Shrinking Profits at large Dealers

April 18th, 2014 8:35 pm | by John Jansen |

The FT has an article on shrinking trading profits at the large investment banks. It is not difficult to understand the problem. Regulation has limited opportunities for profit. The Federal Reserve has neutered volatility as the market trades in exceedingly narrow ranges for months at a time. Electronic trading has narrowed bid offer spreads and has jumbled long standing relationships which had previously allowed dealers to make some relatively easy money.

I think it is rough sledding for dealers until they survive the bear market when rates rise in 2018 (dry humor). Rising rates and increased volatility and the shake out in the business which will precede that will make for profit opportunities later in the decade. In the meantime if you make a living on the East End of Long Island or sell Porsches, tighten your belt.

Via the FT:

US banks post worst start to year for bond trading since 2008

By Tom Braithwaite and Camilla Hall in New York

US banks reported their worst start to the year in fixed-income trading since the financial crisis, raising new questions about whether Wall Street’s profit engine can ever roar back to life.

Citigroup, JPMorgan Chase, Bank of America, Goldman Sachs and Morgan Stanley reported $15.1bn in fixed-income trading between them in this week’s earnings season. That is the weakest first quarter since 2008 when most banks racked up huge losses on their bond portfolios.

It is barely more than half the level that the five banks made in the Federal Reserve-fuelled bumper first quarter of 2009, when the central bank’s efforts to rescue the financial system drove up asset prices and allowed the five banks to record $25bn of profits.

It is also worse than 2007, at a time when the five banks faced more competition before the demise of Lehman Brothers and the acquisitions of Bear Stearns and Merrill Lynch. In the first quarter of that year they made $15.7bn.

Since then new regulations, including the Basel III capital rules that make trading riskier products less profitable and the Volcker rule that bans banks from trading for their own accounts, have curbed risk-taking.

At the same time, the banks’ clients have shown muted appetite to trade in uncertain markets.

Fixed income, where banks trade derivatives, interest rates, bonds, commodities and currencies, is still a hugely significant part of the banks, representing more than 17 per cent of their revenues – even though three of the five banks also have large consumer operations. But it has been steadily declining after surpassing 28 per cent in 2009.

The weak results in the US come as Barclays and Deutsche Bank – two heavyweights in the business – prepare to report their first-quarter results, with some analysts predicting an even worse result there.

The top four US banks are hoping to pick up share from European rivals. “I am a believer that the European firms are going to continue to have to hunger march,” said Guy Moszkowski, analyst at Autonomous Research. “Either they are undercapitalised, which is certainly the case for Deutsche, or they are facing regulatory pressure, whether from the UK or Swiss banking authorities, to minimise their risk participation.”

Brad Hintz, analyst at AllianceBernstein, said: “I think Goldman makes a good case that at some point in the distant future we will reach the nirvana of repriced markets [because competitors shrink their businesses]. I’m not sure that we’re there yet.”

Mr Moszkowski added that “mix really matters”, with banks that were stronger in commodities and credit, such as Goldman and Morgan Stanley, faring less badly than universal banks such as JPMorgan and Citi.

Gerard Cassidy, bank analyst at RBC Capital Markets, said: “The bigger picture everyone is interested in with FICC trading, the 800-pound gorilla, is: are these lower levels the new levels or is there a more cyclical component?”

Banks can hope that investors rediscover a trading appetite this year but they cannot hope to have digested all the regulations that are hampering their businesses. For example, the full force of new rules pushing derivatives trades towards electronic platforms – potentially weakening bank margins – have not yet been felt. JPMorgan has said those rules alone could hit revenues by $1bn. “If that’s the number,” said Mr Moszkowski, “it’s still out there.”

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  1. 3 Responses to “Shrinking Profits at large Dealers”

  2. By CGS on Apr 21, 2014 | Reply

    Thank you, John, for maintaining this blog. I’m an outsider just trying to understand these markets and, since I haven’t read this view elsewhere, I’m wondering about the specific data underlying this comment: “The Federal Reserve has neutered volatility as the market trades in exceedingly narrow ranges for months at a time.”

    Do bond markets in general have very narrow ranges right now? Or are you thinking of specific markets?

  3. By John Jansen on Apr 21, 2014 | Reply

    The 10 year note traded at a yield of 2.82 early in March after the labor report on that first Friday of the month. Since then it has never revisited that level. On the other side of the ledger the issue is for sale around 2.60. I believe we have traded into the mid 2.50s but that was a response to the situation in Ukraine. So for all practical purposes we are locked between about 2.75 and 2.60. That doe not give you a lot of opportunity to make money if you are dealer.

    Regarding the Federal Reserve neutering volatility, if you manage a portfolio of fixed income assets and the FOMC tells you as they have since 2008 that funding will essentially be zero forever then there is not too much risk in owning that stuff and you can just book the carry. Some of the carnage in the belly of the curve is people unwinding structural positions they have owned for a long time and who are preparing for the eventuality that at some point funding costs will rise.

  4. By CGS on Apr 21, 2014 | Reply

    Thank you for explaining to a neophyte.

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