ahh that's still pretty great. In rough numbers, a $71 billion position in five-year CDS should move by about $35 million for every basis point that credit spreads move. (That is, 0.01% times $71 billion times 5, though really you should discount that a little for time value.) If credit spreads had widened by one percentage point, Ackman would have made $3.5 billion; if they had tightened by 0.1%, he'd have lost $350 million. If they'd stayed flat, he'd have been on the hook for that $485 million annual premium. In fact, he put the trade on when the index credit spread was "close to the lowest it has ever been: around 50 basis points of the insured amount for investment grade debt, per year," so he could only lose so much, and spreads quickly blew out to more than 120 basis points, thus the $2.6 billion profit.

There is nothing especially fancy about it; it's just a great trade. All he did was make a huge bet that investment-grade credit would get worse, at exactly the right time—when investment-grade credit was as good as it had ever been, right before it collapsed.

People are worried about dividends and buybacks

One thing that I used to do as an investment banker was advise companies on how to buy back stock. Part of that advice sometimes involved whether to buy back stock, and specifically whether a company should return money to shareholders via stock buyback or dividend. To be clear, as a banker, your preference is for stock buybacks over dividends, for the simple reason that banks make money from stock buybacks, while they don't generally make any money from dividends: A company needs to hire a bank to execute a buyback, while with a dividend the company just sends out money to shareholders without paying any fees. 

But there are also good reasons for the company to prefer buybacks over dividends. The best reason is quite well known: Buybacks are more tax efficient; a dividend imposes taxes on all shareholders, while a buyback is only taxable to shareholders who actually sell (and then only to the extent of gain). Another, somewhat less good reason is also well known: Buybacks tend to be accretive to earnings per share (since they reduce shares outstanding), while dividends aren't. Among those who dislike stock buybacks, both of these reasons are controversial; the first can sound like tax evasion, while the second can sound like accounting fakery.

A third argument that bankers will give to prefer buybacks is that they are more "flexible." What this means is that if you have $100 million a quarter to spend on capital return, and you spend it on buying back stock, and then one quarter you turn out to have no money to spend on capital return, you just don't buy back any stock that quarter. It's fine. Companies regularly start and stop buyback programs. Investors would prefer bigger and more consistent buybacks over smaller and inconsistent ones, but that is a mild preference, and if you stop buying back stock they'll live. 

On the other hand if you have $100 million a quarter to spend on capital return, and you spend it on a regular 25-cents-a-share quarterly dividend, and then one quarter you turn out to have no money to spend on capital return, you can't just cut the dividend. I mean, you can; it's not illegal or anything; the shareholders can't force you to pay the dividend. Companies do cut their dividends when they come on hard times. But expectations around dividends are way stronger than expectations around buybacks. 

And so for instance it is relatively straightforward, in the current environment, for companies to stop buying back stock to preserve cash, but it is much harder for them to stop paying dividends. We talked recently about how companies are paying dividends without profits, how "European low-cost carrier easyJet drew criticism for proceeding with a £175m payout last month to shareholders despite grounding its entire fleet." And we talked last week about how U.S. banks want to keep paying dividends because, they argue, "cutting them would be 'destabilising to investors.'" "That's what creates a financial crisis," says an analyst; "when dividends start to be ratcheted lower that shakes confidence." I was unimpressed by this argument; I wrote:

If you take seriously the claim that banks can't cut dividends in a generational crisis, for fear of undermining investor confidence, then, fine, I guess, but then the obvious conclusion is that when times are good you can never let banks raise their dividends. Every time a bank raises its dividend, on this theory, it incurs more unavoidable quarterly debt and creates a new drain on its funding, one that can't be turned off in the bad times for fear of being "destabilising to investors." 

Now, I tend not to take that claim too seriously; I think that companies (and even banks) can temporarily cut their dividends in times of plague without causing a financial crisis. Shareholders are supposed to be risking their money; surely their income should be cut before that of bondholders or employees or suppliers.

Still it is a very popular claim and it is worth taking a little seriously. Simply, the claim is that a company with a regular dividend cannot cut that dividend without causing a crisis of confidence that will make its financial situation worse: It might save some money by cutting the dividend, but it will spark a panic that will make it harder for it to raise money, will make customers and lenders nervous, etc. On the other hand a company with a regular stock buyback program can stop it at any time to save money without freaking anyone out.

My impression is that most people who dislike stock buybacks dislike them more than they dislike dividends. Because of the tax-evasion and earnings-fakery arguments, because buybacks are viewed as a trick to increase executive pay, because there is a theory that they are "stock manipulation," because dividends are sort of quaint and old-fashioned, etc. If those are your concerns I suppose you can keep disliking buybacks and grudgingly accepting dividends. But if your specific concern, now, about stock buybacks is that they wasted money that companies turned out to need for the present emergency, then you should be more concerned about dividends. Dividends are still wasting money that companies need for the present emergency, just because they are harder to turn off than buybacks are. Dividends happen every quarter whether they make sense or not; buybacks don't.

Anyway here is Nathan Tankus arguing that the government should "Suspend Dividends and Buybacks During the Crisis":

Some will object to this on the idea that financially healthy companies shouldn't be "punished". The problem is it's hard to know what is a financially healthy company and what is a company three months away from needing grant assistance in such uncertain and volatile times. Further, what public purpose is there for a company to be making dividend payments or conducting buybacks during this time period? Whatever one's opinion about dividends and buybacks in general, it's clear that in a crisis they drain companies of their most precious asset- cash. At the same time, not making these restrictions universal generates a powerful perverse incentive for companies to payout cash and then ask for assistance. 

More generally, why should we let companies gamble and lose on whether they need financial support in a futile attempt to keep the payouts going? It is a far greater harm for companies to make payouts and then need funds than it is for companies to have to wait until the crisis is over to make payouts. 

I think this would be pretty hard to pull off as a practical or legal matter. (What authority does the federal government have to forbid dividends? What limits that authority to a global pandemic and not, you know, any time people are worried about corporate leverage?) Still I think there is some force to his argument, and I think that the counterargument from a lot of healthy-ish companies would be of the form "no, we have to pay out dividends, people are relying on them, and if we don't they will panic." That's kind of a worrying argument too!


To me, the paradigmatic small business that needs and deserves a government bailout right now is a restaurant. There are lots of good restaurants that employ a lot of people and provide a useful service that customers value and pay for, and then they were all shut down by government decree due to a pandemic that is not their fault. When the pandemic ends we will want restaurants, and the restaurants that we had before will presumably still be the ones we want, but we can't have them now; it seems socially beneficial for the government to keep them on ice—give them money to pay their employees to keep them around—for when normal times return. The government told them to shut down; it should soften the blow of that decision for them.

On the other hand there are lots of white-collar knowledge-work-y businesses that nobody told to shut down. They were told to work from home, and if your job is making spreadsheets and typing emails you can probably do that from home. In principle there is no first-order reason that these businesses can't continue working more or less normally.

But there are lots of second-order reasons that they can't. Schools are closed, and, I can say from some personal experience, it is harder to make spreadsheets and type emails when you are caring for children all day. Also the fact that so many other businesses are closed has knock-on effects: If you work in a white-collar knowledge-work-y business, your work is probably in some sense derivative of other businesses, and if they are closed then your revenue might dry up too. If you work in ad sales, you can keep selling ads from home, but if retail businesses shut down you will sell fewer ads.

I suppose hedge funds are a particularly unsympathetic category of white-collar knowledge-work-y business? They are not closed by government decree. In some vague theoretical way they are supposed to be "hedged" (or at least that's in the name), so their performance and revenue are not supposed to be too levered to general economic conditions. They have a reputation for paying more than a lot of other businesses. If there is a limited pool of government funding to keep small businesses afloat, or if there is a limited pool of bank attention and resources for distributing that money, you might expect hedge funds to be low on the priority list. 


Since early April, law firms have hosted Webinars and sent out alerts, and accounting firms have reached out to clients, all with the goal of explaining how they might be able to tap into the Paycheck Protection Program. The $349 billion package administered by the Small Business Administration provides loans to cover payroll, rent and utilities for up to eight weeks. The loans can convert to grants if recipients retain or rehire their workers.

Some hedge funds already have applied, filling out forms to show they have fewer than 500 employees and certifying the "current economic uncertainty makes this loan request necessary to support the ongoing operations." …

The question of whether to partake in the program is dividing members of the money management community. Some traders have called it morally corrupt, while others insist they are small businesses -- just like hair salons, restaurants and dry cleaners -- that could use a helping hand after global markets tumbled and cost them money. Given that the program is first come, first served, some managers were quick to submit their paperwork, according to market participants, even if eligibility remains unclear. …

One manager, who asked not to be named, said he was outraged when he received a note from his accountant analyzing his potential eligibility. Why, he asked, would a hedge fund that earns its money collecting management fees, and can make money if it's skilled, avail itself of a government handout?

"It's a complete abomination," agreed Nate Koppikar, a partner at San Francisco-based money manager Orso Partners. 

We talked about this controversy last week, and I said that my impression is that "hedge funds are not quite the intended target for these grants." But I am not exactly sure that's right; lots of white-collar knowledge-work small businesses are suffering from the current crisis, and I guess if your hedge fund is one of them you kind of are an intended target? Maybe? (As that article says, their regulatory eligibility is maybe a bit unclear.) "If you're a hedge fund applying for government grants, let me know why I'm wrong," I wrote, and one manager did. From that manager's email:

Due to the collapse in management fees, it pained me but I had to let two staff members go. Then I thought we could apply for a PPP loan to keep us going a couple of months to see if things turned for us. Worst case I got to employ them two more months and to provide healthcare. Best case we came out of this well and I got to keep them even longer. ...

I'm glad you wrote the piece today because I frankly hadn't realized there would be pitchforks out for funds like us. I am going to reach out to our [investors] to see their thoughts. If they advise us not to take it, sadly this means on Tuesday I'm going to fire the two employees, neither of whom are rich, ivy educated people like what is pictured at a hedge fund. 

I realize how unsympathetic HFs are and also that many HFs with management fees to spare could decide 'oh, free money' and take from the program. But in our case, the soak the rich mentality is unfortunately going to cost jobs and it's not of people who will dejectedly just go back to their Hamptons houses and bemoan that they couldn't take the helicopter.

Things happen

Coronavirus Pandemic Fuels Rapid Increase in Missed Mortgage Payments. China Weighs Merging Its Biggest Brokers to Take on Wall Street. SoftBank Expects Nearly $17 Billion Loss on Tech-Focused Vision Fund. WeWork U-turn reignites SoftBank and Benchmark battle. China's Big Oil Urged to Copy Mexican Hedge Amid Price Crash. The U.S. Postal Service Has Never Been More Important, or More Endangered. Federal Reserve faces blowback over plan to back some cities over others. Anthony Scaramucci's Firm Hit Hard by Credit Collapse. WWE deemed an essential service, returns to live televised shows. A 64-year-old man accidentally ejected himself from a fighter jet at 2,500 feet. 

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