Can corporate and investment banking anchor big banks' bottom lines — again?
With loan defaults surging, Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. relied heavily on revenue from fixed-income and equity trading to offset credit-related losses in 2009.
But there is growing concern that such sources of income will be weaker this year, putting more pressure on corporate finance to fill the void.
Such a gamble on a sustained economic recovery, combined with the lingering threat of heightened governmental oversight, could portend a bumpy year ahead, some industry watchers said.
Analysts said they hope CEOs address the questions when the big banks report fourth-quarter results. JPMorgan Chase is set to be the first of the three biggest banks to report, on Jan. 15.
Steve Stelmach, an analyst with Friedman, Billings Ramsey & Co. Inc., forecasts an overall 15% decline in trading revenue in 2010, partly because of tighter spreads and less volatility. It remains unclear whether investment banking operations can play catch up elsewhere.
"We believe that most of the easy money has already been made," Stelmach said. "Investors are going to be disappointed if they are looking for 2010 earnings growth to be a repeat of 2009."
John Jay, a senior analyst at Aite Group LLC, agreed. "We think it will be tough sledding," Jay said. "All the big banks will be looking this year for an offset to muted activity."
Potential counterweights, observers said, include resurgent debt underwriting, especially if the economy recovers while banks by and large keep their lending standards tight.
Brian Moynihan, Bank of America's new chief executive, gave an optimistic view this week of the company's corporate activity. "Larger companies stand ready to access new equity and debt capital when growth opportunities present themselves," he said Monday at an economic forum in Raleigh.
"Capital markets are largely open," Moynihan added. "Our deal pipeline coming into 2010 is much stronger than it was this time last year." He forecast increased activity in mergers and acquisitions, leveraged buyouts and initial public offerings, especially in health care and technology.
Stelmach said any increase in M&A would be helpful, given that volume hit a low last year. He would only go as far as to forecast "incremental revenue expansion" from such activities, though he said the average deal size and premiums "are tracking in the right direction."
Ralph "Chip" MacDonald, a partner at Jones Day in Atlanta, said he believes 2010 could be a strong year for IPOs, particularly as private equity firms look to cash out and reinvest. He said investment banking operations could also benefit from consolidation within the financial services industry as banks begin to look beyond government-assisted acquisitions.
Overseas opportunities, particularly in emerging countries, could be another anchor, Jay said. "You have to consider those markets," he said. "China is apparently firing on all cylinders, so its financing needs must be growing."
Observers also want to hear executives talk more in their fourth-quarter reports about the challenges to investment banking, particularly competition and regulation, and their impact on revenue.
Moynihan said bankers need to work with Washington to make changes, mentioning derivatives, securitization, compensation and reliance on ratings agencies as starting points. "The vehicles and practices that got us here, and have cost our industry billions of dollars in capital through losses, have to be reformed," he said Monday.
MacDonald said auto and credit card securitizations rose 5.6% last year, boosted by the Term Asset-Backed Securities Loan Facility, or Talf. He said the Credit Card Accountability, Responsibility and Disclosure Act could affect the credit quality and ratings on credit card securitizations, and the winding down of Talf for auto and credit cards poses some risks in 2010, but that he is optimistic about the industry's resilience in light of an improving economy.
The banking industry may have also dodged a bullet with derivatives reform, MacDonald said. "Some of the more draconian proposals look like they are going to fall off," though the greatest uncertainty involves whether a systemic-risk regulator would revisit the issue, and what approach it might take.
Jay said more big banks may develop larger in-house expertise to tamp the influence of rating agencies. "The big banks have really taken it on the chin, particularly on securitized debt," he said. "They may decide to do more of their own legwork," which could prove more costly.
Stelmach said unknown capital and liquidity standards from regulators could also influence investment banking decisions and stymie profits this year. "These guys are going to be a little gun-shy taking action involving capital and liquidity," he said. "No one wants to be raising capital on the back end of 2010."
A final unknown is the impact of the altered competitive landscape. Nonbanks such as Bear Stearns Cos. and Lehman Brothers Holdings Inc. are no more. In their place, several small boutiques have been launched, and U.S. Bancorp has been beefing up in corporate banking. (The Minneapolis company took a major step in May when it opened a capital markets and corporate banking office in Charlotte after hiring former Wachovia Corp. bankers.)
Moynihan expressed some concern about the disappearance of big competitors, particularly when it comes to funding corporate clients. "Nonbank lending sources … provided huge amounts of credit," he said during Monday's speech. "Most of this is gone, or at least far more limited. This has drawn tremendous liquidity from the system."
Stelmach said the changes could benefit the survivors over the long term. The key for all big investment banking operations will be the ability and willingness to make adjustments as the markets change. "We've lost competitors and consolidated others, but there is plenty of capacity left in the industry," he said.