Recently, large banks reported second quarter earnings. While overall earnings were generally down due to the impact of the pandemic, one bright spot for large banks was earnings from underwriting corporate bonds and equity. As we have previously discussed, large banks have led the way in supporting companies all across the country to secure much needed funding to keep their doors open, employees paid, and the economy operating during this pandemic. Large banks have continued this trend well into the second quarter, having helped raise over $868 billion in corporate bonds and $135 billion in equity for U.S. companies. This capital raising by large banks fulfills an absolutely critical need in the economy to connect savers, such as pension funds and endowments, with companies like Pfizer and 3M that need to borrow capital for everyday business needs.
The earnings generated by large banks from these underwriting services are an indication of the value they create for savers and borrowers alike. In addition, the diversifying nature of underwriting revenues that are providing a helpful lift to large bank earnings in a period of economic stress should be viewed as supporting a safe and sound banking sector that ultimately supports the whole economy during these uncertain times.
Capital Raising During the Pandemic
Companies all across the country have seen their activities curtailed as a result of the pandemic. Social distancing and related measures have shut down an array of workplaces while also severely crimping demand for goods and services. At the same time, companies are unable to walk away from their obligations to their employees, vendors and other stakeholders. In order to manage through this pandemic, companies have increasingly turned to public capital markets to provide much needed temporary financing. And Financial Services Forum members are key partners in helping companies access public markets as they facilitate over 70 percent of stock and bond underwriting in the United States. As shown in Figure 1 below, U.S. companies issued over $868 billion in corporate bonds and over $135 billion in equity during the second quarter of 2020. Comparing these amounts to the amount of debt and equity issued in last year’s second quarter shows that U.S. companies have essentially doubled their debt and equity raising activity. U.S. companies are raising capital from public markets at an accelerated pace in direct response to the challenges presented by the pandemic. And large banks, such as Financial Services Forum members, are working hard to ensure that companies like 3M and Pfizer can continue the important work they do to support the economy and play their part in combating this pandemic.
Earnings Generated from Underwriting Reflect Value
In the wake of second quarter earnings releases, some have suggested that large bank earnings generated from underwriting services somehow represent “ill-gotten gains.” This perspective is misplaced and doesn’t fully recognize the value that these services create for both savers and borrowers or the competitive nature of the market for underwriting services. Large banks expend a significant amount of resources in underwriting debt and equity. Matching borrowers with savers requires a significant amount of expertise in a variety of technical areas including finance, accounting and legal. All of these activities take time and expertise that must be compensated. Imagine a natural disaster that knocks out a bridge that must be repaired. All of the required materials such as concrete, steel and cable must be purchased in a competitive market, and all of the people who put that bridge back together – engineers, construction workers, and the like – must be paid a competitive wage. Similar economic forces generate earnings for large banks and their employees as they work hard to build bridges between savers and borrowers in the underwriting process.
Also, and importantly, right now underwriters are working full tilt to connect savers and borrowers. In general, when there is an increase in demand for a service then the amount of earnings generated from that service rises. If a construction company doubles its bridge repair work after a catastrophic flood, they will generate more earnings from repairing a greater number of bridges. In this sense, the torrent of underwriting that is occurring in the wake of this pandemic can be meaningfully compared to the surge in economic activity that follows a natural disaster. These earnings represent the value of the good and meaningful work that large banks are doing to support the economy during these tough times.
The U.S. economy is struggling to meet the many challenges presented by the pandemic. A key challenge is the vital need to keep companies operating so that our economy can continue to function, people can continue to be paid, and the critical goods and services that are so important right now can continue to be produced. All of this requires financial resources and companies all throughout the country are turning to public capital markets to access the capital they need to keep their doors open. Large banks have played an outsized role in connecting savers with companies that need access to funding. The earnings generated from these services represents the value they create for both savers and borrowers in a competitive market. Finally, the lift that these earnings provide during this period of stress helps to offset some of the costs associated with the pandemic. As a result, these earnings help to diversify the revenue stream of large banks and promote a healthy and safe banking system that supports the whole economy.