Global Banks: A Securities Blanket for Q3 Earnings
Generally solid earnings of global banks' securities-related businesses, including various trading, investment banking, asset-management, and wealth-management activities, bolstered third-quarter results. In some cases, this helped to stabilize overall profitability—and credit ratings—despite continuing asset-quality pressures at their commercial-banking operations. Counterparty Credit Ratings/Outlook* Holding company Operating company Bank of America (BAC) A/Stable A+/Stable Barclays (BCS) A+/Negative AA-/Negative Citigroup (C) A/Stable A+/Stable Credit Suisse (CS) A/Stable A+/Stable Deutsche Bank (DB) N.A. A+/Stable Goldman Sachs Group (GS) A/Negative A+/Negative JPMorgan Chase (JPM) A+/Negative AA-/Negative Morgan Stanley (MS) A/Negative A+/Negative UBS (UBS) N.A. A+/Stable
*As of Nov. 10, 2009. N.A.-Not available. Source: Standard & Poor's Research. Healthier business conditions continue to have the most visible effect on trading revenues—particularly on fixed-income trading revenues. Transaction volume has surged in several product segments within fixed-income trading as clients have regained their risk appetites, to some extent, and moved to reverse their prior flight into the perceived safe haven of government bonds. Persisting low short-term interest rates, coupled with the lack of any signs that inflation is heating up, have helped. Moreover, bid/ask spreads, although narrower than those reported earlier in the year, remain relatively wide from a historical perspective. The competitive environment is more favorable because fewer major trading firms are open for business, and some players remaining in a defensive posture. Thus, although there was a normal seasonal weakening of revenues in the third quarter compared to the second, trading revenues remained very strong. Rising asset prices have also boosted reported trading revenues, to the extent that companies have booked mark-to-market gains on inventory positions. Although fair-value accounting helped accentuate the impact of the downturn on reported results in 2008, we are now seeing the flip side in 2009. Standard & Poor's Ratings Services believes this phenomenon was especially significant for some companies in the third quarter, given the extent of asset-value appreciation. Particularly noteworthy is that pricing of asset-backed securities and commercial mortgage-backed securities has improved significantly, partly because of U.S. government programs like the Federal Reserve Bank of New York's Term Asset-Backed Securities Loan Facility (TALF) program, which became operational in March 2009. According to Thomson Reuters (TRI), the volume of third-quarter global stock and bond sales ($1.3 trillion) was down 25% from the second quarter but up 73% from third-quarter 2008. Consequently, underwriting revenues also weakened somewhat in the third quarter compared to the prior period. This was partly because of seasonal factors, but also because major financial institutions did not rush to raise capital as they did earlier in the year. Activity is now broader based, with the global equity markets open across industries and geographies and the IPO markets improving, particularly in emerging markets. In theory, better availability of funding could spur increased merger and acquisition (M&A) activity. In actuality, the large banks' M&A advisory businesses remain moribund, with the third quarter marking the weakest quarter for advisory fees since third-quarter 2004. Several companies have commented that their deal backlogs have grown, but it remains to be seen how long this takes to translate into better fee volume. Performance and management fees related to these companies' asset-management businesses have benefited directly from the rallies in stock and bond prices. Trends in customer fund inflows and outflows have been mixed, with JPMorgan faring significantly better than its peers. Finally, wealth management (including retail brokerage and private banking) has been on a similar trajectory as asset management. Retail investors largely remained on the sidelines earlier in the year, following the tumultuous market developments of late last year. However, the better market environment since the first quarter has provided the basis for a return to more normal conditions and improved revenue generation. Retail brokerages' longer-range profit potential should benefit from the sweeping industry consolidation that has occurred since mid-2008. With the formation of the Morgan Stanley Smith Barney joint venture, Bank of America's acquisition of Merrill Lynch, and Wells Fargo's (WFC) acquisition of Wachovia, the retail brokerage sector in the U.S. is now more concentrated than ever, offering potentially significant cost savings and greater pricing power. For the most part, though, these benefits have yet to be fully realized. All the companies in this peer group have benefited from improved funding conditions. Although fair-value losses stemming from tightening credit spreads marred reported third-quarter results, this accounting anomaly–-for which we adjust in calculating core earnings-–underscores the reality that the capital markets are viewing the banking sector more favorably.