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Today, Wells Fargo reported record quarterly earnings of US$3.8bn, up nearly 50% on the same quarter last year. JPMorgan kicked off the reporting season last week with quarterly net profit growth of 67%. The country’s other banking giants—Bank of America, Citigroup and Goldman Sachs—shared less encouraging news, with first-quarter profits down on last year.
What all of these banks have in common, however, is falling revenues. From racy investment banks to retail-focused lenders, America’s largest banks are still shrinking. Releasing provisions and cutting costs can only go so far; a true recovery will begin when top lines start to grow again.
America’s three key investment banks have now reported their third-quarter results. Beyond the revenues, earnings, provisions and the like, analysts are combing financial statements for details on bankers’ compensation; lower pay is seen as an important sign of cost control and, equally important, contrition in the face of public scorn.
As a percentage of net revenues, compensation ranged from 39% at JPMorgan to 43% at Goldman Sachs in the first nine months of the year. The year-on-year decline at Morgan Stanley was especially large, dropping from 60% last year to 42% so far this year. Absolute pay has fallen at all three banks, with a particularly steep 21% drop at Goldman Sachs. In terms of the average pay per employee at Goldman, the decline is an even more severe 30%. Still, few would consider an average wage of more than US$370,000 for nine months’ work a sign of major sacrifice.
Level 3 assets at large American investment banks may have “bottomed out”, according to a new report by Moody’s. The stores of these illiquid, difficult-to-value assets often housed many of the most toxic securities that battered banks’ balance sheets during the credit crunch. Any decline in Level 3 assets is considered positive for banks’ credit profiles, Moody’s claims. (For previous coverage of Level 3 assets, click here.)
Somewhat ominously, the ratings agency adds that further falls in Level 3 inventories are unlikely. Although risky and illiquid, these securities feature “attractive yields and wide bid-offer spreads.” Under pressure to boost shareholder returns, it will be difficult for bankers to shun them completely.
Small cracks are beginning to show on Goldman Sachs’s remarkable trading record. In the second quarter, Goldman’s traders lost money on ten days, almost as many down days as the previous four quarters combined.
Although the second-quarter result still means that the bank’s traders registered gains 85% of the time, this performance nonetheless looks somewhat lacklustre in relation to previous quarters. Traders recorded “only” 17 days with more than US$100m in daily net trading revenue in the second quarter, half of the average achieved in the previous four quarters. An admirable record, to be sure, but for a bank that relies so heavily on trading—it accounted for 75% of total revenues in the second quarter—any stumble, however small, is keenly felt.
As in previous quarters, American investment banks continued their remarkable run of profitable trading days in the first quarter of this year. Bank of America, Citigroup, Goldman Sachs and JPMorgan recorded positive net trading revenues every day in the first three months of the year. Morgan Stanley, a laggard by comparison, lost money on only four days during the quarter. (Citigroup does not routinely report its daily trading results, but mentioned that it had no losing days in the first quarter.)
“Like peering through a grimy factory window, trading revenue histograms can provide a few clues as to what is happening down on opaque trading floors,” Moody’s writes in a recent commentary. Normally, a lack of negative trading days would be a positive sign of the “strength and diversification of customer franchises and risk management expertise,” Moody’s claims. But the stellar performance of banks’ trading operations is, perversely, becoming a risk as regulators and investors cast aspersions on the motives and methods that these market makers employ to generate bumper profits on their own accounts.
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Earlier this week, Goldman Sachs announced US$3.5bn in net earnings for the first quarter of 2010. Normally, a 91% rise in profits from the previous year would be cause for celebration. But given the sensational announcement a few days earlier that the Securities and Exchange Commission was launching fraud charges against the bank, Goldman’s stellar quarter did little to help its case.
If the regulator’s action is only the first salvo in a wider campaign, what other banks could face similar charges?
Read more at Financial Services Briefing: “Widening the net” (April 21st)
The blockbuster case brought against Goldman Sachs on Friday by American securities regulators put a particularly exotic species of structured security—the synthetic collateralised debt obligation—in the public spotlight.
The CDO at the centre of the Goldman case was particularly toxic, with some 99% of the underlying assets downgraded by ratings agencies within a year of the deal closing. The suit focuses on the influence that a hedge fund, Paulson & Co, may have had on the CDO’s construction, and whether Goldman should have told prospective investors more about this influence. Paulson famously bet heavily against the mortgages of the sort that were packed into the CDO that Goldman sold to investors.
However, it’s not as if other CDOs were performing well while Goldman’s tanked. Some 70% of CDOs rated by Fitch were downgraded during 2009. Less than half of the securities that began 2009 rated AAA ended the year that way, with 16% of formerly AAA securities plunging all the way to “junk” status in a matter of months.
In a “noteworthy sign of returning liquidity to capital markets,” a report from Moody’s highlights a drop in Level 3 assets (L3) at the biggest American investment banks in 2009.
These assets cannot be valued easily because they are generally illiquid. Many of the credit boom’s newfangled financial instruments—subprime-linked securities, collateralised debt obligations and the like—were classified as L3 and marked to internal models when reporting their values on balance sheets. Subsequent write-downs of these assets called into question the judgment and competence of bank executives.
In general, creditors now prefer banks to hold less L3, with outright disposals preferable to transfers into the Level 2 or 1 categories. As a percentage of tangible common equity, cash L3 at five lenders with large investment-banking operations fell sharply in 2009; “good news for creditors,” according to Moody’s. (L3 derivative positions were excluded from the analysis due to inconsistent disclosure practices.)
Despite the decline as a share of equity, the absolute value of L3 at Bank of America and JPMorgan remained relatively flat in 2009. Bank of America reported the largest increase in value of L3 (US$9.4bn) in the sample, while JPMorgan was the only bank to disclose a net transfer into the L3 category. Morgan Stanley reported the largest absolute decline in L3, trimming its balance by some 38% during the year, largely through disposals.
As part of its bailout programme, the US government has spent some US$205bn on a range of securities from more than 700 banks. In recent months, some aid recipients have repaid Uncle Sam for this support.
Last week, the treasury department published a report on these repurchases. At the end of 2009, the government had collected US$2.9bn from 31 banks that repurchased warrants (long-dated options). Details of the bids these lenders submitted to the treasury before settling on a price make for interesting reading.
For one, it looks like Goldman Sachs overpaid. For each group of warrants, the treasury used three valuations to guide the negotiations—a composite market quote, a third-party’s model-based estimate and the treasury’s own internal evaluation. For Goldman, the average of these three estimates suggested a price of US$907m for the warrants. The bank ended up paying US$1.1bn, around 20% more than the purported fair-market value.
Compared to what others paid in relation to their warrants’ average valuations, the larger financial firms—including Goldman Sachs and Morgan Stanley—appear to have paid over the odds to buy back their warrants. Although Old National Bank of Evansville, Indiana no doubt employs many capable negotiators, it’s not often that the lender can say it drove a harder bargain than Wall Street’s finest.
Even though some of the big investment banks are raking in profits, a new report from Moody’s questions whether “reliable repairs” have been made to these companies’ business models. The ratings agency then runs through some of the key ratios it will be following to gauge the health of the wholesale investment banking units at the largest financial firms.
One of the simplest metrics, gross leverage, is also the most telling. The scale of deleveraging at the pure-play investment banks is striking, as is the fact that high-flying Goldman Sachs and Morgan Stanley (the green line in the chart) were once practically indistinguishable from credit crunch casualties Bear Stearns, Lehman Brothers and Merrill Lynch (yellow line) as far as gross leverage was concerned.
Among the investment banking survivors, “few managers have been willing to reset promises to shareholders for a less free-wheeling environment,” Moody’s warns. “As a result, some firms may be tempted to again increase risk and leverage to meet shareholder demands as the crisis recedes.”