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Nearly Half of Wall St. Bank Profits Are Gone

Louise Story|The New York Times
Monday, 16 Jun 2008 | 4:59 AM ET

Only a year ago, Wall Street reveled in an era of superlatives: record deals, record profit, record pay. But a mere 12 months later, nearly half of the profits that major banks reaped during that age of riches have vanished.

The numbers are staggering. Between early 2004 and mid-2007, a period of unprecedented wealth on Wall Street, seven of the nation’s largest financial companies earned a combined $254 billion in profits.

But since last July, those same banks — Bank of America , Citigroup , JPMorgan Chase , Lehman Brothers , Merrill Lynch , Goldman Sachs and Morgan Stanley — have written down the value of the assets they hold by $107.2 billion, gutting their earnings and share prices. Worldwide, the reckoning totals $380 billion, much of which reflects a plunge in the value of tricky mortgage investments.

More downbeat news is expected this week, when several big banks, including the ailing Lehman Brothers, are scheduled to report results for the latest quarter. As the tally of losses keeps growing, many bank executives — and their shareholders — keep asking the same question: When will the pain end?

But the finish line just seems to keep moving further away. Even when the losses end, bank executives are looking toward a new era of lower returns, thinner profits and fewer jobs. Greater scrutiny from regulators is forcing Wall Street firms to reduce their use of leverage, or borrowed money, which had fueled profits in good times but backfired when the credit crisis struck last summer. Nearly every finance company is cutting jobs and battening down.

“They are going to have to build a new business model,” Richard X. Bove, a financial services analyst at Punk Ziegel, said of investment banks. “I do not believe those businesses have the ability to generate the kind of profit they did in recent years without all the leverage.”

The threats to the broader financial system have receded in large part because of the extraordinary government-led effort to rescue Bear Stearns . And Wall Street seems to have the ability to come back from just about any downturn with new ways to churn even greater riches. That new, new thing may already be brewing across Bloomberg terminals and trading desks.

For now, investors are not holding out hope. They have dumped bank stocks with each round of bad news, and recently the financial sector lost its perch atop the nation’s stock market. The combined value of technology shares, those darlings of yesteryear, has eclipsed that of financial stocks. And the energy sector is not far behind.

Lehman Brothers sent shock waves across Wall Street last week, when the bank disclosed that it expected to post a quarterly loss of $2.8 billion. The bank, which has been struggling to win back investors’ confidence, is scheduled to provide more details of those results on Monday.

Lehman executives gathered at the bank’s Manhattan headquarters over the weekend, fueling speculation that the bank might try to raise capital from investors or even seek a buyer. A Lehman spokeswoman declined to comment.

Lehman, which for months had assured investors that it was managing its risks well, said last week that the loss reflected $4.1 billion in write-downs of its investments.

Goldman Sachs is scheduled to report results on Tuesday, followed by Morgan Stanley on Wednesday. Bank of America, Citigroup, JPMorgan and Merrill Lynch release results in July.

Goldman Sachs and Morgan Stanley are expected to have fared better than Lehman did in the latest quarter. They are more diversified than Lehman, which has traditionally focused on fixed income. And the two banks’ commodities traders may have profited handsomely in recent months as the prices for oil and foodstuffs have soared. Even so, many investors are anxious to see whether Goldman, which made money last year even as many of its rivals lost big, has continued to dodge trouble.

The latest round of results is likely to draw special scrutiny because Wall Street firms are disclosing capital levels under new international banking standards known as Basel II. And Merrill Lynch, Citigroup and UBS are also expected to suffer from the ratings downgrades recently issued for MBIA and Ambac , two bond reinsurers.

The more that banks take write-downs, the more they are, in a sense, shredding through the record profits they made when times were good. Citigroup, for example, has written down its mortgage and other loan investments by $37.3 billion or a full half of the handsome profits the global giant pulled in during the boom years.

Merrill Lynch, much smaller in size, has taken write-downs of $32.6 billion — or a whopping 153 percent of its profits from 2004 through last summer. Even if Merrill is given credit for the money it earned in the past year, the bank still had write-downs that translated into losses of $14 billion, and that is two-thirds of its profits in those three and a half years that ended with a pop last July.

“It’s a fairly unique situation, that you would give so much back,” said Alec Young, global equity strategist for Standard & Poor’s Equity Research. “The industry did enjoy real salad days over that period, but now the write-downs and losses have been so huge. It’s a significant percentage of the money generated.”

Even the winners in this cycle — JPMorgan Chase and Goldman Sachs — have had to pull out giant erasers to work through their loan books. JPMorgan, which had the financial heft to buy Bear Stearns, wiped out 15 percent of recent profits by lowering the values of its loan and mortgage assets. At Goldman, the cost of such write-downs is so far 12 percent of recent profits.

The banks are supposed to be especially good at valuing all the lumps of loans and assets they own. That is why many a Wall Street bonus is based on estimates of hard-to-value dealings in arcane assets. The very mortgage bonds that are now being written down, in fact, led to hefty bonuses for bank employees before the good times ended.

Some analysts predict that independent brokerage houses will merge with commercial banks, if the government begins regulating them. That uncertainty leaves executives at these companies unsure of how to plan for the future, said David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, who is predicting bank consolidation.

“We’re in a weird limbo now,” Mr. Trone said.

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