February 13, 2014 6:25 pm

The real titans of finance are no longer in the banks


©Reuters

If the mighty J Pierpont Morgan were reincarnated in New York today, who might he be? Jamie Dimon, the man who is now chief executive of JPMorgan, the bank that shares the great man’s name? Or might Morgan prefer to return as Stephen Schwarzman or Leon Black, respectively the heads of Blackstone and Apollo, two gigantic private equity firms?

I would bet that his second coming would be as Mr Schwarzman or Mr Black. Never mind the fact that these alternative assetmanagers – as they prefer to call themselves now – are more entrepreneurial and swashbuckling these days than bank CEOs. And ignore the $100m plus in potential renumeration – including salary, dividends and shared profitsdrawn by both Mr Schwarzman and Mr Black, which makes Mr Dimon’s recent $20m package seem almost modest.

What is really striking is the volume of non-bank financing that is quietly being supplied to western economies with minimal regulatory scrutiny – a trend on which my colleague Henny Sender has reported extensively. The “non-bankers” who provide it now matter as much as the bankers, and they appear to be having more fun

Results released in the past two weeks by asset management groups illustrate the point. Last decade, Goldman Sachs’ return on equity peaked at 40 per cent. Last year it was just 11 per cent. Meanwhile, KKR’s return on equity was 27.4 per cent in 2013 - a margin that the banks can only dream of.

These groups’ recent profits were boosted by sales of companies they acquired several years ago. But today they are branching out beyond turnround activity, partly because there are fewer new deals around, and jumping into areas that were the terrain of banks: credit and property.

Only a quarter of Apollo’s $160bn-odd business is now focused on private equity. It has recently gobbled up so many corporate loans and bonds that its credit portfolio has exploded to more than $100bn, compared to just $4bn seven years ago. At Blackstone and KKR the switch is less dramatic: according to Bloomberg’s calculations, credit is just a quarter of their portfolios. But they are shifting focus too. Just last week, Blackstone announced plans to start extending mortgage credit as part of its property business.

Of course, a $100bn credit book is still smaller than that of JPMorgan. It is bigger than many midsized American banks, however. And the asset managers’ economic footprint is expanding in other ways too. Blackstone’s portfolio companies, for example, now have 600,000 employees and $79bn of revenue. “The private equity houses today look like merchant banks were 100 years ago,” observes Jes Staley, formerly head of JPMorgan’s investment bank (who now works at BlueMountain Capital, an investment group). “They are very big and powerful.”

This may not be entirely desirable. Non-banks are swelling in size because they do not face the same regulatory burdens as banks, allowing them to turn a profit on business that banks now find uneconomic. This worries regulators. The US Office of the Comptroller of the Currency recently warned that the activities of non-banks has fuelled a boom in risky corporate loans – and warned banks not to “skirt rules” by teaming up with non-banks to create more credit.

But the good news about non-banks is that they are not plagued with the maturity mismatches of real banks; they do not take retail deposits but attract long-term funding instead. That reduces systemic risk; or so regulators hope. And what nobody can denyeven those who dislike this regulatory arbitrage – is that non-banks’ business has swelled due to unmet demand. After all, the only reason that non-banks can turn a profit by extending credit is that banks are no longer supplying enough credit to risky endeavours, such as small companies.

The great irony of the post-2008 regulatory clampdown is that by forcing established banks to become safer, regulators have given wings to a gaggle of new financial players – with potentially unpredictable consequences. Call it, if you like, a triumph of Wall Street’s entrepreneurial spirit; or testament to its unseemly ability to run rings around rules. Either way, financial arbitrage is once again the theme of the day, and it is producing the kind of profits that J Pierpont Morgan would have savoured.


Copyright The Financial Times Limited 2014

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