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It was a bleak first quarter for Wall Street with profits down across the board year-on-year for the largest six firms, mainly due to trading losses and diminished customer activity. Trading was the weak link thanks to low oil prices, a delayed US interest rate hike, negative rates in Japan, and continued questions regarding the stability of the European Union. On average, US banks reported FICC revenues down 23% year-on-year and equity revenues down 14%, according to Citi analysts. Yet another quarter of weak earnings show once more that banks need to lean on traditional banking as a buffer to the headwinds in the markets businesses. “The bottom line is that if you look at traditional banking, deposits are up and loans are up. It’s the capital markets businesses that are killing earnings,” says Dick Bove, analyst at Rafferty Capital Markets.
Goldman Sachs epitomizes this new reality. It had its worst quarter in four years. Revenue was down $4.3 billion on the first quarter last year. Trading revenue was down $2.1 billion. By contrast Wells Fargo, where trading revenue is not even 1% of total revenue, was the only bank in the top six to see an increase in revenue in the first quarter year-on-year.
The market environment in the second quarter may not be quite as dire as at the start of 2016 but does not show signs of dramatic improvement and earnings calls revealed little optimism. Marianne Lake, CFO at JPMorgan Chase, chase says her firm remains “cautious about the second quarter”.
James Gorman, CEO at Morgan Stanley, went as far to say that, “if the markets were to continue as is, [the firm’s] goals would be extremely difficult to achieve”.
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Harvey Schwartz, |
Goldman CFO Harvey Schwartz offered little other than “we will see how the year progresses”. It is Goldman that Bove says has the most to lose if markets continue the way they are. The firm has not evolved to become a bank for the new market paradigm – one less capital markets-oriented, he says.
“They’ve doubled down on improving the structure of their balance sheet, and improving the quality of their product, and they are the best in everything they do,” says Bove. “The problem is you can create the best buggy whips in the world but if no one uses them anymore, then what good does it serve? The world has changed and they didn’t change with it.”
It’s a bold statement. Goldman has been talking a good game about adapting its business model to increase its lending and venture into new areas. But the proof is in the numbers. The first quarter earnings show revenues in its large principal investment and lending unit to have dropped 95% to $87 million year-on-year. Schwartz says gains in private equity holdings that the unit contains were dragged down by losses on publicly traded stocks.
“Last year its earnings were 50% less than in 2007, and this year they will struggle to match last year’s,” says Bove. “They keep patting themselves on the back about the balance sheet and all the experimenting they are doing with new businesses like GE, but it’s been nine years since the crisis and what have we got from them? Zip.”
The firm desperately needs to change with “fresh people and fresh thinking”, he says. Indeed its relatively better experience during the crisis means it hasn’t been forced to rethink its business model and has therefore missed the opportunity to address the change in the functions of the market. There has been little in the way of bold transformation versus its peers, says Bove.
Citi prepared
Citi is an example of where a forced, painful and large-scale transformation has better prepared the firm for the new paradigm of decreased capital markets activity and slower global economic growth. Since the crisis it has divested $700 billion in Citi Holdings and sold 60 businesses. It has pulled out of many countries and shed both Smith Barney and its asset management business. Citi may have placed a few chips on the equities business but it’s a leaner ship and has shifted its focus from capital markets to the consumer bank, transaction services, and private bank, while investing heavily in technology that touches clients.
True, its first quarter earnings were nothing to celebrate – Citi’s profit declined $1.3 billion year on year – but at least CEO Mike Corbat has a bright spot to point to for the future. Its deposits were up, as were loans, and Citi Holdings should be wound down by the end of the year.
Morgan Stanley is another firm whose profits declined but where at least it is moving in the general direction of the market. Before the crisis, asset management and wealth management together comprised just 10% of the whole business. Now the figure is 50%. While wealth management revenues were down from the previous quarter, due to client nervousness around the markets, its lending business experienced a boost. Funded lending balances in wealth management grew by about $2 billion, or 5%, during the quarter and $12 billion, or 30%, year-on-year.
“It’s traditional banking that is going to provide revenues for the forseeable future,” says Bove. “The ship has sailed for anyone who didn’t move their business to incorporate this new paradigm.” For Goldman Sachs, he says it may be time for new blood or for a merger of equals with a company in different business lines.
