Wall Street Sees Record Revenue in ’09-10 Recovery From BailoutMichael J. Moore
Wall Street’s biggest banks, rebounding after a government bailout, are set to complete their best two years in investment banking and trading, buoyed by 2010 results likely to be the second-highest ever.
The five largest U.S. firms by investment-banking and trading revenue -- Goldman Sachs Group Inc., JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Morgan Stanley -- will likely have a better fourth quarter than the previous two periods, driven by equity underwriting and higher volume in stock and bond trading, according to data compiled by Bloomberg. Even if this quarter only matches the third, the banks’ revenue will top that of any year except 2009.
The surge has come after the five banks took a combined $135 billion from the Treasury Department’s Troubled Asset Relief Program and borrowed billions more from the Federal Reserve’s emergency-lending facilities in late 2008 and early 2009 following the collapse of Lehman Brothers Holdings Inc. Since then, the firms have benefited from low interest rates and the Fed’s purchases of fixed-income securities.
“This is a once-in-a-lifetime opportunity for most of these banks, and I think they’ve recognized it as that,” said Charles Geisst, a finance professor at Manhattan College in Riverdale, New York, who has written about Wall Street’s history. “The profits they’re making now will allow them to replenish their capital and take care of the other things they need to do.”
That may include beginning to return more of their profits to shareholders. The Fed issued guidelines last month on how it will decide whether large U.S. banks may increase dividends and buy back shares.
New rules that will force banks to hold more capital and move derivatives trading to clearinghouses may make it difficult for the firms to continue bouncing back from the worst financial crisis since the Great Depression. Revenue growth may also be threatened by narrower spreads than those that spurred fixed-income trading over the last two years and less client trading, analysts said.
“The strength of 2010 was really front-loaded,” said Roger Freeman, a banking analyst at Barclays Capital in New York. “The best quarter of the year was by far the first quarter, which had some carry-over from the 2009 environment. The other quarters have actually highlighted the challenges in their world right now.”
Those challenges may lead banks to cut bonuses as they seek to reduce costs and boost profitability amid lagging stock prices. Overall pay for investment-banking and trading employees at Wall Street firms will be down 22 percent to 28 percent from 2009, according to Options Group, a New York-based executive search and compensation consultant firm.
Goldman Sachs’s compensation expenses in the first nine months were 21 percent less than a year earlier, while the pay pools at JPMorgan’s and Morgan Stanley’s investment banks were down 10 percent and 8 percent. Morgan Stanley has told some employees to expect investment-banking bonuses to decline 10 percent to 30 percent, according to two people briefed on the matter. All three firms are based in New York.
The five banks generated $93.7 billion in the first nine months from advisory, debt and equity underwriting, and from trading stocks and bonds, about 10 percent less than the same period in 2009, when revenue for the year was $127.8 billion.
The banks don’t all report profit from investment banking and trading, so the only way to compare those businesses is to look at revenue. Spokesmen for the five banks declined to comment on fourth-quarter performance.
Trading and investment banking account for 33 percent of the five firms’ total revenue, ranging from 79 percent at Goldman Sachs to 21 percent at Charlotte, North Carolina-based Bank of America, according to company filings.
Including Bear Stearns Cos., purchased by JPMorgan in 2008, and Merrill Lynch, which Bank of America bought last year, the seven Wall Street firms posted a then-record $119.4 billion in 2006. That doesn’t include revenue at Lehman Brothers, which filed for bankruptcy in September 2008 and was acquired, in part, by London-based Barclays Plc.
Business this year has centered largely on trading bonds, credit derivatives, interest-rate swaps, currencies and commodities. The firms’ fixed-income trading divisions accounted for 61 percent of total investment-banking and trading revenue in the first nine months of the year, compared with 50 percent in 2006 and 51 percent in 2005, according to company filings.
Goldman Sachs made $7.39 billion from fixed-income trading in the first quarter of 2010, more than it made in that division in all of 2004.
“We’ll go back toward normal investment banking one of these days, but until then, this is going to be mostly concentrated in fixed income,” said Geisst. “The low-interest-rate environment is creating arbitrage opportunities and positive carry opportunities.”
The banks have benefited from rising bond prices as well as the Fed’s purchase of fixed-income securities, known as quantitative easing, said James Ellman, president of San Francisco-based hedge fund Seacliff Capital LLC. The Fed purchased $1.7 trillion of assets in the first round of buying and last month announced it will purchase an additional $600 billion of Treasuries through June.
“The Fed is a much greater influence in the fixed-income markets than it has been in the past,” Ellman said. “They are moving very large dollar amounts around, and they are indicating in advance what they are going to be doing.”
The banks are set to post higher revenue in the last three months of the year than in the previous two quarters, each of which was down 34 percent from the first quarter. Equity underwriting may be double that of the third quarter and stock and bond-trading volumes are higher.
Global equity offerings have already topped those of any quarter since 1999, when Bloomberg records begin. Companies have raised $205.2 billion through share sales so far this quarter, and initial public offerings are more than double those of the full year-earlier period, Bloomberg data show.
“Overall equity-issuance volumes have been disappointing for most of the year but have rebounded quite smartly since Labor Day, and we have done our best to take advantage of that,” said Paul J. Taubman, 49, co-president of institutional securities at Morgan Stanley, which is the top equity underwriter so far this year.
Companies worldwide completed $270.2 billion of mergers and acquisitions in the first two months of the quarter, Bloomberg data show. That’s down from the first two months of the third quarter, when they completed $275.4 billion of deals before ending the quarter with $372.9 billion.
The average daily dollar amount of U.S. Treasuries traded so far this quarter is up 29 percent from last quarter, according to data from ICAP Plc, the world’s largest inter- dealer broker. The average trading volume in high-yield corporate bonds is 9.7 percent higher than last quarter, while investment-grade trading is up 1.2 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Equity investors have traded a daily average of 7.8 billion shares on major U.S. exchanges so far in the fourth quarter, according to Bloomberg data. That’s up 2.8 percent from the third quarter, when the five banks posted their lowest trading revenue this year.
“Wall Street likes a little bit of volatility around a steady trend,” Ellman said. “That’s the best situation for them, and right now we’ve got that.”
While trading volumes are an indicator of performance, they 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.
Banks’ fourth-quarter performance may be more dependent on principal gains or losses in their trading businesses than last quarter because of increased volatility, Barclays’ Freeman said.
“When you get volatility, the principal positioning becomes more of a wild card,” he said. “When you’ve got credit spreads moving quickly, that could be good or bad, depending on how you’re positioned.”
Banks may have trouble sustaining the rebound in fourth-quarter revenue in 2011 as new regulations are put in place. While trading could benefit from investors moving into higher-yielding assets next year, banks will begin to feel pressure from new rules on derivatives and a ban on most proprietary trading, analysts said.
Those rules, signed into law by President Barack Obama in July, will reduce pretax margins in fixed-income trading to 23 percent from 24.9 percent and in the equities business to 10 percent from 13.8 percent, according to estimates from Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York.
Investment-banking revenue, less than one-fourth of the banks’ trading revenue, may increase in 2011 because of higher numbers of mergers and acquisitions, according to Keefe, Bruyette & Woods Inc. analysts led by Frederick Cannon.
Revenue increases over the last two years haven’t translated into record profits for many of the banks, as they have faced higher costs and credit losses.
Bank of America shares have dropped 15 percent this year through Dec. 10, while Morgan Stanley has fallen 9 percent, JPMorgan 0.6 percent and Goldman Sachs 0.2 percent. Shares of New York-based Citigroup, which have plunged 92 percent from their 2006 high, have climbed 44 percent in 2010. The Standard & Poor’s 500 Index has risen 11 percent this year.
The banks’ record performance in 2009 might be a “high-water mark” for a while, said Kenneth Crawford, a senior portfolio manager at Argent Capital Management LLC in St. Louis, which oversees more than $1 billion.
“The advent, one hopes, of a growing world economy and the demand that implies means that you might have more volume at a lower margin, and at some point we’ll eclipse 2009 levels,” Crawford said.
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