Shrinking Bank Revenue Signals Dawn of `Worst' Growth Decade

Bloomberg

 

Shrinking revenue at U.S. banks, led by Goldman Sachs Group Inc. and Citigroup Inc., may continue to fall as the industry heads into what could be its slowest period of growth since the Great Depression.

After the six largest U.S. banks posted record revenue in 2009, combined net revenue fell by an average of 8 percent in the third quarter from a year earlier and 16.3 percent over the last two quarters, according to data compiled by Bloomberg. Revenue so far this year is down by 4.1 percent, driven by declines in everything from trading at Goldman Sachs to home lending at Bank of America Corp. New laws restricting account and credit-card fees, as well as derivatives and capital rules, are also squeezing lenders.

Next year will kick off a decade that will bring the “worst revenue growth” for U.S. banks in 80 years, according to Mike Mayo, a banking analyst at Credit Agricole Securities USA Inc. in New York. Net revenue at U.S. commercial lenders has expanded at a slower pace in each of the last three decades, falling to 6 percent in the last decade from 12 percent in the 1970s, according to Federal Deposit Insurance Corp. data.

“Revenues aren’t just weak for this quarter, or even for this upcoming year, but for the entire upcoming decade,” said Mayo, a former Federal Reserve analyst who has more than 20 years of industry experience. “The speed limit’s been lowered for how fast banks can drive earnings.”

The trend over the last two quarters is hitting almost every line of income statements and is spread across the sector, affecting investment banks, consumer banks and commercial lenders. It’s eating away at profits, depressing stock prices and threatening bonuses and new hiring.

BofA, JPMorgan

The 17.6 percent drop in net revenue since March 31 at Charlotte, North Carolina-based Bank of America, the largest U.S. bank by assets, came mostly from its mortgage-lending and credit-card businesses. The company reported a $7.3 billion loss in the third quarter after taking a $10.4 billion goodwill writedown against new debit-card laws.

JPMorgan Chase & Co., where revenue dropped 13.9 percent over the same time frame, has been hurt by bad credit-card loans. Revenue from credit cards at the New York-based lender, the second-largest in the U.S., fell more than 17.6 percent in the third quarter from a year earlier.

The bank’s revenue is also suffering, along with the rest of the industry, from new restrictions on the fees it can charge for credit cards, checking accounts and other consumer services. Chief Executive Officer Jamie Dimon, 54, told analysts Oct. 14 that the bank will lose about $750 million in profit as a result. He also said new derivatives rules will cost $1 billion in lost revenue.

Trading Revenue

Wells Fargo & Co.’s decline of 2.7 percent since the first quarter has come from its community-banking operations. New limits on overdraft fees trimmed revenue at the San Francisco- based lender by $380 million in the third quarter, Chief Financial Officer Howard Atkins told analysts on an Oct. 20 conference call.

Goldman Sachs and Citigroup, whose revenue fell 30 percent and 18 percent over the last two quarters, have been hampered by lower trading results. The two New York-based firms had the biggest drop of the six banks so far this year. Lucas van Praag, a Goldman Sachs spokesman, declined to comment. Shannon Bell, a spokeswoman for Citigroup, said it is “uniquely positioned to take advantage of growth opportunities in the emerging markets.”

Drawing Down Reserves

At Morgan Stanley, a fall in fixed-income and equity trading drove revenue down 25 percent over the six months. Goldman Sachs and New York-based Morgan Stanley posted declines in fixed-income trading revenue of more than 37 percent from a year earlier, while Citigroup’s investment banking revenue was down by 20 percent.

Lower credit costs and a less gloomy housing outlook allowed lenders to draw down reserves and set aside fewer provisions against consumer loan losses. That helped them to remain profitable. Net income for the first nine months was $39.6 billion for the six banks, compared with $39.5 billion for the same period last year. Still, some analysts questioned the growth prospects of an industry that made up as much as 20 percent of the profit from Standard & Poor’s 500 Index companies before the financial crisis, according to Bloomberg data.

“That five- or six-year period during the boom, that was just purchase activity created by credit,” said Christopher Whalen, a former Federal Reserve Bank of New York analyst and co-founder of Institutional Risk Analytics in Torrance, California. “The ‘new normal’ terminology, the cliche we all hate, is absolutely true. When you’ve withdrawn all of this credit from the economy, you’re also taking a component of revenue out.”

40-Year Trend

“We’ll be lucky” if revenue growth for U.S. banks is flat this decade, Whalen said.

Financial companies have trailed the broader equity market this year. The S&P 500 Financials Index is up 1 percent, while the overall S&P 500 Index has climbed 6.3 percent. Bank of America and Morgan Stanley have each fallen more than 17 percent through yesterday, while Citigroup had the only increase among the biggest six, jumping 27 percent before today.

The six largest lenders are trading at an average of 0.9 times their book value, less than half the average level over the last 10 years. Bank of America’s market value is about 53 percent of its book value, while Wells Fargo is trading at 1.2 times its book value.

Declining revenue growth rates for banks is a 40-year trend, according to FDIC data. U.S. banks had compound annual revenue growth of 12 percent from 1970 through 1979, about 10 percent during the 1980s, 8 percent in the 1990s and 6 percent over the most recent decade.

‘Not Your Friend’

“When it comes to decade-long revenue growth for banks, the trend is not your friend,” Mayo said. “Basic traditional banking is likely to remain weak. It’s a slower-growing economy, and banks can’t or shouldn’t try to overcome headwind by reaching for inappropriate risky growth.”

Gross domestic product in the U.S. is projected to grow by 2.7 percent this year, 2.4 percent next year and 3 percent in 2012, according to median estimates of 65 economists surveyed by Bloomberg.

To find growth, banks including JPMorgan are looking to expand their reach overseas, where GDP growth rates are about twice those of the U.S. The bank announced in February plans to double its 4 percent share of the Asian market over the next few years and has expanded its global commodities-trading unit through a $1.7 billion purchase of parts of RBS Sempra Commodities LLP earlier this year.

Brokerage Strategy

Citigroup, which already derives more than two-thirds of its revenue outside the U.S., is “well-aligned with the growth trends we see globally,” CEO Vikram Pandit, 53, told analysts Oct. 18.

Morgan Stanley is looking for growth from its brokerage unit after buying a controlling stake in a joint venture with Citigroup’s Smith Barney, more than doubling its brokerage ranks to about 18,000. Bank of America is also relying on its brokerage unit, Merrill Lynch, to sell investment services to existing bank customers, both in the U.S. and overseas.

Wells Fargo CEO John Stumpf told analysts Oct. 20 that his bank is making up for lost revenue growth by offering customers service across multiple platforms -- where they shop, at ATMs, online, via telephone and mobile banking.

Generating growth will be about “taking share away from other banks,” said Whalen of Institutional Risk Analytics. “At best the global economy will be a zero-sum game.”

Loan Growth

Bank revenue will benefit when loan growth returns, said Christopher Kotowski, an analyst at Oppenheimer & Co. in New York. In the savings and loan crisis of the 1990s, average annual loan volume didn’t grow until two years after the amount of new troubled assets peaked, he wrote in a July note to investors.

Consumer and commercial loans at U.S. banks climbed 0.6 percent in September to $6.8 trillion from a year earlier, the first rise in 15 months, according to data from the Federal Reserve Bank of St. Louis. That compares with an annual growth rate of 11 percent from 2005 through 2007 during the height of the housing boom. Loan volumes peaked at $7.29 trillion in 2008.

“Loan growth and job growth are always the last things to come back,” Kotowski said. “I know people are impatient because there’s a lot of pain out there, but I don’t think there’s a way to jumpstart the process. It needs to run its course.”

Appetites for Risk

William Rogers Jr., president of Atlanta-based SunTrust Banks Inc., told analysts Oct. 21 that large corporate customers are using about 17 percent of their loan capacity, compared with an average of “mid to high 20s.” For mid-size companies, the rate is in the “low 30s,” compared with an historic average in the low to mid 40s, he said. The rate of decline has abated this year, he said.

“I would hope that we’d start to see some kind of increase depending on some type of economic recovery,” he said.

Betsy Graseck, an analyst for Morgan Stanley in New York, said bank revenue will likely shrink this year and next before rebounding in 2012. Consumer loan growth and investor appetites for risk will begin to rise again late next year, she said.

“We’ve got two more years of slog and workout,” Graseck said. “We see the light at the end of the tunnel. It’s a faint glimmer, and it’s growing brighter over the course of the next two years.”

Operating Margins

Bank revenue in the first quarter surged in part because of two government programs designed to revive the U.S. housing market -- the Fed’s $1.25 trillion mortgage-bond purchase program that ended in March and a homebuyer tax credit that expired in April. Revenue has been weak since.

Expenses aren’t falling as fast as revenue at the six largest banks, which is squeezing their operating margins. Non- interest expenses, including compensation and rent, fell 3 percent in the third quarter from a year earlier. The overhead ratio for the six banks -- non-interest expenses divided by revenue -- climbed to more than 60 percent for the first time since the height of the financial crisis in 2008.

That helped lead to Bank of America and Morgan Stanley posting the first quarterly per-share losses this year among the six banks.

Dividend Impact

Slower revenue growth could hinder banks’ plans to raise dividends. The six banks currently pay quarterly dividends totaling 51 cents, down from $2.49 in 2007. JPMorgan’s Dimon told investors earlier this month that he hopes to raise his bank’s dividend in the first quarter of next year, and Wells Fargo’s Atkins said last week that an increase is a “top priority” for the bank.

Banks also may be forced to cut pay and headcount to control bank risk management if the revenue decline continues. Goldman Sachs reduced the amount it set aside for compensation in the first nine months of the year, as did the investment banking divisions at Morgan Stanley and JPMorgan. U.S. securities firms may cut as many as 80,000 jobs in the next 18 months as revenue growth slows, bank analyst Meredith Whitney, founder of New York-based Meredith Whitney Advisory Group LLC, said last month.

The size of the biggest banks places them at a disadvantage to increase revenue relative to smaller competitors.

“Size is a problem -- there are four banks that are over $1 trillion in assets, and it’s really tough for them to grow,” said Thomas Brown, CEO of Second Curve Capital LLC, a New York hedge fund that focuses on financial institutions. “The smaller banks have other issues, but their growth prospects are much better.”

Citi Discovers Security Flaw in iPhone Application

NY Times

 

After Citigroup on Monday discovered a potential security flaw in the Apple iPhone app that its customers use to access its Web site, the bank urged customers to upgrade to a newer version of the software, which it says will correct the problem.

In a statement, Citigroup said the original app accidentally saved information from a banking customer’s account into a hidden file on the iPhone. The statement from Citigroup was first reported by The Wall Street Journal.

Citigroup said the update “deletes any Citi Mobile information that may have been saved” to a customer’s iPhone or computer. The bank also said the update “eliminates the possibility that this will occur in the future.”

Although Citigroup was working with customers to fix the problem, the bank said it did not believe its customers’ personal information was affected. Citigroup also said the bug only affected iPhone users in the United States, though it did not say how many.

John Hering, co-founder of Lookout, a security company specializing in the protection of mobile phones from viruses and malware, said that the vulnerability of smartphones was a growing concern, and that Citigroup’s  announcement shows how unsafe these devices can be.

“I think this just underscores the importance of making sure these devices stay safe and this isn’t a one-time problem either,” he said. “Mobile apps are often exposing more information than people realize.”

Mr. Hering and other security experts believe that the mobile industry is on the verge of some major security problems as more people use their phones for banking and other personal information.

“At this point, it’s not a matter of if, it’s a matter of when,” he said.

Although Apple says the iPhone is a safer environment than other mobile competitors because of the company’s strict rules about approving the apps it allows on the iPhone, bugs like this show that flaws can always make it onto a system, sometimes at the fault of the application’s owner.

“I think this is going to be the beginning of more and more applications that have this kind of problem,” Mr. Hering said. “I commend Citibank for staying on top of this, but in the next scenario it could be a much different story.”

Regrets of Ex-Citigroup Execs don't Satisfy Federal Panel

LA Times

Apologies from Chuck Prince and Robert Rubin -- but no acceptance of blame -- for the near-collapse of the giant firm that led to a $45-billion bailout leaves fiscal crisis panel members frustrated.

 

Two former top executives of Citigroup Inc. on Thursday publicly apologized for the financial crisis and the near collapse of the giant firm that required a taxpayer bailout of $45 billion, but took heat from a federal panel investigating the crisis for not accepting blame for the company's dramatic fall.

"Let me start by saying I'm sorry. I'm sorry the financial crisis has had such a devastating impact on our country," former chief executive Chuck Prince told the federal commission investigating the causes of the financial crisis. "I'm sorry that our management team, starting with me, like so many others, did not see the unprecedented market collapse that lay before us."

Prince's mea culpa came on the second of three days of hearings by the Financial Crisis Inquiry Commission into the subprime mortgage meltdown. He was followed by former Citi board chairman, Robert Rubin, who expressed regret for the failure of himself and others to see the approaching financial turmoil.

"Almost all of us in the financial system, including financial firms, regulators, rating agencies, analysts and commentators, missed the powerful combination of forces at work and the serious possibility of a massive crisis," said Rubin, who served as Treasury secretary under President Clinton. "We all bear responsibility for not recognizing this, and I deeply regret that."

But Prince and Rubin did not take direct responsibility for leading the company into a financial morass. They said they were not aware until the fall of 2007 of the high risks of the mortgage-backed assets the company was holding and largely blamed the company's problems on a confluence of outside market forces.

Democrats and Republicans on the panel ripped the two executives for diverting blame.

"At the end of the day, the two of you in charge of the organization did not seem to have a grip on what was happening," said commission Chairman Phil Angelides, a Democratic appointee.

"I'm not so sure apologies are as important as assessment of responsibility. . . . Instead of asking what did you know and when did you know it, I should be asking what didn't you know and why didn't you know it," he said.

The panel's vice chairman, Bill Thomas, a Republican appointee, slammed Prince and Rubin for not returning any of the tens of millions of dollars in compensation they received before Citigroup's fall. He said a "simple apology" isn't enough "no matter how often you feel really really sad."

Citigroup has been the most contrite of the firms that received a major bailout, and because of the large amount of assistance it received, has been a major focus of lawmakers and the panel investigating the crisis.

Last month, Citi's current chief executive, Vikram Pandit, publicly thanked taxpayers for the $45 billion in federal money that helped save the company in late 2008. The bailout also included a government guarantee of $102 billion for a large portion of Citi's assets. That guarantee has since been removed. Citi in December repaid $20 billion of the bailout. The remaining money was converted into a $27-billion government ownership stake

The Treasury Department said last week it intends to cash in those shares, which could result in an $8-billion profit for the government.

Prince said risk assessments by Citigroup on about $40 billion of highly rated securities based on subprime mortgages turned out to be "dramatically wrong." But he said he could not fault company employees for acquiring those assets because of their AAA-plus credit ratings.

"Having $40 billion of AAA-plus-rated paper on the balance sheet of a $2-trillion company would typically not raise a concern," Prince said. But the value of those assets began deteriorating amid the collapse of the housing market. Prince resigned in Nov. 4, 2007, after Citigroup announced $8 billion to $11 billion in write-downs for those investments, which ultimately cost the company $30 billion.

Although Prince and Rubin said they were not alone among financial executives to miss signs of the coming crisis, commission member Byron Georgiou, a Democratic appointee, said they and others were "hallucinatory" given the risks being taken with subprime mortgages.

"When you look at the fundamentals, it belies logic," to say the crisis was impossible to foresee, he said.

The financial crisis inquiry panel is focusing much of their three days of hearings on Citi's problems. On Wednesday, Richard Bowen, the former senior vice president and business chief underwriter of CitiMortgage Inc., testified that he began warning company officials in 2006 about the risks being taken with securities backed by subprime mortgages. He finally sent an e-mail on Nov. 3, 2007, to Rubin and other top officials "resulting in significant but possibly unrecognized financial losses existing" within Citigroup.

Rubin said Thursday he referred the e-mail to the appropriate company officials and "I do know factually that was acted on promptly." Angelides asked Rubin to submit details on who acted on it and how.

EMI in Dire Straits

LONDON (AP) - Struggling music group EMI faces being taken over by its bankers after failing to clinch a deal to sell the North American distribution rights for its artists to Universal Music Group or Sony Music.

EMI, which has the Beatles, Coldplay, Lily Allen and Pink Floyd on its books, had hoped to raise around 200 million pounds ($304 million) by offering its rivals a five-year licensing contract.

A source close to both sets of talks, who requested anonymity because the discussions were private, said Thursday that they fell apart after a failure to agree on price. EMI declined to comment.

The collapse of talks leaves EMI battling to raise 120 million pounds by mid-June to meet its commitments on loans from U.S. bank Citigroup.

If funds can't be raised from investors and the loan goes into default, Citigroup could seize EMI and cause it to be sold or broken up.

EMI has been struggling to stay afloat since it was bought by private equity firm Terra Firma Capital Partners for 4.2 billion pounds on the eve of the credit crunch in 2007, saddling the company with debt.

Several big-name acts, including Radiohead and the Rolling Stones, quit the label amid the cutbacks and restructuring that followed.

Terra Firma, led by British financier Guy Hands, still owes some 3 billion pounds to Citigroup because of the deal and relations between the two have soured.

Hands is suing Citigroup in New York, alleging that the bank falsely claimed there were other bidders for EMI, encouraging the private equity firm to raise its own offer. Citigroup has denied the allegations.

EMI has fared worse than the three other major labels - Universal, Sony BMG and Warner Music Group - amid the decline of CD sales and the rise of digital music downloading.

Analysts have blamed Hands' relative inexperience in the music business for exacerbating the company's decline.

EMI earlier this year put its iconic Abbey Road studios up for sale after reporting a pretax loss of 1.7 billion for the year to March 31, 2009.

However, it shelved those plans after a public outcry led to the site being put on a protected list by English Heritage and said it would instead seek an investor to help rejuvenate the loss-making studios.

Adding to the company's woes, Pink Floyd successfully sued the company for selling individual tracks digitally and Chief Executive Elio Leoni-Sceti quit the group last month after just 18 months in the job.

Like Hands, Leoni-Sceti, who joined the company from consumer products group Reckitt Benckiser, had found his music industry experience questioned.

Charles Allen, the former chief executive of broadcaster ITV PLC, who was EMI's non-executive chairman, filled the vacancy by taking over as executive chairman.

Owning Citi is No Party, Partner
From CNN Money

Citigroup's health is slowly improving, but the bank's owners are stuck paying for its costly rehabilitation.

The New York-based financial giant returned to the black Friday after five quarterly losses, saying it swung to a $1.6 billion profit. Citi cited stronger trading results and a 23% drop in operating costs, driven by 13,000 job cuts during the latest quarter.

But common shareholders, who are the ultimate owners of the struggling bank, are still waiting to enjoy the fruits of CEO Vikram Pandit's turnaround push.

That's because as accounting rules dictate, Citi calculated its profit before deducting the costs related to preferred shares. The bank has issued these in droves in recent years, to the government and private investors alike, in a bid to bolster its capital cushion against souring loans and trading bets gone bad.

Paying for the preferred shares has gotten expensive, as a look at Friday's earnings statement shows. In the first quarter alone, Citi paid out $1.2 billion in preferred stock dividends. It also took a $1.3 billion hit when the price on some convertible preferred shares it sold in January 2008 reset.

Those costs come out of common shareholders' pockets - which is why the bank ended up posting a loss of 18 cents a share in a quarter that was otherwise profitable.

The unusual split - a profit for the bank but a loss for the shareholders - highlights the cost of the blizzard of preferred stock Citi has issued since Pandit took over at the end of 2007.

In his first two months at the bank's helm, Citi issued $30 billion in preferred shares to private investors around the globe. Since last fall, the bank has issued an additional $45 billion of preferred stock to the government.

Despite the huge sums raised by Citi via the preferred share sales, investors have continued to fret about the health of the bank's balance sheet as real estate prices tumble and more consumers fall behind on their auto and credit card payments.

In hopes of quelling worries about the bank's capital and ending talk of nationalization, the government announced a plan in February to convert the bulk of Citi's preferred shares to common shares.

Citi said Friday that the conversion, which had been scheduled to take place this month, will be delayed until regulators complete their stress tests on the 19 biggest U.S. banks. Results are expected by early May.

As a result of the swap, private sector holders of existing preferred shares will end up owning 38% of Citi and taxpayers will own 36%.

The conversion will reduce Citi's preferred dividends. That should mean that when Citi posts a profit in future quarters, common shareholders will share in them.

But the downside for current shareholders is that the preferred-to-common conversion will result in the issuance of billions of new common shares - which will reduce their stake in the company by three-quarters.

Still, given how poorly Citi has done since the collapse of the credit boom nearly two years ago - it had rung up $28 billion in losses since its last profit back in the third quarter of 2007, and saw its shares dip below a dollar each earlier this year - investors and taxpayers will gladly take even modest progress.

And there were signs Friday that Citi is, like the other giant financial institutions that have posted their first-quarter numbers this month, enjoying the benefits of cheap government-backed funding and less competitive financial markets.

Thanks to federal programs that allow big financial companies to borrow at low, subsidized rates, Citi's net interest margin - the difference between the bank's lending rates and its borrowing costs - rose half a percentage point from a year ago, to 3.3%.

Like its rivals JPMorgan Chase and Goldman Sachs, Citi posted a strong quarter in its trading business. The bank's securities and banking unit posted a first-quarter profit of $2 billion, reversing the year-ago loss of $7 billion, which was driven by writedowns of Citi's exposure to subprime mortgage securities.

Citi said revenue at its fixed income markets business hit $4.7 billion, "as high volatility and wider spreads in many products created favorable trading opportunities."

But as with its peers, there are questions as to whether Citi will be able to replicate that trading performance in coming quarters.

More than half of the first quarter's fixed income revenue - $2.5 billion worth - came from a valuation adjustment on Citi's derivatives books, mostly due to a widening of the bank's credit default swap spreads.

Credit default swaps are insurance-like contracts. Widening spreads reflect a greater belief that a company may not be able to pay back its debt. So in a sense, Citi was profiting from increased bets that it and other banks were in danger of failing. Those fears may subside a bit following the release of the stress test results.

Consumer credit headaches loom

Perhaps more alarming for Citi -- as well as JPMorgan, Wells Fargo and Bank of America, which will report its first-quarter results Monday -- is just how high losses on consumer loans such as credit cards could go later this year.

Citi's North American cards business swung to a $209 million loss in the first quarter, reversing the year-earlier $537 million profit. Credit costs - reflecting loans gone bad and expenses tied to reserving against future losses - nearly doubled.

The surging losses reflect "rising unemployment, higher bankruptcy filings and the housing market downturn," Citi said - national trends that show few signs of slowing any time soon.

Altogether, credit losses on the global cards business rose to 9.49% in the first quarter from 5.39% a year ago.

But consumers also appear to be doing a better job of keeping their cards in their wallets. The company reported an 18% decline in North American credit card purchase sales during the quarter. This drop will add to the pressure on the company's card portfolio.

Those declines were mitigated somewhat, however, by a rise in interest and fee revenue, as already debt-laden consumers ran bigger balances on their cards and made smaller payments.

So no matter how you look at the results, it seems that the taxpayer -- especially those who also happen to be Citi customers -- still have little reason to celebrate with the bank's return to profitability.