Bye-Bye, Bonus: Brexit Seen Biting Profit for Years at U.S. Banks

How Brexit Will Impact Banker Bonuses
  • Analysts estimate second-quarter profit fell 18% at top firms
  • ‘Nobody is talking about having a great year,’ recruiter says

When U.S. banks post second-quarter results in days, it’ll boil down to this: Bonus cuts are coming for just about everyone this year, says Wall Street recruiter Richard Lipstein. “If you are break-even, it’s an achievement.”

That’s the picture taking shape as analysts trim estimates for the quarter and overhaul long-term projections for banks’ main businesses after the U.K.’s vote to leave the European Union. Starting this week, JPMorgan Chase & Co., Citigroup Inc. and Goldman Sachs Group Inc. probably will say they saw a quick bump in trading after the June 23 referendum, but that deals are stalling and years of pain lie ahead.

Combined net income at the six biggest U.S. banks is estimated to fall 18 percent in the second quarter from a year earlier, according to analysts surveyed by Bloomberg. Fred Cannon, global research director at Keefe, Bruyette & Woods, said many analysts are just starting to rework projections for future periods to account for Brexit’s fallout, such as the prolonging of low interest rates.

“We went from lower for longer into what seems like lower forever,” he said.

That will erode interest from lending. Market turmoil and economic drags linked to Brexit will hurt investment banking revenue as companies reconsider acquisitions and selling new securities. And that’s after trading units suffered their worst first quarter since 2009.

For the full year, analysts predict combined earnings at the six U.S. banks -- which also include Bank of America Corp., Wells Fargo & Co. and Morgan Stanley -- will drop 14 percent. It may only partially recover in 2017, the estimates show. The projections for both years tumbled after markets swung earlier this year, and then slipped further after the U.K. vote as analysts began updating research.

“Up until June 24, everybody thought the second quarter was building a nice recovery, and now you have to question that,” said Chris Kotowski, a bank analyst at Oppenheimer & Co., referencing the day ballots were tallied. “I’m more cautious than I was.”

He cut full-year estimates for the six banks’ earnings per share by an average of 8 percentage points after the U.K. vote. Stock offerings will “slow significantly,” corporate acquisitions will “grind to a halt,” and fixed-income trading will cool again, he said. Any Federal Reserve interest rate increases are off the table indefinitely, thwarting the long-awaited improvement in interest income. Altogether, that probably will result in another bite out of year-end bonuses, Kotowski said.

Three weeks before the referendum, executives across Wall Street were busy trumpeting a resurgence in revenue from trading. At JPMorgan, it was expectations for a “mid-teens” percentage increase in the second quarter. Bank of America said it was on track to rise “mid-single digits.” Citigroup also signaled improvement from a year earlier.

Jamie Dimon, chief executive officer of JPMorgan, the biggest trader of fixed-income securities, said on the day U.K. voting results were announced that currency-trading volumes had just reached a record.

‘Big Unknown’

While some analysts, including Kotowski, suggest banks probably focused on handling the surge in client orders without risking their own money, others are cautioning against putting too much weight on the early optimism.

“Choppiness” across markets posed dangers to trading desks before and after the referendum and means investors can’t rely much on the revenue predictions from weeks earlier, Deutsche Bank AG’s Matt O’Connor wrote in June 27 note to clients.

Trading during the last week of June remains “the big unknown,” said Atlantic Equities LLP’s Chris Wheeler. Even with preparation, at least some desks could’ve been caught on the wrong side of the market moves, he said. And firms may have funneled much of the heightened volume through low-margin electronic platforms, leading to lean returns.

Even if Brexit produced a short-term trading boon, analysts say it will soon be overtaken by other challenges wrought by the U.K. vote. Banks now face a flattening yield curve, or narrowing of the difference between short- and long-term interest rates, which makes it even harder to eke out a profit on lending

The phenomenon may cut Bank of America’s interest income by $400 million in the second quarter, according to Deutsche Bank’s O’Connor. Kotowski predicts the damage may reach $800 million.

Bright Spot

Goldman Sachs’s investing and lending segment may have been hurt by a drop in the value of equity and credit positions on Brexit. Revenue in the division could fall by $700 million to $1.1 billion, KBW’s Brian Kleinhanzl wrote in a July 5 note to clients. Still, analysts predict that companywide net income may rise 39 percent after the firm incurred costs a year earlier tied to legal claims.

One bright spot is mortgage lending. Low rates will spur new loans and refinancings, generating fees for banks such as Wells Fargo, the national leader in that business. Kotowski trimmed his estimate for its earnings per share by only 2 percent for 2016, the least among the big six banks.

To be sure, many of the largest investment banks beat analysts’ gloomy profit estimates for the first quarter by slashing costs. That included limiting funds earmarked for year-end compensation.

Across Wall Street, “there’s not a terribly good mood,” said Lipstein, managing director at New York-based recruiting firm Gilbert Tweed International. “Nobody is talking about having a great year.”

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