How do balance sheets affect a banks performance? What about a bank’s (JPM, BAML) balance sheet enables it to compete better in IB? What exactly do banks use large deposits for?
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bigger balance sheets,= the ability to underwrite bigger deals in the capital markets. EB's IB business is for advisory- like yea they can advise on a cap raise, but dont underwrite at all
So basically, the more access to cash, the more business they can handle? And it doesn’t have to be banks with large deposits but banks with huge cash reserves as well?
Balance sheet has a multi faceted impact on a BB’s ability to compete.
1) source of capital determines cost of capital that needs to be cleared. For example, JP Morgan using deposits from consumers is cheaper than say, Jefferies lending money from Leucadia insurance arm (Leucadia is the parent company of Jefferies). So BB cost of capital is lower. As a result, you will see more of BBs lending Revolver credit facilities to companies. Revolvers (think of this as a credit line for companies) are very low interest...only a large bank with a low cost of capital can afford to lend at Revolver rates...and even then, these are considered “relationship” loans because Revolvers don’t generate sufficient returns for the banks (money could be used elsewhere) and revolvers are lent with the expectation that the companies will “compensate” the banks with other deals (i.e., M&A). So in summary, low cost of capital lets BBs foot in the door (this is important for relatively new, growing companies, especially).
2) Lending relationships provide an early learning curve. When BBs lend for Revolver credit, they conduct a lot of due diligence, and often than not, the companies will provide proprietary information to help bankers get educated on their business model so that subsequently those bankers can vouch for the companies in front of internal lending committees at the banks. So the bankers in Revolvers usually have a decent understanding of the company and access to management. Think about a scenario where there is a billion dollar company that BBs have not been covering as much. Say that company has been financing with regional banks with limited capital markets ability. Now a BB banker gets a meeting and make a good impression and helps them upsize their Revolver or even help them raise term loans from institutional investors. The companies will trust the BBs to execute and in the process educate the bankers. This is a steep learning curve. Now, the balance sheet size matters because the larger you are, the larger you can lend comfortably. For example, Bank of America’s lending committee is more comfortable lending large sum of money than say...Deutsche Bank’s committee because their balance sheet is so large so as a % of total balance sheet, there is a difference for the two banks.
3) in addition to the relationship/learning curve perspective, larger balance sheet also means ability to single-handedly run capital markets deals. For example, If a fifty billion dollar company wants to acquire a twenty billion dollar company and need to raise ten billion, they will need banks to “commit” financing (as in have them legally bound to fund the money from their own balance sheet even if the banks fail to raise funding from investors). These large deals can only be done by large BBs with large balance sheets...bc they have that much more money and from a risk perspective, they can afford to commit more dollars (even if it might be the same % of total balance sheet). This is an important edge. Now, from companies perspective, money is money. However, the ability to execute large deals is the difference. This matters in the context of large capital markets or M&A deals.
Good summary. Another example for your 3rd point are bought equity deals. Huge differentiator for a BB bank is that they can just buy the whole equity deal using their b/s, so a company can undoubtedly raise the funds instead of relying on a smaller bank to distribute the whole deal immediately to investors. Riskier for the bank obviously, but an effective way to win business.
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