The world's leading banks have accounted for writedowns of $20 billion or more. Paul McNamara looks at who won and who lost
There are many bankers who wished that they had the luck that JPMorgan Chase seems to have had over the past few months. Third quarter results for the bank showed an increase of 2 per cent from last year and topped $3.4 billion. Lest it seem that the bank had survived the summer unscathed, these figures still showed a hit of $1.3 billion including writedowns of leveraged loans net of fees.
Imagine where they would have stood if the markets had not tumbled. Investment banking profits were a mere $296 million representing a massive 70 per cent fall from last year and this may explain why the bank is cutting 100 jobs in order to keep itself in trim.
Bank of America (BoA), the second largest bank in the US, looks like it will have to take a chainsaw to its investment banking business after its profits dropped 32 per cent when third quarter earnings were announced. BoA is relatively small in the investment banking business so the scale of the losses from the bank caused more than a few raised eyebrows. The bank has indicated that it has no plans to increase the level of its exposure to investment banking lines of business. BoA's leveraged loan losses will be around $700 million with a further $300 million in mortgage write downs.
Citibank found itself in the same boat with third quarter earnings down a whopping 57 per cent mostly because of poor performance in its investment banking business. When the great book of finance faux pas is written it seems likely that Chuck Prince's 9 July comment that 'we're still dancing' will be somewhere near the top of the list.
Prince, as Citigroup's chief executive, then had to face the music just weeks later and confess that the group had $6 billion in writedowns and losses in the third quarter. Hardly surprising that this should be followed by calls for Prince's resignation, although he seems to have held the hounds at bay by shuffling some key people around and is still in the driving seat at present. Vikram Pandit became head of the bank's institutional business while Tom Maheras, the former head of capital markets operations, discovered where the door was. Randy Barker, a co-head of Citi's fixed income business joined him in leaving the bank in haste.
What of Merrill Lynch (ML)? ML looks like it might walk away with the award for handling the results announcement process least well. ML initially announced that the third quarter saw the bank write off $5 billion, mostly as a result of the credit crunch with $4.5 billion coming from writedowns in its collateralised debt obligation business. Such huge losses were causing analysts to ponder whether ML's strategy was flawed and perhaps explain why both ML's head of fixed-income and its head of structured credit had been fired as the bank suggested it would report a loss for the quarter of $2.3 billion.
When the real figures were announced, they looked much worse than had been originally thought. In the event, $7.9 billion was the real figure of ML writedowns on mortgage-related securities. This meant that ML had misjudged its original estimates by around $3.5 billion causing some analysts to wonder if Stan O'Neal, chief executive of ML, could weather the storm. Perhaps more distressingly there seemed to be no real reason given for the original miscalculation.
Apart from a share price slide for ML and a ratings downgrade from S&P, perhaps the most worrisome aspect of the debacle was that analysts continued to speculate that there might be more bad news to come and that the $7.9 billion hit might not be an end of the affair.
Washington Mutual, the US's largest savings and loans operation, also saw its third quarter profits plummet by 75 per cent as it increased its loan loss provision to $975 million.
In Europe UBS admitted that it was facing its first quarterly loss in nine years in the third quarter of the year. The losses amounted to $513 million and resulted largely from the bank's exposure to the US subprime market. An anticipated 1500 jobs will go as a result of this and the attendant writedowns of $3.7 billion, although the bank will still manage to make $85 billion in profits for the first nine months of the year.
Credit Suisse looks like it is also going to face a drop in profits in the third quarter when it announces its results on 1 November and Deutsche Bank is looking at writedowns of $3.1 billion
So where do we go from here? One view is that the worst is now over and that markets can go back to doing what they do best: making money. For the investment banking community at large these losses were huge but not life threatening. The banks have learned a crucial lesson or two that involves age-old pieces of advice such as putting too many eggs in one basket, buyer beware, and so on.
Most banks will suffer a reduction in headcount but most banks know that this is a fairly cyclical game anyway. The race, generally speaking, goes to the swift which in this case means banks that can mobilise their capital quickly to take advantage of the next big thing before the rest of the market catches up. As long as the US does not move into a protracted recession and as long as regulation and oversight are tightened up to make a replication of this summer's events impossible a second time around, the banks should be all right.
Perhaps the greatest change that we will see emerge from the credit crunch is a general distrust of structured finance on the part of investors. Structured finance, the domain of boffins with bulging foreheads, and its rapid growth were a direct result of investors demanding returns that were above average. Rule number one of investing is that the higher the reward, the higher the risk and this summer's fallout was no more than a grand manifestation of that.
The problem of structured finance is that it is opaque. Investors do not really know what they are buying and this is generally a recipe for disaster. What this summer has taught investors is that they need to understand what they are getting themselves into in order to be able to understand the risks.
It is unlikely that there will be a resurgence in wacky investment vehicles until current memory fades. Anything with the word mortgage attached to it is likely to be treated with suspicion for some time to come and this can only be bad news for the man in the street who simply wants to put a roof over his head.
With the price of oil heading towards $100 a barrel it looks like being a strange fourth quarter for everyone and no one is prepared to draw a breath of relief until such times as they hear the dulcet tones of the fat lady as she starts to belt out some new songs.
© Banker Middle East 2007
