AMERICAN BANKS : THROUGH FICC AND THIN / THE ECONOMIST ( VERY HIGHLY RECOMMENDED READING )

American banks

Through FICC and thin

Jan 21st 2010 NEW YORK
From The Economist print edition

A possible end to the pain for lenders

POLITICIANS tend to tar all bankers with the same brush. The results unveiled this week by America’s financial giants were, however, far from uniform. Citigroup and Bank of America (BofA) posted thumping quarterly losses. Morgan Stanley eked out a modest gain. Wells Fargo and JPMorgan Chase made healthy profits. Goldman Sachs was expected to report a glittering set of numbers as The Economist went to press.

The differences were partly down to one-off hits. Citi, for instance, had to swallow $6.2 billion in after-tax charges related to repayment of its federal bail-out funds. Behind the noise, however, some trends are emerging. Loan losses appear to be stabilising. For some, the worst may even be over. At BofA, America’s biggest lender, net write-offs fell by 13% in the fourth quarter, the first decrease in nearly four years. Across the industry, credit-card delinquencies are flattening out.

Nevertheless, the mood is cautious. In a call with analysts, Jamie Dimon, JPMorgan Chase’s boss, hinted at the possibility of a double-dip recession. Even if the recovery continues, loan losses could remain high for some time. They lingered at peak rates for six quarters in the 1991-92 downturn, says Chris Whalen of Institutional Risk Analytics. One wild card is mortgage modification: banks may yet be forced to reduce the principal owed on some loans.

The outlook is cloudy in investment banking, too. Merger advice is picking up smartly, but capital-markets revenues fell in the fourth quarter, thanks to a big drop in fees from fixed income, currencies and commodities (FICC), previously the heart of the rebound (see chart).
This decline was partly seasonal. After a great year, many investors reduced activity in the fourth quarter to preserve profits. But it may presage a longer slowdown. The bid-offer spreads that banks earn on trades are falling from artificially high levels. Analysts at Citigroup expect FICC revenues, an estimated $190 billion in 2009, to be 15-20% lower this year. A further 15% of the pie could be lost if most over-the-counter derivatives migrate to exchanges. In absolute terms, any shrinkage is likely to hit hardest at Goldman, the market leader in FICC, unless it can continue to expand its share beyond the current 14% level.

Banks face other headwinds. The lacklustre economic recovery will keep loan demand weak. Tougher rules on capital will hurt banks’ return on equity and could yet push them out of profitable areas such as proprietary trading. JPMorgan Chase expects restrictions on credit-card practices to cost it at least $500m in annual profit—though it may be cheered that plans for a new financial consumer-protection agency seem to be in disarray. And painful accounting changes are coming. Absorbing off-balance-sheet assets will erode Citi’s core capital by 1.4 percentage points.

Punitive taxes will bite, too. Writing in the Financial Times, Mohamed El-Erian, head of Pimco, a fund manager, suggested that Barack Obama’s plan to recover bail-out costs through an annual levy on large financial firms “marks the beginning of the era of banks being targeted for selective incremental taxation in advanced economies.” The chances of further taxes will rise if bonuses continue to inflame tempers. Banks have made what they consider to be big changes to their pay structures. JPMorgan will hand its investment bankers just 11% of the revenue they generated in the last three months of 2009, a quarter of the norm; Citi has capped cash bonuses at $100,000. But this is unlikely to calm public fury, which could flare up again when Goldman announces its bonus pool.

On top of all this, banks face the gradual withdrawal of extraordinary government support. The industry’s attention is turning to interest-rate risk. Rate cuts in 2007-08 greatly steepened the yield curve, handing banks a huge boost in profits. As and when short-term rates start to rise again, banks’ net interest margins (the difference between their interest income and funding costs) will come under pressure. These are already being squeezed as some firms restructure their balance-sheets: Citi’s margin fell to 2.65% from 2.95% in the third quarter. Over the past three years, America’s banks have gone from feast to famine and (for some) back again. The future lies somewhere in between.

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