Goldman Buoyed by Credit Rally Seen Leading Bank Gains
Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM) are among investment banks that stand to benefit from the biggest first-quarter credit rally in more than 15 years, as bond prices rise and some competitors pull back.
Volumes have jumped more than 33 percent from last quarter and spreads on high-yield bonds fell more than 1 percent. That could help Goldman Sachs the most as it is “geared” toward credit trading in its fixed-income business, Kian Abouhossein, a JPMorgan analyst in London, wrote in a Feb. 22 note to clients.
The rebound may provide relief after investment banks posted more than $3 billion of losses from credit trading in the second half of 2011 as spreads widened and volumes plunged amid Europe’s debt crisis. The European Central Bank’s unlimited three-year loans to banks have eased anxiety about a global slowdown, and increased debt issuance has boosted trading.
“The Street is naturally long credit and tends to perform very well in an environment where credit spreads are narrowing,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York who rates shares of Goldman Sachs and Morgan Stanley (MS) outperform, meaning he predicts the stocks’ returns will exceed the average among peers. “If the U.S. economy continues to move ahead and Europe continues to kick the can down the road, then credit spreads narrow.”
Spreads between global company bonds and comparable government debt contracted 58 basis points in the first two months of the year to 209 basis points, or 2.09 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. That’s the biggest decline to start a year since the index began on Dec. 31, 1996.
U.S. high-yield bond spreads narrowed 1.39 percentage points to 5.98 percent, according to Merrill Lynch’s U.S. High Yield Master II Index. Spreads narrow when prices of corporate bonds rise relative to government debt. That often leads to gains in bonds that banks hold as trading inventory.
Credit trading typically includes investment-grade and high-yield corporate bonds, distressed debt, leveraged loans, credit-default swaps and collateralized debt obligations. Many banks also include trading in mortgage-backed and other asset-backed securities in the credit category. Fixed-income trading accounts for about 16 percent of total revenue for the five largest Wall Street banks.
The average daily trading volume for investment-grade corporate bonds this year through March 6 jumped 39 percent from the fourth quarter to $14.1 billion and is more than 2011’s first quarter, according to Richard Ramsden, a Goldman Sachs analyst. Mortgage-backed-securities volume rose 36 percent from the year-earlier quarter and 20 percent from the last three months of 2011, he wrote in a note last week.
Average daily trading volume of high-yield bonds jumped to $5.6 billion through March 8, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s up from an average of $5.37 billion in the same period last year and $3.47 billion in the fourth quarter.
Trading volumes also have benefited from increased debt issuance. Corporate-bond underwriting in the U.S. may have its best quarter since at least 2002: Companies sold $355.5 billion of bonds through the end of last week, 53 percent more than in the entire fourth quarter of last year.
Assuming the pace holds through March, the amount would surpass the record of $419.1 billion sold in the first quarter of last year, according to data compiled by Bloomberg. JPMorgan is the biggest underwriter, with a 12 percent market share. Among the top 10 underwriters, Zurich-based Credit Suisse (CSGN) Group AG gained the most in share, while Morgan Stanley lost the most.
The increased trading may be helping fewer banks because competitors are exiting some businesses, Goldman Sachs Chief Financial Officer David Viniar, 56, said at an investor conference last month. The bank is seeing wider bid-ask spreads and more “rational” pricing, he said. Michael DuVally, a spokesman for the firm, declined to comment further.
UBS AG is shrinking its U.S. credit-flow unit and will no longer trade complex structured fixed-income products, the Zurich-based bank said in November. Credit Suisse has said it wants to cut risk-weighted assets in fixed income by 50 percent, which includes “evolving” its credit-products business. Royal Bank of Scotland Plc, based in Edinburgh, said it’s disposing of some structured credit assets.
“Capacity is clearly coming out of the markets,” Colm Kelleher, 54, who oversees Morgan Stanley’s trading business, said at an industry conference last week.
The number of major players has dropped from 14 in 2006 to about half that today, and smaller banks in Europe are exiting the market, Kelleher said.
JPMorgan had the highest share of clients in U.S. credit trading in the first half of 2011, followed by Bank of America Corp. (BAC), Frankfurt-based Deutsche Bank AG (DBK), Morgan Stanley, Barclays Plc (BARC) and Goldman Sachs, according to a Greenwich Associates survey of institutional investors released in July.
Banks with strong balance sheets and established franchises such as JPMorgan and Goldman Sachs, both based in New York, may gain from the drop-off in competition, said Richard Staite, an analyst at Atlantic Equities LLP in London.
“It was hard to see who was picking up market share in what was a very weak market at the end of last year, but once you get a pickup in activity, that’s more likely to go to the stronger players, and at that point you’ll see who’s really gaining market share,” Staite said.
The rally came as Greece reached its participation target in the biggest sovereign-debt restructuring in history, the U.S. unemployment rate fell and the ECB expanded lending.
More than 800 banks borrowed more than 1 trillion euros ($1.3 trillion) from the ECB’s Long-Term Refinancing Operation in December and February. The central bank’s president, Mario Draghi, said the two tranches of three-year loans have had “a powerful effect” and have been an “unquestionable success” in unlocking credit markets.
The credit rally is still fragile and could reverse, analysts including Staite said. Credit spreads widened last week after the European Union’s statistics office said the region’s economy shrank 0.3 percent last quarter and the central bank’s balance sheet surged to a record 3.02 trillion euros amid crisis-fighting efforts.
‘Jury’s Still Out’
Even with the improving environment, total fixed-income trading likely will be down 13 percent from the first quarter of 2011, Abouhossein said.
“There’s still ongoing debate as to whether the downturn in trading revenue is a secular or cyclical event, and the jury’s still out on that,” Staite said. “This is a bounce off very low levels, but the question is whether we return to the levels we saw in 2009 and 2010.”
The 10 largest global investment banks reported more than $3 billion of losses from credit trading in the second half of last year, according to industry consultant Coalition Ltd. That brought credit-trading revenue at the firms in 2011 to about $6 billion, down from $18 billion in 2010 and $29 billion in 2009, according to Coalition data.
Goldman Sachs’s revenue from market-making and other principal transactions in credit products fell $5.96 billion in 2011 to $2.72 billion. The firm said it faced challenges in the fourth quarter because prices between derivatives and underlying securities diverged, affecting its hedging of positions.
Trading-account profits tied to credit risk at Bank of America fell $3.51 billion from 2010, according to the Charlotte, North Carolina-based bank. That represented 88 percent of the lender’s drop in fixed-income trading revenue. JPMorgan’s principal transactions tied to credit risk fell $1.15 billion in 2011. The banks’ figures were disclosed in annual regulatory filings and may not be comparable.
UBS had a loss of $156 million in credit trading in the third quarter. Credit Suisse said markdowns on investment-grade European positions led its credit business to a loss in the fourth quarter. Royal Bank of Scotland earned 9 million pounds ($14 million) in the fourth quarter from credit and asset-backed markets, a 98 percent plunge from a year earlier.
Those declines and losses have made banks wary of piling back into corporate bonds, according to analysts including Bernstein’s Hintz. Inventory holdings of corporate bonds by the top dealers this quarter are about half the level of a year ago and less than 20 percent of the 2007 peak, Bloomberg data show.
“The natural response of the risk managers will be to take credit bets, but to be much more cautious in terms of the size of the bets,” Hintz said. “If Europe in any way spins out of control, credit is the first sector that’s going to get hurt.”
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