Lloyd Blankfein may travel by train rather than private jet these days, but the firm he heads has moved back into the fast lane. On April 13th Goldman Sachs kicked off the banks’ earnings season in impressive fashion: the $1.8 billion of net profit it posted for the first quarter smashed analysts’ forecasts, leaving them wondering, if only for a moment, whether they were back in 2006. At the same time, Goldman cheekily raised more than $5 billion of common equity to help pay back the $10 billion of taxpayer money it was arm-twisted into taking last October.
Goldman is keen to distinguish itself from weaker banks, but optimists see its results as part of a pattern of recovery for the industry. JPMorgan Chase reported stronger-than-expected results on April 16th. Wells Fargo expects to post record quarterly profits, largely thanks to surging mortgage refinancing as interest rates have fallen. Optimism about banks’ performance has given their shares a much-needed lift from their March lows. Hope is growing that, with markets thawing and the yield curve steeper, allowing banks to lend at higher rates than those at which they borrow, many will be able to earn their way out of trouble. The reality may be less cheering.
It is easy to see why Goldman considers it a “duty” to repay the government (it would be the first big bank to do so). With a business model that relies on rewarding top performers handsomely, it is chafing more than most under the executive-pay restrictions that come with the infusion-though it still managed to pay employees slightly more last quarter, as a proportion of total costs, than it did the year before, a “massive middle finger” to congressional critics, as one rival puts it. Goldman worries about other forms of interference, too: politicians have questioned, for instance, whether it should have so much invested in foreign banks, such as China’s ICBC.
Goldman hopes to be able to settle its debt to the taxpayer once it gets the result of the stress tests being conducted on America’s 19 largest banks, which are due to end at the end of April. A clean bill of health seems all but assured given its high capital ratio, a $164 billion pool of cash and a culture of marking assets to market.
But what is good for one bank may be bad for the system as a whole. Regulators worry that letting one or two strong banks repay risks turning the weak into targets and takes lending capacity out of the system. They also worry about the embarrassing prospect of banks that repay early having to return to the trough if markets deteriorate again, which would create political fireworks. Brad Hintz of Alliance Bernstein expects the government to delay Goldman’s repayment until a larger group of banks is able to repay simultaneously.
When that might be is far from clear. Even Goldman is in less stellar shape than its results might suggest. First, they excluded December, a poor month that fell into a convenient gap when Goldman and Morgan Stanley switched to calendar-year reporting on becoming bank-holding firms.
Second, Goldman, like others, benefited from one-off boosts, such as the surge in corporate-bond issuance as seized-up markets began moving again in January, and from managing each other’s government-backed debt issues. They are also enjoying freakishly high bid-ask spreads and margins in “flow” businesses, such as fixed income, currencies and commodities (FICC). These have widened by up to 300% thanks to spiking volatility and the retreat of several big rivals, according to a study by Morgan Stanley and Oliver Wyman, a consultancy. Fully 70% of Goldman’s first-quarter revenue came from FICC.
These spreads are sure to come down as new actors enter the fray and old ones return, albeit gingerly. Other businesses will struggle to take up the slack any time soon. Goldman’s quarter-on-quarter investment-banking revenues were down 20%. Merger-advisory fees are likely to remain depressed for several years.
There is, moreover, still plenty of red ink sloshing around. Citigroup was expected to post its sixth straight quarterly loss on April 17th. It continues to shrink its balance-sheet and to look to sell non-core assets. Morgan Stanley, too, is expected to report a loss on April 22nd, largely thanks to having to mark-to-market its own debt, which has become more expensive. Across the Atlantic UBS, a Swiss bank, warned on April 15th of yet another loss and more job cuts as it tries to stem client defections that, according to its outgoing chairman, have put it in a “precarious” situation.
More blows are coming. Banks worldwide have written down their assets by $1.1 trillion. The final tally is expected to be double that, or more. The pain is only now starting to spread through commercial property and commercial loans. As a result, the first-quarter reprieve will turn out to be a “head fake”, says Chris Whalen of Institutional Risk Analytics.
It does not help that many banks have not set aside enough reserves for credit losses-though the blame lies as much with accounting rules as with their own managers. Analysts at Keefe, Bruyette & Woods argue that Wells Fargo holds an array of assets at rose-tinted values and may need another $25 billion in capital, on top of the $25 billion it has already taken from the Treasury. Few banks hold their commercial-property portfolios anywhere close to the 50-60 cents on the dollar valuation that Goldman does.
The longer-term outlook is equally sobering. In 2006 investment banks made an average return on equity of 17%. Just to get back to double digits, they will have to cut costs by well over $100m for every $100 billion of assets they hold, reckon the authors of a recent report from the Boston Consulting Group. Commercial banks can expect their returns to stay in the 10-12% range of the 1940s-80s for the indefinite future, says Richard Ramsden, a Goldman analyst.
Although the overall pie will be less mouth-watering, some will enjoy a bigger slice. Barclays, which snapped up Lehman Brothers’ American operations for a song, now boasts a 15% share of the Treasuries market, for instance. But even the survivors remain cautious. David Viniar, Goldman’s chief financial officer, this week said market conditions remain “dangerous”. One interpretation of the timing of the bank’s capital-raising is that it wants to grab what it can in case the second quarter is not as hospitable as the first. No wonder American bank shares are still, on average, trading some 70% below their peak.