By Peter Rudegeair
The big currency swings of the past three months have whipsawed
many investors. Wall Street may end up loving the action.
As U.S. banks closed out the first quarter, analysts and
investors said the turbulence in foreign-exchange markets triggered
by central-bank actions should have boosted profits in the trading
units of the country's biggest financial firms. The key will be by
just how much and which firm benefited the most.
The start of the European Central Bank's huge bond-buying
program and the Swiss central bank's surprise abandonment of its
policy limiting the appreciation of the franc sent foreign-exchange
markets into a frenzy, boosting the activity and volatility that
banks need to juice their lucrative fixed-income trading
businesses.
Volatility in the currency markets, which tends to drive sales
and trading activity, rose 18% between the start of the year and
mid-March, setting the stage for a rebound at banks that deal
heavily in those products, according to analysts at Deutsche Bank
AG.
Banks tend to make more money when markets jump around, assuming
the moves aren't so sharp that they scare investors away or cause
the banks' to write down the value of their inventories. Moves
likes the ones in the first quarter often prompt investors to
change strategies and buy and sell securities through banks'
trading desks. The banks generally charge for such trades.
"The foreign-exchange quarter was a blowout," said Nancy Bush,
an analyst at NAB Research LLC. "You've got two ingredients there,
volume and volatility, and you had both of them in the first
quarter."
The performance of the foreign-exchange units may prove the
swing factor in a generally good quarter. Overall, when U.S. banks
start reporting earnings April 14, analysts surveyed by Thomson
Reuters expect the six largest firms to report $21.4 billion in
total profit in the first three months of 2014, up 16% from a year
ago. The increase is helped by the absence of a $6 billion charge
for legal expenses that Bank of America Corp. took in the first
quarter of 2014.
This quarter, the legal load may prove to be lighter, and banks'
long-suffering fixed-income trading businesses are expected to have
come to life.
Foreign exchange makes up about 9% of the overall revenue in
fixed-income, currencies and commodities, or FICC, Goldman Sachs
Group Inc. analysts say. But this quarter, the bump in business may
give foreign exchange an outsize influence and also help related
businesses, such as interest-rate trading.
Overall revenue for the six banks is expected to be $105
billion, more or less unchanged from the previous year's quarter,
according to Thomson Reuters. The average estimates vary from a
6.1% increase in revenue at J.P. Morgan Chase & Co. to a 5.5%
decrease at Bank of America.
But in trading, often an important driver of results in the
first quarter for banks, strength in currencies, as well as
government bonds and equities, could make the period the first
since 2009 in which first-quarter markets revenue rise on a
year-over-year basis, said Steven Chubak, a bank analyst at Nomura
Holdings Inc.
While the foreign-exchange moves won't affect every big bank,
those with large trading operations such as J.P. Morgan and Goldman
Sachs could be separated from peers this quarter, depending on how
well they traded.
Not all banks were well positioned to take advantage of the
abrupt currency movements. Citigroup Inc.'s finance chief said in
early March that the bank expected trading revenue to fall by a
mid-to-high-single-digit percentage due in part to a "modest loss"
related to swings in the Swiss franc.
The New York-based bank might also be disadvantaged by the
dollar's rise, since over half of the bank's revenues come from
outside the United States, though that will be somewhat offset by
lower expenses in those foreign countries, according to Morgan
Stanley bank analyst Betsy Graseck.
Another area of weakness could be in the trading of corporate
bonds, leveraged loans and other credit-related instruments, which
could hurt banks like Morgan Stanley and Bank of America that are
dominant in those products, according to Goldman Sachs analysts.
Companies issued fewer of those kinds of securities in the quarter,
making for a difficult trading environment. "Credit trading tends
to feed off primary issuance, and there was a slowdown" in the
first quarter, said Charles Peabody, an analyst at Portales
Partners LLC.
Lending income, an important driver for big commercial banks
like Wells Fargo & Co., is likely to be held down by continued
low interest rates and the fact that the first quarter had two
fewer days to collect interest on loans and securities than the
fourth. Bank of America, for example, expects its net interest
income to be a couple of hundred million dollars lower as a result
of the lower day count, finance chief Bruce Thompson told analysts
in January.
In recent months, shares in the largest banks have
underperformed the broader market. The KBW index of bank stocks has
fallen 3.1% since the start of the year, while the S&P 500
index has stayed roughly flat over the same period.
The strength in currency trading comes amid an investigation
into banks over their foreign-exchange practices. A group of banks
including J.P. Morgan and Citigroup are in negotiations with the
U.S. Justice Department over allegations the banks manipulated
foreign-exchange rates, The Wall Street Journal has reported, even
as banks have settled similar allegations with other regulators.
The banks have said they are cooperating with the
investigations.
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