- Most big banks cut trading desks' value-at-risk as year began
- An exception is JPMorgan, where it jumped 59% from a year ago
Wall Street bank chiefs have vilified the profit-crushing markets that opened 2016 as “challenging” and “exceptionally violent and turbulent.” Trading revenue plunged. Job cuts ensued.
More granular figures in banks’ quarterly reports over the past two weeks hint at decisions managers made to weather that storm, and how they played out -- in many cases not well -- across traders’ desks.
Value-at-risk, an estimate of the most a firm might lose on all but the most exceptional trading days, should theoretically climb as price swings increase, so long as the banks’ holdings stay the same. In JPMorgan Chase & Co.’s main trading arm it jumped 59 percent in the first quarter from a year earlier. But at two U.S. rivals -- Bank of America Corp. and Citigroup Inc. -- the figures fell as they reined in certain businesses. And a similar drop can be seen across the Atlantic, as firms including Deutsche Bank AG shrank operations.
JPMorgan blamed market volatility after its surge in value-at-risk, known as VaR. It also acknowledged “increased exposures in fixed income and equities” within its investment bank. That is, it tolerated more risk. Daily trading VaR in that division averaged $54 million in the quarter, up from $34 million a year earlier. A company spokesman declined to comment.
Regulators have been hammering big banks since the financial crisis to rein in risk-taking, banning many forms of proprietary trading. The idea is to head off excessive bets that can topple deposit-taking institutions, undermine the financial system and prompt a repeat of 2008’s taxpayer-funded bailouts. Popular anger over that episode continues to animate political candidates’ platforms in the U.S. and beyond.
Firms can cut VaR by limiting the assets they park on their books while arranging clients’ trades, or hedging their positions. Bank of America wrote that VaR dropped 32 percent to $42 million in its trading portfolio because of “reduced exposure to the credit and interest-rate markets.” The company said that’s the lowest level for any quarter since it merged with Merrill Lynch at the start of 2009.
At Citigroup, total trading VaR fell 25 percent to $80 million. The firm said there was “a change in risk profile” in its equities-trading business, without elaborating. Spokesmen for both firms declined to comment.
“They’ve really dialed back their risk-taking,” said Mark Williams, a former Federal Reserve bank examiner who teaches risk management at Boston University. From a shareholder perspective, banks might even have been too cautious, missing opportunities to earn more, he said. “At the time when they really should be -- because of the greater market volatility -- jumping in and taking more profit, they’re moving away from it.”
Indeed, Bank of America and Citigroup’s revenue from trading fell 16 percent and 13 percent respectively. JPMorgan’s slipped 11 percent.
Meantime, Goldman Sachs Group Inc. and Morgan Stanley reported relatively modest drops in VaR and saw their revenue fall hard -- 37 percent and 30 percent, respectively. To be sure, part of the drop at Morgan Stanley stemmed from shrinking commodities operations and its broader bond-trading division.
One benefit of keeping VaR in check is that, at least theoretically, it reduces the occurrence of major trading losses. Bank of America, for example, had only one money-losing day in the quarter. In contrast, Goldman Sachs posted nine, a jump from five last year. JPMorgan reported 25 days of trading losses. The largest was about $50 million, according to a chart in its quarterly report.
A disadvantage of curtailing VaR is that it also limits big profits. Most banks break out how many days they generate gains surpassing $75 million. The occurrence of such events has declined more than 90 percent since 2010. At JPMorgan, traders made up for relatively smaller losses by scoring between $40 million and $70 million on at least four days.
Another way that VaR -- and profits -- can fall, is if clients simply aren’t trading, for example, because they are spooked by price swings. That’s the phenomenon Goldman Sachs pointed to when an analyst asked on an earnings conference call last month how VaR in its commodities business fell despite market gyrations.
“While there was volatility during the course of the period, obviously in commodities, client flows were pretty muted as people really were a bit taken back,” Chief Financial Officer Harvey Schwartz told analysts on a conference call. “It didn’t translate into lots of activity during the course of the quarter.”
Spokesmen for Goldman and Morgan Stanley declined to comment.
VaR isn’t without detractors. One complaint is that it assumes outcomes will tend to remain within historic norms, looking at past patterns and failing to anticipate the impact of potential disasters. So while managers, regulators and analysts use it as a tool for gauging risk-taking, regulators focused on systemic stability have increasingly relied on stress-testing in recent years to gauge how well firms are positioned for worst-case scenarios.
There are also lots of caveats when examining VaR. Because every firm develops its own model and may include different operations and portfolios, raw dollar figures for risk-taking often aren’t comparable between companies. Looking at trends over time can be fraught, because firms periodically adjust models. UBS, for example, said it tweaked its system in the first quarter. And at least one big investment bank, Barclays Plc, discloses VaR in semi-annual reports.
Still, the broad industry drop in VaR spotlights an issue weighing on clients’ minds: Some banks are shying from danger when markets get raucous.
And all that risk-avoidance -- whether because of regulatory edict or imposed by internal managers -- means less market-making and reduced market liquidity, according to Cliff Rossi, a former chief risk officer for Citigroup’s consumer lending group. Ultimately, it sets the stage for even larger price swings.
“That can impose costs onto the financial markets and can manifest itself in the form of, basically, a liquidity crisis again like we had coming out of 2008,” said Rossi, who teaches at the Robert H. Smith School of Business at the University of Maryland.
The last crisis, of course, was fueled by excessive risk-taking. On a conference call with analysts last month, Bank of America’s Chief Executive Officer Brian Moynihan, who has spent his tenure cleaning up the fallout, summed up his view of avoiding catastrophes.
“Our job from the management team was to set this company up that it would never have the kind of risk embedded in it that would lead us to difficult times in a real recession,” he said.