Don't get me wrong-the fallout from Brexit will be a net negative for JPMorgan (NYSE:JPM) and other multinational banks. A prolonged period of low interest rates will keep net interest margins suppressed, investor uncertainty will weigh on trading revenues, and many corporate borrowers will refrain from raising capital until more stability returns to the markets. In the three trading days that followed Britain's exit from the EU, shares of JPM declined 10%. But the news is not all bad for JPMorgan, and the bank will benefit from Brexit in one major way.
JPMorgan has made it a strategic imperative in recent years to expand into developing countries, particularly the Middle East. The move has started to pay off, as the large drop in oil prices over the last two years has left governments in the Gulf region starved for cash. In order to fund their budget shortfalls these states have issued billions of dollars in sovereign debt. JPM's entrenched relationships with Gulf state borrowers has allowed it to secure major underwriting wins in recent months (such as the $9 billion offering from Qatar in May), and the bank is now the market leader in sovereign bond issuance in the Middle East with 34%, according to Bloomberg.
The IMF predicts budget shortfalls in the Middle East will reach $900 billion by 2021. Governments will keep having to borrow, but it becomes increasingly difficult to do so as leverage levels grow and interest payments mount. But Brexit provides a catalyst that can drive loan growth in emerging markets. Brexit gives Janet Yellen the excuse she needs to keep rates at rock-bottom levels for the remainder of the year. With interest rates near zero (or negative) in the developed world, yield-hungry investors have nowhere to go but emerging markets. Capital has begun flooding back into these regions, pushing yields down. Since Brexit, the average emerging market bond yield declined 26 basis points to 4.44%, a three year low.
This is the exact reversal of what has been going on in recent years as capital spilled out of emerging markets in anticipation of the Fed's "lift-off". Many countries, starved of funds, found it more difficult to borrow and growth slowed. But now that the money is returning, borrowers are looking to take advantage of the low yields. This is especially true for JPM's clients in the Gulf Region, whose mounting fiscal burdens have made it all the more necessary to borrow cheap whenever possible. This could potentially be a big windfall for JPMorgan: Saudi Arabia and Kuwait are now looking to borrow $10 billion and $9.9B respectively, with JPM as the lead underwriter. We are also optimistic about India. Some of JPM's peers have divested away from the country due to protectionist regulations that make life difficult for foreign banks, but JPM recently announced that it would open three new branches in India. The IMF predicts that India will be the fastest growing emerging market in 2016 and 2017, and lower interest rates will only boost what is already a healthy demand environment.
Like most banks, JPMorgan needs a lifeline. Weak global growth, rock bottom interest rates, credit losses from oil customers, widespread uncertainty, and heavy regulations have weighed on growth and profitability. Now the sector has to deal with Brexit. JPM's debt underwriting fees in the first quarter fell 35% year over year to $531 million, the lowest level since the financial crisis in 2008. But while Brexit presents new challenges it also creates a minor tailwind - one that will drive loan growth in emerging markets, regions that JPM has considerable exposure to. In 2015 EMEA and the Asia Pacific accounted for almost one quarter of total revenues. JPM is still too reliant on the US consumer for our liking, and Yellen's refusal to hike rates makes us even more pessimistic about the outlook for JPM's Consumer & Community Banking segment. But where one door closes another opens, and that door could be a lucrative one.
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