Bank investors may have to wait at least another quarter for trading to rebound as analysts expect lower trading revenue in the current period, the fifth straight year-over-year drop, amid weaker volume and market declines.
Fixed-income trading revenue at U.S. banks likely will fall 30 percent from the first quarter, while equities trading will drop 15 percent, Keith Horowitz, a Citigroup Inc. (C) analyst, wrote in a report this week. Seven analysts have cut their earnings estimates for Goldman Sachs Group Inc. (GS) and Morgan Stanley in the past four weeks, according to data compiled by Bloomberg.
Wall Street faced lower trading volumes as clients stepped back amid concerns that the Greek debt crisis will spread to other European nations and evidence that U.S. economic growth is slowing. Declining trading revenue expectations have fueled share declines of more than 10 percent at each of the six largest U.S. banks since March 31.
“There are a number of headwinds and the markets haven’t really been cooperating,” said James Ellman, president of San Francisco-based hedge fund Seacliff Capital LLC. “This trend can turn around in a moment if clients become more active, and you get more volume and volatility in generally rising markets, but we haven’t seen that yet.”
Total trading revenue at the five biggest Wall Street banks -- Goldman Sachs, JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup, and Morgan Stanley -- may drop to $21.7 billion, a 4.4 percent decline from the second quarter of 2010 and 17 percent from last quarter, according to estimates by Chris Kotowski, an analyst at Oppenheimer & Co. in New York. Trading accounted for almost a quarter of the firms’ revenue last year.
The second quarter likely saw “a continuation of the sluggish risk-on/risk-off environment that we have had for the past four quarters,” Kotowski wrote in a report this week. His figures exclude charges tied to the firms’ own debt.
Revenue from fixed-income, currencies and commodities, or FICC, has been hindered this quarter by weak trading volumes, low levels of client leverage, widening credit spreads in high- yield and sovereign assets, and declining volatility, Horowitz said. Banks also are starting to see the effects of the absence of proprietary-trading groups that were shut down to comply with new rules, Ellman said.
“It’s not just the trading activity, it’s the shrinking of these prop businesses,” Ellman said. “As you shut those areas down, you lose some of the more profitable areas of FICC.”
Fixed-income trading revenue at the five banks fell 25 percent in the first quarter, compared with the first three months of 2010, according to company filings. Equities trading revenue dropped 4.5 percent.
Jefferies’s Profit Falls
Jefferies Group Inc. (JEF), the New York-based investment bank that’s been expanding its advisory and fixed-income businesses, yesterday reported that profit fell 3.8 percent in the fiscal second quarter ended May 31 as trading revenue decreased.
“The general climate pretty much throughout the quarter was one of clients being uncertain of direction of positions and basically not being very active on the trading side,” Jefferies Chief Executive Officer Richard Handler, 50, said during a conference call with investors. “As a result, you just do not get the natural flow that we enjoyed during the first quarter.”
David Trone, an analyst at JMP Securities, has cut his second-quarter earnings estimates for all five banks over the last two weeks. Fixed-income trading likely will fall 16 percent from the first three months of the year, while equities trading will probably fall 14 percent, he wrote in a note today.
‘Turbulent Macro Environment’
“Overall, cash equities trading volume is expected to decline in the second quarter compared to a seasonally strong first quarter,” Trone said in the note. “The decline will be challenged further by the turbulent macro environment which should further dampen investor activity as the appetite for risk decreases.”
Banks are turning to cost-cutting measures amid the lack of revenue growth. Morgan Stanley (MS) Chief Financial Officer Ruth Porat said earlier this month that the firm has commenced a three-year program to reduce expenses by $1 billion. Morgan Stanley may also cut 300 brokers in its wealth-management unit.
Goldman Sachs is aiming to reduce $1 billion in non- compensation expenses over the next 12 months, according to a person familiar with the matter who declined to be identified because the plan hasn’t been publicly announced.
Wall Street Cuts
Weak trading revenue so far this year is likely to lead to cuts on Wall Street, analysts including Meredith Whitney and Nomura Holdings Inc.’s Glenn Schorr have said. U.S. banks may accelerate announced job reductions after eliminating 11,400 positions in the first five months of the year, a 21 percent increase over 2010, according to Challenger, Gray & Christmas Inc.
Managing directors in the fixed-income trading divisions are likely to be cut, Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, said in a Bloomberg Television interview last week. The ratio of managing directors on staff at investment banks is going to drop to about 10 percent from 15 percent at well-run firms and from 20 percent at those that are poorly run, Hintz said.
“You don’t have to fire lots of people, you just need to fire expensive people,” said Hintz, adding that the 40 percent of compensation that goes to managing directors isn’t sustainable. “You are going to change the shape of the pyramid.”
After reporting record investment-banking and trading revenue for 2009, banks have had declines in those businesses for four straight quarters compared with year-earlier periods. A fall in fixed-income trading revenue, the biggest capital- markets business for the banks, largely spurred the decreases.
Aggregate fixed-income revenue for the five U.S. banks and four international rivals -- UBS AG (UBSN), Credit Suisse Group AG, Barclays Plc, and Deutsche Bank AG -- dropped to $101 billion last year, from a record $146 billion in 2009, according to Schorr, a Nomura analyst in New York.
Commodities trading revenue for 10 of the largest U.S. and European banks rose about 55 percent in the first quarter from a year earlier, according to a report last month by London-based research firm Coalition Development Ltd. That led commodities to contribute 7 percent of overall fixed-income trading revenue in the quarter, up from 4 percent in the first quarter of 2010, Coalition said.
Commodities trading probably won’t provide the same boost in the second quarter, Citigroup’s Horowitz said. That may lead to Goldman Sachs and Morgan Stanley, which have large commodity businesses, reporting larger FICC revenue declines than their competitors, he wrote.
Crude oil has fallen 12 percent to $93.65 so far this quarter, which would be the largest drop since the fourth quarter of 2008. Silver prices dropped 28 percent in a week in May as CME Group Inc., owner of Comex, raised margin requirements.
Average daily equity-trading volume on the largest U.S. exchanges is down 32 percent from the second quarter of 2010, and is on pace to fall 9.8 percent from last quarter. Dollar volume of high-yield corporate bonds has declined 17 percent from a year earlier, while volume of investment-grade bonds rose 6.1 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Trading volume, an indicator of performance, may not correlate directly with firms’ revenue because banks make money on changes in the value of the securities they hold and transaction fees that may not be related to volume.
Trading accounted for 23 percent of the five firms’ total revenue last year, ranging from 56 percent at Goldman Sachs to 16 percent at Charlotte, North Carolina-based Bank of America, according to company filings.
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