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| Some of the operating strategies under CEO Tidjane Thiam are now working effectively |
Rumblings appear there that banks, big and small, will struggle to report earnings they've enjoyed the past year and a half. This comes after a period of blockbuster results. Partly from the aid of tax breaks and partly from continuing positive signs in the economy, some banks in 2018 posted record earnings and even hurdled past the 10%-return-on-equity barrier.
We're talking about a year where the big-tier banks, one by one, reported over $15 billion in net income--from JPMorgan Chase's $33 billion to Bank of America's $28 billion. Even Goldman Sachs, which since the crisis has joined the club of big universal banks and is just shades smaller than a JPMorgan Chase and Citigroup, topped $10 billion in earnings.
While Wells Fargo is still hampered by scandals and a continuing change-over among CEOs, it still generates enormous profits ($22 billion last year) and reasonable returns (11% last year). For now, the bank must address regulators' concerns and the wariness of the public after widespread cases of checking-account fraud.
Has Wells Fargo finally overcome the cultural and organizational risks that led to the consumer-bank scandals? In the past month, the bank appointed its third CEO in recent years by enticing BNY Mellon's CEO Charles Scharf to assume a bigger, more challenging role in scrubbing the organization at Wells Fargo.
Scharf comes from the inner circle of JPMorgan's CEO Jamie Dimon, under whom he worked while running much of the consumer bank there years ago. Like Dimon, Scharf is a businessman running a financial institution, a leader focused on revenue growth, cost control and strong balance sheets rather than a blue-blood cultivation of client relationships.
JPMorgan Chase, Goldman Sachs and other big investment banks are suffering mild blows after the sudden cancelation of the vaunted We Work IPO, the glorious offering of new stock that would seize headlines in late 2019. Big banks prepared to provide debt financing (up to $6 billion), while arranging an IPO valued above $40 billion.
But a September equity market couldn't digest it and questioned the assessed value of the company and predicted the company wouldn't be profitable at all for many years to come. The once $60 billion company was reduced to $40 billion to $20 billion and now to questionable, uncertain value. Some negative observers even wonder if the company can remain solvent in a few years (although cash received from the new IPO was supposed to help it remain viable in the short term).
The IPO was put back on the shelf, while the market hinted that venture-capital-backed new companies need to do a better job about projecting when they will turn billions in losses to millions in gains.
JPMorgan Chase, Goldman Sachs and other big investment banks are suffering mild blows after the sudden cancelation of the vaunted We Work IPO, the glorious offering of new stock that would seize headlines in late 2019. Big banks prepared to provide debt financing (up to $6 billion), while arranging an IPO valued above $40 billion.
But a September equity market couldn't digest it and questioned the assessed value of the company and predicted the company wouldn't be profitable at all for many years to come. The once $60 billion company was reduced to $40 billion to $20 billion and now to questionable, uncertain value. Some negative observers even wonder if the company can remain solvent in a few years (although cash received from the new IPO was supposed to help it remain viable in the short term).
The IPO was put back on the shelf, while the market hinted that venture-capital-backed new companies need to do a better job about projecting when they will turn billions in losses to millions in gains.
Otherwise, the banking momentum of 2018 continued through much of 2019, until issues with China trade and suggestions that the recovered economy had peaked haunted markets and now threaten bank earnings.
Equity markets have become volatile, and there are further hints that interest rates will trickle downward this year. There was confusion this summer about an inverted interest-rate yield curve. Now banks have begun to prepare for a less-than-spectacular second half, 2019.
Banks normally dislike when interest rates decline, because they hurt earnings. Loan interest-rate spreads decline, especially related to floating-rate loans in the portfolio. Long-term loans, particularly loans that were booked at higher fixed rates, are pre-paid. So last year when consumers and corporate borrowers were squeamish about higher rates, banks quietly enjoyed upturns in net-interest earned. When interest rates trickle downward, they prepare for tighter spreads and declines in net interest.
There is a consensus that if there were another recession or an extended downturn, banks are better prepared, better capitalized, and closely watched. Although the mid-2000s crisis is now a chapter in financial history books and many lessons learned have been set aside, new rules have helped ensure banks can endure tougher times. Losses on loan portfolios and trading positions are inevitable, but if banks have more capital and liquidity, losses won't lead to calls for bank regulators and central banks to bail them out. At least that's what the calculations related to new rules and minimum amounts of capital suggest.
As we approach late 2019 and even if banks, big and small, report slowdowns in earnings, they confront familiar issues and challenges, some of which could be turned into opportunities.
Trading and Market Risks
Post Dodd-Frank regulation, this is the domain of big banks, which continue to trade an assortment of asset classes (interest rates, equities, commodities, currencies, derivatives, etc.), but in the U.S. under the gaze of the Volcker Rule, the Dodd-Frank requirement restricting proprietary bank trading activity. Banks aren't suppose to trade like hedge funds; they are permitted to trade securities, commodities, currencies and derivatives if such trading facilitates customer flow. Despite restrictions, big banks generate billions in trading revenue ($12 billion at JPMorgan last year, $8 billion at Bank of America).
Trading revenues are and have always been volatile, although banks quarter after quarter, year after year, lament the unpredictability of performance. Market behavior, volumes and outlook often dictate what banks earn in trading. When markets slow down, get worried and behave in uncertain ways, banks get pummeled in trading.
Turmoil in markets (equity markets, inverted yield curves, uncertainty about trade tariffs, etc.) will lead to declines in bank trading profits (or perhaps losses in some asset classes). The big banks (from Citigroup to Morgan Stanley and Goldman Sachs) remain committed, even if related revenues surge and dive, surge and dive.
Notwithstanding volatility, probably the most important trading topic in the U.S. is how and whether the Volcker Rule will be changed. Proposals are under review to simplify the rules and turn back time a little toward pre-2010. Banks must still trade for customer accounts and customer flows, but they may not be subject to the complex burden of proof that the trade was not a proprietary trade, one for the bank's own account. Regulation could lean toward the presumption that all trades are customer-related unless the bank shows they are proprietary (or "hedge fund"-like). Stay tuned.
Deutsche Bank and Its Continuing Woes
Among global banks with a footprint everywhere, including in the U.S., Deutsche Bank has had to regroup time and again over the past few years. Investment banking strategies have been misguided, as the bank pushed aggressively to step into the top rungs of underwriting, mergers and acquisitions, and trading (especially in derivatives). Yet the bank wanted to maintain its roots as an important consumer and corporate bank in Germany.
The balance sheet grew faster than capital; earnings hobbled. Sometimes it reported losses, when its peers started having banner years. The marketplace wondered if it could be the next financial-institution behemoth to implode. The New York-based subsidiary was supposed to be the tail wagging the dog and eventually became the tail that unraveled. Top talent has fled.
Replacing leadership with new sector leaders and CEOs hasn't necessarily helped. The bank has tried to complete and replicate what its peers have done (especially in investment banking and trading), but the plans on paper have never resulted in a stream of solid earnings. Something hasn't been right.
Deutsche Bank, once again in 2019, has had to contemplate a reinvention. This time, it promises to step back somewhat from its investment-banking dreams, while it once again shuffles leadership. The bank is not a Lehman or Bear Stearns on the horizon, but it may need to follow strictly its plans to return to plainer, basic consumer and commercial banking roles.
At Thiam's Place
Meanwhile, Credit Suisse had to address similar issues. It, too, has tried to thrust itself into the highest rungs of investment banking and trading. It has tried to whole fast to an investment banking legacy arising from its First Boston roots (when that American investment bank was undoubtedly a top-tier bank during some of the glory days of investment banking in the 1980s and 1990s.)
It, too, had similar performance problems. In 2015, after a lackluster 4.5% ROE performance while its peers were headed toward 10%, Credit Suisse decided to hire a businessman outside, Tidjane Thiam, an insurance-company executive. In sometimes ruthless fashion, he reorganized, restructured, and pared back strategies at the bank. He reduced the emphasis on investment banking and trading and acknowledged Credit Suisse's European heritage in corporate banking and private banking.
Years later, the bank has cleaned up its act and returns are reaching 9% (ROE). Thiam's plan was to overhaul the place, not tweak or massage it, and the results show progress.
(In recent weeks, however, Thiam and team have had to respond to accusations of "corporate espionage." Thiam eased out a top bank executive after the two reportedly had problems getting alone. In the aftermath, there have been accusations the bank engaged in some form of spying in the process. More to come?)
Can Marcus Come Through?
Over the past decade, no doubt mighty Goldman Sachs, now a bank holding company, has observed the successes in consumer banking at its peers. Consumer banking brings in cheap deposits, diverse loan portfolios, and high loan spreads. Other banks also projected continuing growth in consumer banking, especially as the banks look for stable sources of revenue to offset the volatility of revenues in investment banking and trading.
So Goldman stepped into consumer banking. Instead of acquiring an established mid-size regional bank and rebranding it Goldman. Goldman, effectively, has tried to build a consumer bank from scratch. It has branded its consumer business as "Marcus," in an honor of sorts to one of its long-ago founders.
Yet Goldman has stumbled out the door, incurring some losses, partly due to loan losses and inadequacies in risk management, something in which on the trading and corporate banking side it sometimes has few peers. (On the corporate side, it has an $80 billion-plus corporate loan portfolio.) In some ways, it may have tried to grow too fast and too quickly, tolerating exposures and approving loans with improper regard to credit risk if only to gain market share.
Goldman won't quit too soon. It's the Goldman way to commit, learn from its mishaps, polish a strategy that permits it to take advantage of financial technology, and recommit in bigger ways. But this strategy make take a long time. Marcus right now may be for, now, no threat to the offerings from Citi, PNC, USBank, Regions or even some community banks.
Tracy Williams
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