Fog of Legal Bills Seen Lifting at U.S. Banks as Revenue Rises

It would have been a good year for the biggest U.S. banks if it weren’t for $30 billion in legal costs.

Revenue at the six largest firms, which start reporting results this week, probably climbed to $413.6 billion in 2014, second only to a record set in 2010, based on results from the first nine months of last year and analysts’ estimates for the fourth quarter. That’s providing hope that an increase in profit will follow once banks move past 2014’s record legal expenses.

Litigation and investigations dominated a year that also saw a revival of commercial lending, a rebound in mergers and acquisitions and a U.S. economy that probably expanded by 2.3 percent. Investors looked beyond the legal expenses as shares in all six banks rose in anticipation of interest-rate increases that could boost earnings from lending money to customers.

“We’ve finally moved into the eighth or ninth inning of legal costs,” said Paul Miller, an analyst at FBR Capital Markets. “I don’t think you’ll have another $30 billion in legal costs. That doesn’t mean you can’t have another $2 billion to $5 billion, but that’s almost a rounding error at this point.”

The record legal costs probably will result in a 5 percent slump in profit for the six banks, the first decline since 2008, according to data compiled by Bloomberg. Bank of America Corp. and Citigroup Inc. led the drop after spending more than $25 billion combined as they tried to put the biggest disputes behind them, including probes into mortgage-bond sales and currency manipulation.

Rising Shares

The banks, which also include JPMorgan Chase & Co., Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley, saw higher revenue in investment banking last year as initial public offerings jumped more than 50 percent. They also posted increases in asset management, which benefited from a rising stock market.

That helped push up shares of the six firms, led by Morgan Stanley’s 24 percent gain and Wells Fargo, which soared 21 percent. The Standard & Poor’s 500 Index rose 11 percent.

Morgan Stanley probably had the biggest annual increases, with an estimated 7 percent rise in revenue and profit that more than doubled to $6.3 billion. The New York-based bank, led by Chief Executive Officer James Gorman, had a 14 percent gain in trading and investment-banking revenue in the first nine months of 2014, the most of the nine largest global firms. It also was helped by tax benefits and an accounting gain.

JPMorgan Results

JPMorgan, which kicks off earnings season Jan. 14, is projected to report the only decline in revenue for the year among the six biggest banks. The firm, headed by CEO Jamie Dimon, had a 25 percent slump in mortgage-banking revenue in the first nine months as refinancings fell. Fixed-income trading dropped 12 percent, the most of any of the banks, as competitors gained share amid low volumes and industry revenue decreased in interest-rate trading, where JPMorgan is the biggest.

The bank probably will report adjusted fourth-quarter profit of $4.98 billion, a 13 percent drop from a year earlier, on revenue of $24.1 billion, according to analysts’ estimates compiled by Bloomberg through last week.

The six banks’ combined $4.8 billion revenue gain for the year was overwhelmed by legal costs. Bank of America’s legal expenses jumped almost fourfold to $16.9 billion in the first nine months, while Citigroup’s full-year total probably more than tripled to $9 billion.

The $30 billion legal bill is based on banks’ reported costs for the first nine months and the $2.7 billion charge Citigroup said it would take in the fourth quarter. Absent that total, an amount that dwarfs the annual budget for the National Aeronautics and Space Administration, the banks probably would have topped their record profit in 2006 of $82.6 billion.

‘Hoarding Capital’

“Banks have paid out a tremendous amount of money in fines and settlements,” Anton Schutz, president and chief investment officer of Mendon Capital Advisors, said in a Dec. 31 Bloomberg Radio interview. “The big banks have still been hoarding capital because they don’t know what fines they’ll have to pay.”

Banks ran into other regulatory difficulties last year and had to make changes to their businesses. Goldman Sachs, JPMorgan and Morgan Stanley sold units that owned physical commodities amid a Federal Reserve review and a congressional probe.

JPMorgan, the biggest U.S. bank, had its required capital ratio increased by 2 percentage points, meaning the New York-based lender may need more than $20 billion in additional capital. Citigroup had to curtail plans for shareholder payouts after failing the Fed’s stress test, known as CCAR, in March, and Bank of America had to scrap a stock buyback after it made errors in its submission.

‘Clean 2015’

At the beginning of last year, “a lot of us said, ‘I think we’re finally going to get real clarity on regulation,’” said Fred Cannon, a KBW Inc. analyst in New York. “Then what happens? Citi fails CCAR, we get higher buffers, we get continued litigation.”

The banks have said their largest legal exposures have been addressed, and the firms have a better sense of the most important rules, according to analysts. Citigroup CEO Michael Corbat, 54, said his New York-based bank, the third-largest in the U.S., is taking its fourth-quarter charge to “try and really shoot for a clean 2015.”

Still, past issues may still result in future costs.

JPMorgan last week agreed to pay about $100 million to settle a lawsuit brought by a group of institutional investors over allegations of price-rigging in the foreign-exchange market. Morgan Stanley is in talks with the U.S. to resolve an investigation into the bank’s creation and sale of mortgage-backed bonds and may reach an agreement in the next few months, a person familiar with talks said last month.

“There is very little indication that we’re going to see much lightening up on the largest banks,” Cannon said.

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