Investors keeping tabs on the financial sector probably know these banks face a major headwind right now. Although higher interest rates make lending a more profitable business, they also crimp demand for loans. They also tend to swell delinquencies and defaults because higher rates can curb economic growth while curbing inflation.
For a narrow sliver of financial stocks, however, the coming year could be much better than expected for one surprising reason. While mergers, acquisitions, and public offerings remain at subdued levels, that’s likely to change in a big way very soon. That’s great news for Goldman Sachs (GS 0.41%) and JPMorgan Chase (JPM -0.27%), both of which are key players in the capital markets and advisory business.
The struggle is real
It’s been a lackluster couple of years in dealmaking to be sure. The worldwide value of the third quarter’s mergers and acquisitions was around $700 billion, according to numbers from Dealogic, mirroring 2022’s Q3 tally that was well short of 2021’s third-quarter pandemic-prompted M&A worth more than $1.5 trillion. In fact, Bloomberg reports year-to-date mergers and acquisitions are the lowest they’ve been at this point in the calendar year since 2013.
This slowdown is taking a toll on investment banks’ top and bottom lines.
In pre-pandemic 2019, JPMorgan Chase would have seen somewhere around $6 billion worth of investment banking revenue through the first three quarters of the year. The number’s nearer $5 billion this year, down from last year’s depressed figure of just under $5.3 billion.
Goldman Sachs has done less than $4.6 billion worth of underwriting and capital markets business through its third quarter of 2023 — the bulk of it being advisory business — down 17% year to date. That comparison was $10.5 billion in 2021, and $5.3 billion at this point of pre-pandemic 2019 — when companies were neither looking for suitors nor in need of cash.
Meanwhile, Bank of America‘s (BAC -0.40%) mergers and acquisition business through the first half of 2023 is down nearly 40% from 2022’s already-low levels, according to numbers from research firm GlobalData.
Look for a turnaround on this front sooner or later, though, with some industry experts predicting it to start taking shape as soon as next year.
Let’s make a deal!
That’s the good news. The bad news is the reason why so many companies will start showing a strong interest in either being acquired or teaming up with a rival — they’re running out of money.
That’s the take from Discovery Capital Management portfolio manager Jon Redmond, anyway. Speaking at the AlphaMarket Growth Summit last week, Redmond said, “According to our models, there’s 1,200 private companies right now that by the end of 2024 will run out of cash.”
And he’s not alone. Speaking at the same conference, Hudson Bay Capital Management’s Head of Equity Capital Markets Brian Sunshine said: “As those sort of cash piles dwindle in the first half of ’24, they’ll be faced with a challenge of what to do. I think that will be the catalyst for M&A to reemerge.”
This makes sense. Would-be borrowers are increasingly wary of taking out loans at relatively high rates. Pairing up with another bank might be the better long-term choice.
Meanwhile, whether or not a lack of liquidity is a problem, it’s just time for a turnaround. As Evercore‘s U.S. Investment Banking head Naveen Nataraj recently told Reuters: “The view looking forward out of the windshield is very different from the scene looking at the rearview mirror. It’s very consistent with historical trends where after a boom year like 2021, it takes about two years for the market to bottom out, settle, and find its footing — and we are seeing that.”
And it’s not just privately owned companies apt to be snapped up, either. Private equity firms are loaded up with cash too, perhaps on the prowl for promising publicly traded companies in need of cash. Data compiled by Crunchbase late last year suggests private equity firms started 2023 out with $1.3 trillion worth of capital, jibing with PitchBook numbers cited by Goldman’s Chief Credit Strategist Lotfi Karoui. That’s roughly an entire year’s worth of worldwide dealmaking. Meanwhile, venture capitalists ended 2022 sitting on $580 billion worth of cash.
Some of this cash has been deployed in the meantime. Much of it hasn’t. Any of this would-be dealmaking bodes well for middlemen like Goldman and JPMorgan, though, as these financial names get paid to help make these complicated M&A deals happen.
Winners and losers
Most national and regional banks can help connect equity buyers and sellers. The M&A industry’s current dynamic, however, favors some banks much more than it favors others.
The aforementioned Bank of America as well as JPMorgan are two of the more favored banks. Both operate sizable underwriting businesses, and both have good reputations as middlemen who can cleanly steer a deal as it’s intended to be done (going private, going public, merger, fundraising, etc.).
Perhaps the company with the most to gain from a revival of the M&A market, though, is Goldman Sachs. Roughly one-fifth of its current business consists of investment banking fees, but that’s a historically low proportion of its top line. When the company’s underwriting arm is firing on all cylinders, investment banking could be much more fruitful.
And this brewing growth for Goldman Sachs’ capital markets arm may already be underway. While last quarter’s investment banking fee revenue and income weren’t anything to write home about, Goldman Sachs’ CEO David Solomon commented in September that several significant public offerings seen this year are driving a “virtuous cycle of bringing more of the pent-up backlog to market.”
It takes more than one quarter to turn this pent-up backlog into real revenue. It doesn’t take more than a year, though, making 2024 a promising year for the company. In the meantime, GlobalData reports Goldman handled more dealmaking value through the first half of 2023 than any other middlemen. There’s a reason it’s leading the charge (although it’s worth noting that JPMorgan Chase and BofA were second and third, respectively).
Whoever ends up winning in the end, this backdrop is yet another reason to expect more from the banking industry than the market currently seems to believe is in the cards.