Long before unveiling third-quarter 2011 earnings in mid-October, and even before that quarter had ended, banks were keen to manage down the expectations of any investors clinging to the hope of a good outcome.
Speaking at the Barclays Capital Global Financial Services conference in New York in mid-September, Jes Staley, chief executive of JPMorgan Chase’s investment bank, offered troubling insights into the havoc wreaked on bank earnings by market declines and volatility in the third quarter.
Staley told investors: "Given what we saw in August and the current run rate in September you can safely expect a decline in our market business revenues of around 30% from the second quarter to the third quarter." He added that, given low levels of M&A and equity capital markets activity, investment banking revenues will be just $1 billion for the third quarter (almost half the second-quarter result of $1.9 billion) and also pointed out that asset management fees are also correlated to weakening markets.
On the corporate side, the investment bank will likely report a roughly $100 million loss on private equity and will also take further litigation expenses, leading to a small loss for the quarter on corporate net income.
This is worrying news for investors in bank equity and debt, because JPMorgan is the global leader in investment banking, with an industry-leading 8.4% wallet share of fees from equity capital markets, debt capital markets, syndicated loans, leveraged finance and M&A, according to Dealogic. If JPMorgan is suffering, it’s a safe bet that others will be doing even worse.
In its investment banking strategy review for the first nine months of 2011, Dealogic noted that global investment banking revenue totalled $11.8 billion in the third quarter of 2011, down 45% on the previous quarter and down 31% from the third quarter of 2010, to become the lowest quarterly total since the first quarter of 2009 when markets were still frozen in the aftermath of Lehman Brothers’ collapse.
| IB Revenue Product Breakdown by Quarter |
| 2008 to 2011 |
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| Source: Dealogic |
At the same conference, Ruth Porat, chief financial officer of Morgan Stanley, also offered guidance on third-quarter earnings, warning that in M&A "the current market volatility adversely affects our ability to execute on some of our backlog". She added that while volumes in equity had been strong in the third quarter "much of that volume has come through the lower-margin electronic side of the business". In fixed income, Porat noted that "volatility has prevented many clients from taking much risk", and added that Morgan Stanley itself takes the same cautious approach: "We reduced risk at the end of the second quarter and it’s our intention to continue to run it at lower levels." The good news for JPMorgan is that its strong market share in the FICC business seems to be holding up and the bank has managed to make profits in these businesses from customers without relying on risky position-taking.
Staley says: "If you go back over the past 20 or 30 years the market shares of the bulge-bracket banks have been pretty consistent. It’s who those banks are that has changed around a lot." In FICC, he says: "Coming out of the financial crisis, it looked like our market share doubled and the burning question we have asked ourselves is how sustainable that is. In our client business we have not slipped and if you look at revenue to value at risk (VaR) it’s been at historically high levels. Going into the third quarter we had not had a single losing trading day for a year." He suggests that rather than taking risk positions to boost profits, the bank has ridden markets well by avoiding losses.
| "Are we immune to Europe? Not by any measure. But that exposure is manageable" |
As Staley spoke, panic was spreading in European financial markets over banks, and analysts pressed him on JPMorgan Chase investment bank’s exposure to troubled European lenders. Staley repeated earlier statements that the bank’s net exposure is $14 billion to Spain, Italy, Greece, Portugal and Ireland, with roughly 60% of that being to corporates and the remainder split equally between sovereign and bank exposure. "That is quite manageable in the context of JPMorgan’s balance sheet. We are extending credit to European banks and continue to do so. Are we immune to Europe? Not by any measure. But that exposure is manageable."
While much attention has focused on European banks’ reduced access to short-term market liquidity and potential difficulties in rolling over big medium-term and long-term maturities coming due in the first quarter of 2012, there are also signs of stress in funding for some US banks. US financial institution group debt capital market issuance in August 2011 was just $8.6 billion, 75% below the prior 12 months’ monthly average of $35 billion and the second-lowest monthly total since the bankruptcy of Lehman Brothers. It’s not clear whether this feeds through from low borrowing demand from US banks’ customers giving them less to finance, or investor nervousness at possible contagion from US lenders’ exposure to European banks.
The key question for Europe, Staley admits, is the difficulty of divining in advance the possible contagion effects of any disorderly default in Greece. But Staley takes comfort from the European banks’ ability to withstand a sudden contraction in liquidity. "One of the triggers of the crisis in 2008 was when money market funds got worried about their exposure to the US investment banks and took that down quickly. This time, we have already seen an enormous contraction of money fund exposure to European banks. It’s roughly halved in 30 days. But we’ve not seen a liquidity crisis. Rather, the European banks have done a good job of getting through a reduction of access to a certain big source of funding. So I don’t see risk around funding as such a great concern."
