Goldman Sachs Group Inc and Citigroup Inc suffered a steep drop in bond trading revenue in the fourth quarter, a stinging blow for two banks long seen as stalwarts of fixed income markets.
The two banks performed worse in fixed income than rivals JPMorgan Chase & Co and Bank of America Corp, showing that even as bond market trading volume suffers from falling prices, some banks will endure more pain than others.
"You have to be nimble to trade the debt markets these days. If you make a bad bet, it will show up in results, and profits will be harder to earn in 2014," said Matt McCormick, a portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel, which manages about $11 billion.
Goldman's profit fell 21 percent, as revenue from bond trading dropped 11 percent after adjusting for an accounting charge, it reported on Thursday. The bank's shares closed down 2 percent at $175.17.
Citigroup, which also reported on Thursday, said bond trading revenue slid 15 percent in the fourth quarter to $2.33 billion in what it called a "challenging trading environment." Its shares fell 4.3 percent to $52.60.
Trading results for the two banks contrasted with JPMorgan Chase & Co's, whose bond trading revenue rose 1 percent, and Bank of America Corp's, where it jumped 16 percent.
To be sure, a bank's declining bond trading revenue can be a sign of discipline if markets are mispricing assets.
When an analyst on a Goldman Sachs conference call asked about other banks evidently gaining ground in bond trading, Chief Financial Officer Harvey Schwartz said, "(W)e're always going to prioritize the risk management over things like market share."
Citigroup Chief Executive Michael Corbat noted that the bank had decided to take less risk in emerging markets as the Federal Reserve starts scaling back its bond buying stimulus.
"Our desks decided in latter parts of the year to de-risk," Corbat said.
Still, the weak results in the fourth quarter could raise questions about why banks such as Goldman and Citigroup are not moving faster to prune their bond trading operations in areas including fixed income, currency, and commodities. The business is the target of many of the new regulations put in place after the financial crisis, including the Dodd-Frank financial reform law in the United States and Basel III global rules on capital and leverage.
The moves are designed to make markets safer after Wall Street's excesses helped bring the financial system to the brink of collapse in 2007 and 2008. But they also cut into profits.
"VERY COMFORTABLE" WITH FIXED INCOME
Many fixed-income, currency and commodity trading businesses are complex and rely on large amounts of capital. For years, the operations supercharged Wall Street's profits as banks borrowed extensively and minimized the capital they had locked up in the business.
At its peak in 2009, for example, fixed income trading revenue accounted for 48 percent of Goldman's total revenue. In the fourth quarter of 2013, it was 25.3 percent, including accounting charges.
Some banks see those declines as reason to make big changes to their fixed income businesses. Swiss banks UBS AG and Credit Suisse Group AG, under more pressure by their regulators, have taken the lead in paring down. UBS largely exited fixed income, while Credit Suisse has consolidated and exited operations to bring the number of product areas in its bond sales and trading unit to 80 from 120.
Others, such as Morgan Stanley, are relying more heavily on units such as wealth management for growth and as a source of steady revenues. That business is expected to be a bright spot for Morgan Stanley, when it reports fourth-quarter results on Friday.
But consultants and bankers said many on Wall Street are still refraining from cutting their trading operations. They are waiting to see which rivals scale back. For those that stay, they hope less competition makes bond trading profitable.
Goldman CFO Schwartz said on the conference call that the bank was "very comfortable" in fixed income, and hopes to benefit as competitors exit.
Bond markets may be going through a soft patch, but they are hardly going away. Investors will demand fixed-income products for years to take care of a wide range of needs, including income for insurance companies and retirees, said Larry Fink, Chairman and Chief Executive of asset manager BlackRock Inc on a conference call Thursday.
As fixed income trading comes under sustained pressure, other operations such as equities trading, and asset and wealth management, are helping to counter the headwinds.
In its equities business, Goldman's revenue from client stock trading fell 22 percent to $598 million, even as stocks hit new highs. But equity underwriting revenue doubled to $622 million as more companies tapped the market for capital. Revenue from its own equity investments jumped 25 percent to $1.4 billion.
The stock market resurgence also helped Goldman's investment management business, which provides advisory services to wealthy clients and manages money through funds. Revenue increased 5 percent to $1.60 billion in the quarter.
At Citigroup, equity underwriting revenue rose 73 percent to $282 million, and merger advisory revenue rose 29 percent to $266 million.
The bank's overall profit rose 21 percent, after adjusting for items, as it cut costs and dipped into funds set aside for bad loans, but the results missed analysts' estimates in large part because of weakness in the bond trading business.
Separately, BlackRock reported a higher-than-expected quarterly profit, benefiting from strong markets and a flow of new money into exchange-traded funds and its retail business.