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By Lauren Tara LaCapra
NEW YORK, Sept 30 (Reuters) - Wall Street banks have hadanother rough quarter in bond trading thanks to the U.S. FederalReserve, and it might get worse before it gets better.
Analysts have begun cutting third-quarter profit estimatesfor banks including Goldman Sachs Group Inc and MorganStanley, citing an industry-wide fixed-income tradingrevenue decline of 20 to 30 percent compared with a year ago.The quarter's lull has made at least some Wall Streetprofessionals nervous that a fresh round of job cuts may becoming, a trader said.
The third quarter is typically a weak period for banks'trading businesses, but the Fed's decision to keep its programof bond buying intact has hurt trading revenue even more thanusual and weighed on the value of the bonds that dealers keep onhand for trading, bankers and analysts said.
Traders in some of the biggest fixed-income markets -including Treasury bonds, mortgage bonds, interest-ratederivatives and foreign exchange - were burned by their wrongassumptions about when the Fed would pull back from its massivebond-buying program. Many investors had expected the Fed tostart gradually winding down the program, but instead thecentral bank in its Sept. 18 policy statement said that it wouldmaintain its $85 billion monthly purchases for the time being.
The decision led investors to hit the brakes on plans toadjust their portfolios, traders and analysts said, and lessactivity meant less money for banks' fixed-income trading desks.
"From what I can see, it's mainly weaker activity levels -activity levels are just very low," said Richard Ramsden, ananalyst who covers banks for Goldman Sachs.
There are already signs of poor third-quarter results.
The investment bank Jefferies Group LLC said earlier thismonth that its fixed-income trading revenue plunged 88 percentin the three months ended Aug. 31, to $33 million from $266million a year earlier. Jefferies is not directly comparable tobigger Wall Street banks because of its size and because itreports on a fiscal calendar whose quarters are a month earlier,but the results were still surprisingly poor.
Last week, Deutsche Bank AG co-CEO Anshu Jainsaid at a conference that he expected bond-trading revenue would"decline significantly" in the third quarter due to weakvolumes. Bank executives from JPMorgan Chase & Co,Morgan Stanley and Barclays PLC have also recentlywarned in public comments that they expected trading revenues tobe soft.
There were few bright spots in other capital marketsbusinesses.
Debt underwriting revenue is expected to have fallen 26percent compared with the third quarter of 2012, according toBernstein analyst Brad Hintz. The decline comes despite somelarge bond offerings, such as Verizon Communications Inc's $49 billion capital raise earlier this month, and strongleveraged loan activity. Hintz expects equity underwritingrevenue to have dropped 27 percent.
Dealmaking fees are also expected to be soft, even withVerizon's blockbuster $130 billion purchase of Vodafone Group's share of its wireless business. Hintz estimates WallStreet banks will report flat merger and acquisition revenue.
So far this year, global deal volume is up just 0.8 percentcompared with a year ago, to $1.67 trillion, according toThomson Reuters data. Excluding the Verizon-Vodafone deal,global deal volume fell 7 percent to $1.54trillion.
"Although the Verizon deal and a flurry of September M&Aannouncements is encouraging, these deals will not be enough tosave the quarter," said Hintz.
GRAND FUNK LIVES
Although trading revenue is by its nature a volatile lineitem, it has become even harder for analysts to predict sincethe financial crisis, said Oppenheimer analyst Chris Kotowski.Three years ago, he expected trading revenue would havestabilized by now - especially as the industry consolidated -but instead it "looks more like a Ping-Pong ball bouncing downthe stairs" than any kind of decipherable trend line, he said.If trading revenue has dropped in the third quarter, it will bethe 10th decline in the last 14 quarters, he said.
"The funk is not over," Kotowski said.
Wall Street trading desks do not expect an upswing infixed-income revenue before the Fed's December policy meeting,said one bond trader who spoke on the condition of anonymity.The industry has been in decline since the financial crisis, asnew capital rules have prodded banks to sell or unwind some oftheir riskiest assets. Also, derivatives trades that oncehappened among banks are moving onto exchanges and intoclearinghouses, which weighs on profit margins.
With these changes afoot, banks since 2010 have beenslashing thousands of trading, sales and support jobs.
Beyond the secular pressure on the sector, markets wererattled in May when Fed Chairman Ben Bernanke hinted thattapering would come soon. Long-term interest rates spiked inlate May and continued rising until the Fed's latestannouncement. The 10-year Treasury yield ended the quarteraround 2.61 percent, compared to around 2.477 percent at thebeginning of the quarter. But between those relatively similarvalues were some wild gyrations - the yield reached as high as 3percent during the quarter.
"The Fed, through its communications, has caused someuncertainty," said Goldman's Ramsden. "The message has changedand people have gotten wrong-sided, so until people getcomfortable with what the new world looks like and what the pathlooks like, it could keep impacting activity. When will thathappen? Hard to say."
Because fixed-income trading accounts for a big chunk ofoverall income at Wall Street banks, market disruptions can puta serious dent in profits. Interest-rate sensitive products likeTreasury bonds and foreign-exchange represent 40 to 50 percentof fixed-income trading revenue, Ramsden said, making itdifficult for banks to make up for weak trading there with otherbusinesses that performed well, like high-yield debt trading.
