Goldman Sachs Group Inc (GS.N) and Citigroup Inc (C.N) were hit hard by a sharp fall in bond trading revenues 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 (JPM.N) and Bank of America Corp, (BAC.N) showing that even as bond market trading volume suffers from falling prices, some banks will endure more pain than others.
Softer markets are only the beginning of the trouble with trading bonds, which include fixed income, currency, and commodities products, at investment banks. Regulators are boosting capital requirements and making many derivatives markets more transparent for investors.
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.
Goldman's profit fell 21 percent, as revenue from fixed income trading dropped 11 percent after adjusting for an accounting charge, it reported on Thursday.
Citigroup, which also reported on Thursday, said fixed income revenue slid 15 percent to $2.33 billion in what it called a "challenging trading environment."
Profit at Citi, the third-largest U.S. bank, rose 21 percent, after adjusting for items, as it cut costs and released 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.
At rival JPMorgan Chase & Co (JPM.N) bond trading revenue rose 1 percent, while at Bank of America Corp (BAC.N), it jumped 16 percent.
Goldman shares fell 2.3 percent to $174.65, while Citi was off 4.2 percent to $52.68.
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.
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. 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.
"VERY COMFORTABLE" WITH FIXED INCOME
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.
At the same time, Goldman's overall return on equity, which measures how much profit it wrung out of its balance sheet, was 11 percent for 2013, well below the 30 percent returns that the bank generated before the crisis despite some improvements.
Some banks are making big changes to fixed income. Swiss banks UBS AG UBSN.VX(UBS.N) and Credit Suisse Group AG CSGN.VX(CS.N), under more pressure by their regulators, have taken the lead in paring down. UBS largely exited the fixed income business, 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 (MS.N) are relying more heavily on businesses such as wealth management for growth and as a source of steady revenues. The unit 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 holding out on cutting their fixed income businesses. They are waiting to see which rivals scale back. For those that stay, they hope less competition makes bond trading profitable.
On a conference call with analysts, Goldman Chief Financial Officer Harvey Schwartz said the bank was "very comfortable" in fixed income, and hopes to benefit as competitors exit.
As fixed income trading comes under sustained pressure, other operations such as equities trading, and asset and wealth management, are helping counter some of 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.
Separately, BlackRock Inc (BLK.N), the world's largest money manager, reported a higher-than-expected quarterly profit, benefiting from strong markets and a flow of new money into its exchange-traded funds and retail business.
(Writing by Paritosh Bansal, Editing by Dan Wilchins and Jeffrey Benkoe)