Wall Street bankers and traders, given hope by a market rebound in the first quarter, are now seeing earnings and paychecks threatened by turmoil in Greece in what is becoming an annual cycle.
For a third consecutive year, revenue from investment banking and trading at U.S. firms may fall at least 30 percent from the first quarter, Richard Ramsden, a Goldman Sachs Group Inc. (GS:US) analyst, said in a note last week. Greece, which gave English the word “cycle,” has been the main reason each year that the second quarter soured after a promising first three months.
Deal volume has dropped and equity and credit markets have fallen on concern that Greece may abandon the euro and the European sovereign-debt crisis will spread to nations including Spain. Those economic issues cut profit, bonuses and jobs at Wall Street firms in last year’s second half and threaten to do the same in 2012.
“It’s going to be a tough summer at least, and it does feel like the last couple years all over again,” said David Konrad, an analyst at KBW Inc. in New York. “The bank valuations seem unfairly discounted, but investors are looking at this year and saying, ‘I’m not going to fall for this again.’”
Greece is compounding the impact of stiffer capital rules and trading restrictions for banks imposed after 2008’s credit crisis. Those measures already were fueling concern that the industry may be locked in a long-term slump. Combined trading and investment-banking revenue at the five biggest Wall Street banks -- JPMorgan Chase & Co. (JPM:US), Goldman Sachs, Bank of America Corp. (BAC:US), Citigroup Inc. (C:US) and Morgan Stanley -- is likely to drop from a year earlier for the seventh time in eight quarters, according to analysts surveyed by Bloomberg.
The five banks generated about $33 billion from those businesses in the first three months of the year, excluding accounting charges. That was led by $20 billion from fixed- income trading.
Revenue from trading typically peaks in the first quarter in part because corporations raise more debt at the beginning of the year, stoking fixed-income operations, said Roger Freeman, an analyst at Barclays Plc.
Still, a normal seasonal decline for fixed-income trading revenue in the second quarter is 15 percent, while this year probably will be 30 percent to 40 percent, Goldman Sachs’s Ramsden said. Last year, the second-quarter drop for U.S. firms was about 31 percent, while in 2010 it was more than 40 percent.
Those declines were followed by weak third and fourth quarters that featured investment-banking and trading revenues more than 40 percent off the first-quarter pace. The chances of that trend recurring this year look “increasingly likely,” Kian Abouhossein, an analyst at New York-based JPMorgan, wrote in a note last month.
“Deja vu all over again?” Matt Burnell, a Wells Fargo & Co. analyst, wrote in a June 6 report as he cut profit estimates for the five banks by an average 30 percent. “After a relatively upbeat start to 2012, it now appears that this will be the third consecutive year of a spring/summer swoon.”
Eleven analysts reduced earnings estimates (GS:US) for New York- based Goldman Sachs in the past four weeks, and six have trimmed Citigroup’s, Bloomberg’s survey shows.
The five banks face an environment with lower trading volume, wider credit spreads and heightened volatility. The firms likely will report trading revenue that fell a median of 33 percent from the first quarter, Matthew O’Connor, an analyst at Deutsche Bank AG, said in a May 25 note.
Dollar volume of high-yield corporate bonds has declined 10 percent from the first quarter, while the volume of investment- grade bonds dropped 13 percent, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. Average daily equity-trading volume on the largest U.S. exchanges is up 1 percent from the first quarter.
Trading volume, an indicator of performance, may not correlate directly with firms’ revenue because banks also can profit from changes in the value of the securities they hold and transaction fees that may not be related to volume.
Banks also face widening spreads, which occur when prices of corporate bonds fall relative to government debt. That often leads to losses in bonds that banks hold as trading inventory.
Spreads between global company bonds and comparable government debt widened 35 basis points in the first two months of the quarter to 233 basis points, or 2.33 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. That has reversed more than half the 69 basis- point tightening that occurred in the first quarter.
U.S. high-yield bond spreads widened 0.97 percentage point to 6.96 percent in the first two months of the second quarter, according to Merrill Lynch’s U.S. High Yield Master II Index.
The Chicago Board Options Exchange Volatility Index (VIX), or VIX, which measures the cost of buying insurance against drops in the Standard & Poor’s 500, had an average price of 20.02 so far in the second quarter, up from 18.20 in the first quarter and 16.76 a year earlier.
Typically, volatility brings spikes in trading volume as money managers change holdings in response to the environment. That hasn’t happened in recent months, Freeman said.
“The bouts of volatility aren’t driving a lot of volume because, for the most part, portfolios have remained pretty defensive and utilized little leverage, so there’s not much portfolio churning or repositioning,” he said. “The stability in the first quarter wasn’t long enough to drive a risk upgrade.”
Greece is prompting declines as banks face questions about whether they’re experiencing a so-called secular, or lasting, shift in their capital-markets businesses amid new regulations and slower global growth. The industry will see little-to-no growth in the total revenue pool over the next few years and needs to cut 20 percent to 30 percent of its managers, Boston Consulting Group Inc. said in an April 26 report.
JPMorgan Chief Executive Officer Jamie Dimon, 56, and Goldman Sachs CEO Lloyd C. Blankfein, 57, are among top bankers to argue the current slowdown is a cyclical decline that will bounce back.
“We’re in a cyclical business, we’ve always said we’re in a cyclical business,” Goldman Sachs President Gary Cohn, 51, said at an investor conference last month. “And we’re in that part of the cycle where our client base is tending to be more conservative than it is in the up parts of the cycle.”
Moody’s Investors Service is conducting a review of banks with the biggest capital-markets operations and has said it will announce decisions on credit downgrades this month. All five firms may be downgraded, with Morgan Stanley (MS:US) facing a three- level cut, as Moody’s said the industry is facing more regulation, weak markets and fragile funding and confidence.
If revenue remains low, banks will likely be forced to make additional cost cuts through lower pay and firings, analysts said. Trading units at the large banks may need to cut 10 percent of their staff, said David Trone, an analyst at JMP Securities LLC.
Banks already scaled back as revenue slumped last year. About 14 percent of investment-bank employees got no bonus for 2011, up from 6 percent the year before, according to a report by executive-search firm Options Group released last week. The financial industry also announced more than 200,000 job cuts, led by Bank of America and London-based HSBC Holdings Plc, which each said they will eliminate 30,000 positions.
“I wouldn’t expect to see something that significant, but quietly trimming groups of people, that’s probably already happening,” said Shannon Stemm, an analyst with Edward Jones & Co. in St. Louis.
Goldman Sachs cut fewer than 50 jobs about two weeks ago to trim expenses as the bank’s revenue prospects worsen, a person familiar with the matter said. New York-based Morgan Stanley is preparing to cut some employees in its trading business, according to two people with knowledge of the plans.
“It’s not like normal downturns where you’re coming off a peak and you get a lot of excess people,” Trone said in an interview last week on Bloomberg Television’s “Surveillance Midday” program. “I don’t think cost cuts are a good lever at this point. You’ll get a little out of it, but not much.”
The S&P 500 Financials Index (S5FINL) of 81 companies has fallen 11 percent this quarter after climbing 21 percent in the first period. Morgan Stanley has dropped (MS:US) 30 percent this quarter, while JPMorgan, Citigroup, Goldman Sachs and Bank of America have all declined more than 21 percent.
The index slid 0.1 percent at 10:08 a.m. in New York as all five banks fell.
Investors still have interest in the group because the stocks have shown large moves to the upside as well, Konrad said. From Dec. 8, the day the European Central Bank announced its longer-term refinancing operation to help provide liquidity to the region’s lenders, through the end of March, the five banks jumped an average of 39 percent, led by Charlotte, North Carolina-based Bank of America’s 71 percent surge.
“The tough part for investors is it would be tempting just to say ‘I’m going to walk away from the group,’ but we’ve also seen these stocks can move up 30 percent on just some more breathing room,” Konrad said. “Because the capital and liquidity is so strong at these financials, any program that the market likes coming out of Europe is going to have a strong impact on the valuations.”
Spokesmen for the five banks declined to comment or didn’t return requests for comment.
The concern that Europe’s debt crisis will spread or that the economic union would splinter has crimped deal activity as well, Stemm said.
Global equity issuance is on pace to be down 8 percent from the first quarter and 29 percent from the second period of 2011, according to data compiled by Bloomberg. Issuance of U.S. bonds is on pace to fall 39 percent from the first quarter and 11 percent from last year’s second quarter. Announced mergers and acquisitions are on pace to drop 25 percent from a year earlier.
That will lead to the banks reporting investment-banking revenue about 10 percent lower than in the first quarter, O’Connor estimates. The number of events that have produced market turbulence also is having a cumulative effect on companies and investors, Freeman said.
“Every time investors -- institutional, corporate and retail -- get smacked with one of these bouts of volatility, it feels like the recovery time is a little longer, a little slower spring effect,” Freeman said.
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