Wall Street's Big Ax Seen Reaping Best Year-End Profit Since '06

  • Analysts estimate fourth-quarter costs lowest in seven years
  • Expense cuts overcame `a pretty sluggish revenue environment'

Wall Street Cuts Spending to Boost Profits

In their quest for higher profits, the biggest U.S. banks have seized on the one thing they can reliably control: cutting costs.

The nation’s six largest lenders will spend $61.8 billion on items including employee compensation, marketing and real estate in the fourth quarter, the lowest total for a quarter since the final three months 2008, according to analysts’ estimates. That’s helping companies deliver more revenue to the bottom line, which at a projected $19.9 billion for the group would be the most for the final quarter of a year since 2006.

Investors get a first glimpse when JPMorgan Chase & Co. reports Jan. 14. Analysts expect the depth of cuts in the fourth quarter to highlight the firms’ success in trimming bloated operations by firing workers, settling legal disputes and centralizing back-office functions to preserve returns in the face of low interest rates that have sapped income. Now, banks are under pressure to find new sources of savings at a time when prospects for revenue growth remain uncertain.

“Cost-cutting has enabled the banks to essentially combat what has been a pretty sluggish revenue environment,” said Shannon Stemm, an analyst in St. Louis at Edward Jones. “A lot of the benefit from cost-cutting has already been felt.”

Fourth-quarter revenue will rise 2 percent for the group from the prior year to $97.9 billion, while expenses will fall 14 percent, analysts estimate.

Swollen Costs

Emerging from the financial crisis, firms had swollen costs they needed to work down. They were paying temporary workers to service soured mortgages and writing checks to settle government investigations into the sale of bonds backed by the home loans. More recently, banks have paid billions of dollars in fines to end allegations of rigging in markets such as foreign exchange.

Lenders announced cost-cutting programs with catchy names and set targets for efficiency ratios, a measure of how much it costs to produce one dollar of revenue. As part of an initiative dubbed Project New BAC, Bank of America Corp. said in September 2011 that it planned to cut 30,000 workers and consolidate 63 data centers inherited through acquisitions. The following year, Wells Fargo & Co. set an efficiency-ratio target in a range of 55 percent to 59 percent, and in March 2013, less than six months after getting the top job at Citigroup Inc., CEO Michael Corbat established a 2015 target of about 55 percent.

Analysts project Citigroup will meet the target, and Wells Fargo has told investors that it expects to be within its range. Bank of America cut headcount by about 75,000 employees over the four years through September.

One bright spot for the industry has been lower litigation costs as old cases are settled and fewer new ones are filed. The legal tab for the five largest U.S. banks excluding Wells Fargo, which doesn’t disclose the costs in earnings announcements, amounted to more than $33 billion in 2014, according to figures compiled by Bloomberg. Through the first three quarters of 2015, the tally was less than $7 billion. The group includes JPMorgan, Bank of America, Citigroup, Goldman Sachs Group Inc. and Morgan Stanley.

Operating units also have been asked to slim down, with management teams taking their scalpels to institutional businesses and consumer operations alike. Banks have trimmed branch networks as clients move to mobile phones, while more trading goes digital, reducing the reliance on human beings.

Projected Income

Since the end of 2010, Bank of America has cut the most, reducing total expenses by 34 percent, according to data compiled by Bloomberg. Citigroup lowered costs by 17 percent, while Goldman Sachs’s are down 14 percent.

That’s got analysts projecting net income of $3.29 billion for Bank of America and $3.55 billion for Citigroup. Wells Fargo will lead the group, with $5.36 billion in profit, followed by JPMorgan with $4.75 billion, according to estimates.

The expected fourth-quarter results cap a year marked by a surge in dealmaking, a strengthening U.S. economy and the first rate hike in almost a decade. Mergers and acquisitions reached more than $4.2 trillion in transactions last year, a record, data compiled by Bloomberg show. As the U.S. unemployment rate improved to 5.3 percent for the year, the best since 2007, Federal Reserve policy makers raised interest rates for the first time in nine years, boosting banks’ prospects for higher lending margins in 2016.

JPMorgan’s earnings announcement this week will be followed by Citigroup and Wells Fargo on Jan. 15. Morgan Stanley and Bank of America are scheduled to report Jan. 19. Goldman Sachs posts results on Jan. 20.

Wells Fargo rose 0.7 percent to $49.88 at 11 a.m. in New York. Citigroup climbed 0.4 percent, while Bank of America fell 0.3 percent. The 24-company KBW Bank Index has dropped 9.3 percent this year.

Morgan Stanley and Citigroup preannounced fourth-quarter charges, at $150 million and $300 million, respectively. Morgan Stanley’s hit will cover the cost of cutting 1,200 workers worldwide, including about 470 traders and salespeople in its fixed-income and commodities business, a person briefed on the matter said last month. That should help the firm save $300 million to $400 million this year, Deutsche Bank AG’s Matt O’Connor wrote in a Jan. 4 note. Citigroup is planning to cut at least 2,000 jobs this month, including some front-office personnel, people familiar with the matter said last month.

‘Banks Underinvested’

Rising revenue may push expenses higher, according to Jason Goldberg, an analyst at Barclays Plc in New York.

“As revenue picks up, we think expenses grow,” Goldberg said. “It’s cybersecurity, it’s mobile banking, it’s new technologies, it’s adding to sales forces. Perhaps over the past several years there are certain things banks underinvested in as they grappled with the tight revenue environment. To the extent that the revenue environment gets easier, aided by help from the Fed, we think banks will start investing in those areas.”

While higher rates will help earnings, the slow pace of Fed tightening that many people expect means that rates will offer only modest help in the near-term, according to Alison Williams, a senior analyst at Bloomberg Intelligence. The average net interest margin for the largest banks, a key measure of profitability, will rise to 3.09 percent in 2016 and 3.15 percent in 2017 from 3.04 percent at the end of 2015, according to estimates compiled by Bloomberg. It was 3.21 percent at the end of 2014. 

And it’s not clear how much more room the banks have to lower costs as they face new demands for investment. Firms have poured resources into compliance and regulatory functions as well as technologies to protect against cyber-attacks. JPMorgan said it spent $250 million in 2014 to prevent cybercrime, while Bank of America CEO Brian T. Moynihan has said his bank is spending five times what it was six or seven years ago.

“If revenue is going to continue to be a bit of a drag and we don’t reach potential in terms of growth, how are you going to grow?” said Chris Mutascio, an analyst at Keefe, Bruyette & Woods. “It’s going to be on expenses. And that’s going to be interesting, because we’ve gotten a lot of expense savings out. There’s not a lot to be had from here. It may be difficult for the banks to toe the line.”

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