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Wall Street’s five biggest banks reported the worst start to a year since 2008. They’re still asking investors to be patient.
JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) had combined first-half revenue of $161 billion, down 4.5 percent from 2011 and the lowest since $135 billion four years ago. The firms blamed the decline on low interest rates and a drop in trading and deal-making driven by concerns about European government finances and slowing growth in the U.S. and China.
Most of the banks have failed since 2009 to earn a return that exceeds their cost of capital, said Roy Smith, a finance professor at New York University’s Stern School of Business and a former Goldman Sachs partner. The impact of new capital requirements and legislation such as the 2010 Dodd-Frank Act is having a more profound effect on profitability than managements seem willing to acknowledge, he said.
“I’ve been wondering how long this has to go on before people started to take it seriously,” Smith said in a telephone interview. “This is a long time for this to continue, and it’s just getting worse.”
Since 2005, the banks have posted lower revenue in the second half of the year than in the first, company reports show, signaling even worse to come.
While Goldman Sachs said it will seek $500 million in expense cuts focused on personnel costs this year after reporting an 11 percent drop in second-quarter profit, the firm, like its competitors, has resisted calls for more radical changes to its business model.
The day after the bank reported its lowest first-half revenue in seven years, Chief Executive Officer Lloyd C. Blankfein explained the dilemma he faces as he asks shareholders to wait for the rebound he’s expecting.
“There are certain things that are cycles and that it’s not very good for us to overreact to,” Blankfein, 57, said at a July 18 Economic Club of Washington lunch. Even so, “cycles can be severe and they can last a long time and if you get killed in the bad part of a cycle because you don’t manage your business closely enough, when the cycle turns you’re still dead.”
While Bank of America (BAC)’s second-quarter profit of $2.46 billion showed an improvement over a record $8.83 billion loss in the same period last year, shareholders were spooked by a jump in mortgage-bond repurchase demands that cast doubt on whether the bank’s recovery will last. The lender, the second- biggest in the U.S. by assets, plans to trim $3 billion in annual expenses from investment banking, trading and wealth- management units.
“We continue to have work to do, as you can see in the numbers,” Brian T. Moynihan, 52, CEO of the Charlotte, North Carolina-based bank, said of his company’s earnings on a July 18 conference call with analysts and investors. “But we’ve put ourselves in a position to be successful.”
Morgan Stanley, which reported a 50 percent drop in second- quarter profit that missed analysts’ estimates, said it will eliminate 700 more jobs by the end of 2012, bringing the total for the year to 4,000.
“It’s tough to make money in this environment, and so I think there’s going to be a further round” of cuts, Charles Peabody, an analyst at Portales Partners LLC in New York, said in an interview yesterday.
In their 2009 book “This Time is Different: Eight Centuries of Financial Folly,” economists Carmen Reinhart and Kenneth Rogoff showed that financial crises cause deep economic slumps in developed and emerging-market economies. So it’s not a surprise that would affect banks’ profits.
“The U.S. continues to follow the slow and halting recovery that is characteristic of the aftermath of deep financial crises, and recent weakness in bank profit statements in part reflects this reality,” Rogoff, a professor at Harvard University, said in an e-mailed response to questions. New regulations “no doubt also play a role, with financial institutions facing significant transitional costs and considerable uncertainty.”
Morgan Stanley and Citigroup shares have dropped 15 percent and 1.4 percent respectively this year, while JPMorgan and Goldman Sachs are both up less than 5 percent. All four of those banks are headquartered in New York. Bank of America is up 28 percent following declines in both 2010 and 2011. JPMorgan, which reported record profit in 2011, is the only one of the five that isn’t trading at a discount to its tangible book value, an estimate of how much shareholders would receive if the bank was liquidated.
Investors and analysts are showing signs of impatience with management teams. Pershing Square Capital Management LP, the hedge fund founded by Bill Ackman, sold its entire Citigroup stake, according to a July 16 letter Ackman sent to investors. The bank, the third-biggest in the U.S. by assets, was Pershing Square’s fifth-largest U.S. equities holding with a value of $955 million on March 31.
“After one bad night’s sleep thinking about Citi, I pulled the rip cord,” Ackman wrote. “While I still believe that Citi is a very cheap, well-managed, high-quality banking franchise that is likely to increase in value over time, there are much easier ways for Pershing Square to make money.”
David B. Sochol, a former financial-stock analyst for Legg Mason Wood Walker Inc. who now helps manage money at Levin Capital Strategies LP in New York, referred to himself as a “long-suffering shareholder” before quizzing JPMorgan CEO Jamie Dimon on a July 13 conference call about whether that bank’s $5.8 billion trading loss might be a sign that the New York-based lender had become too big to manage.
“We don’t feel great that we haven’t done a great job for shareholders recently, that we completely acknowledge,” Dimon, 56, responded. “But we’re going to keep on building the company, and one day the stock will reflect it.”
Four days later, one of Dimon’s own fund managers -- JPMorgan Asset Management’s Steven Wharton -- asked Goldman Sachs Chief Financial Officer David A. Viniar if his firm was failing to recognize change in the business by continuing to set aside 44 percent of revenue for compensation.
“We’ll see what it ends up being this year,” Viniar said. “We could cut comp very dramatically in one year and it would help our returns, but we live in a competitive environment.”
While banks such as Citigroup and Bank of America will recognize eventually that they have to alter their models and break up or shrink dramatically, according to NYU’s Smith, he said he expects to see changes first at London-based Barclays Plc (BARC) and Switzerland’s Credit Suisse Group AG (CSGN) and UBS AG. (UBSN)
Barclays, which acquired the U.S. assets of failed investment bank Lehman Brothers Holdings Inc. in 2008, had a share price yesterday that was just 42 percent of tangible book value. The chairman, CEO and chief operating officer all resigned after the bank agreed to pay 290 million pounds ($456 million) for manipulating the London interbank offered rate, a benchmark interest rate known as Libor.
A new management team may be more willing to sell the investment bank, in effect recreating Lehman Brothers, just as American Express Co. spun off Lehman as a separate company in 1994 a decade after acquiring it.
“There’s a good chance that might happen at Barclays,” Smith said. “If it does, and that does make the stock price increase, that might send a message to others.”
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