Wednesday, June 6, 2012
Wall Street braces for job cuts
Investors, consultants and analysts say that the big banks are just not bringing in the revenue needed to keep their workforces at current levels, especially given the cost of complying with new regulations.
The share prices of the big American banks, which are mostly trading below book value, tell the tale. And bank earnings for the second quarter, most of them to be reported next month, are expected to underscore the gloom. Many on Wall Street say pink slips are likely to follow.
"If things don't get better, then I would expect staffing levels to come down for sure," said Alan Johnson, chief executive of Wall Street compensation consulting firm Johnson Associates, who estimated that banks may cut another 5 per cent of their workforce by year's end.
"When banks do that reassessment, it will go beyond just the short-term economics. They'll be asking, 'Where is the global economy going? And is there going to be a recovery, or more of a struggle than a recovery?'"
Johnson's estimate of 5 per cent cuts would translate to about 40,000 layoffs in the United States, based on Labor Department data showing Wall Street employment at around 800,000.
Though no formal announcements have been made, signs are appearing that a culling has begun.
Goldman Sachs Group Inc let go several dozen employees in its securities division this week, including some managing directors, in response to weak market conditions, a source familiar with the matter said. Fewer than 50 people were cut across the globe, the source said.
Morgan Stanley is likely to lay off a "modest" number of employees in its investment banking and trading divisions, another source familiar with the matter said. That source said exact numbers had not yet been determined but that most of the cuts would occur in international divisions.
Both sources spoke on condition of anonymity. Goldman and Morgan Stanley declined to comment on the matter.
BLEAK SECOND QUARTER
As Europe lurches from one crisis to the next - on Tuesday, Spain said that it is shut out of credit markets - and economic growth slows in the United States, the banking business has become tough. Major developing economies such as Brazil, China and India have also been slowing, providing little relief.
Trading volumes are low and merger activity has fallen, while low interest rates are translating into lower profits on lending.
JPMorgan analyst Kian Abouhossein predicts a 32 per cent decline in global banks' trading revenue from fixed income, currency and commodities during the second quarter, along with a 14 per cent drop from equities trading and a 17 per cent drop from investment banking.
So far this year, the global mergers and acquisitions market has fallen 26 per cent from the same period in 2011, according to Thomson Reuters data. Similarly, year-to-date global equity issuance is down 31 per cent and debt issuance has dropped 9 per cent.
The IPO market is in no better shape. Well-publicized difficulties with Facebook Inc's $16 billion mega-IPO on May 18 have only further damped interest in bringing IPOs to market, as has the recent slide in stock markets globally. A series of IPOs have been pulled or delayed in Asia in the past two weeks.
Proceeds from initial public offerings are down 45 per cent year-to-date to $52.9 billion from a year ago. And that is after the Facebook IPO, one of the biggest ever in the United States.
JMP Securities analyst David Trone, who downgraded Goldman, Morgan Stanley, JPMorgan Chase, Bank of America and Citigroup to "underperform" and cut estimates on May 21, said the banking sector offers no place to hide these days.
"It's just the perfect storm: You've got zero rates which are unheard of, squashing net interest margins like never before in history; the greatest regulation ever limiting fees, raising costs, demanding more capital; and then you've got a brewing economic disaster in Europe," said Trone.
"They're getting hit on all fronts, really. There's literally not one thing to be happy about."
He said he expects further job cuts in the "single digit" percent range by year-end.
Looking at profit per employee in the past few years will provide little comfort to bankers.
For example, six years ago, Goldman earned more than twice as much money as it did in 2011, on lower revenue, and its return on equity was six times as high. Goldman was able to generate those returns with 11,000 fewer employees.
"Many investors remind us that our 2011 revenues were more consistent with revenues that were generated six years ago, but our headcount is higher and our profitability is lower," Chief Financial Officer David Viniar said at an event in February. "That is factually correct."
Viniar said Goldman needs those additional employees for its expanded footprint around the world and its bigger client base. Yet compensation is the single biggest line-item cost for banks, apart from interest expense, and for that reason job cuts are the quickest and easiest way for Goldman and its competitors to boost profits when times are tough.
Skepticism about returns and valuations has been priced into bigger bank stocks for some time, with market values far below the stated value of assets on banks' balance sheets.
Bank of America's closing share price of $7.02 on Friday represented just 35 per cent of stated book value of $19.83 per share as of March 31.
Citigroup and Morgan Stanley on Friday both closed at 41 per cent of book value. JPMorgan closed at 67 per cent of book value, while Goldman closed at 69 per cent of that number. Of the six largest U.S. banks, Wells Fargo was the only one trading at a premium to book value, being 19 per cent above it at $30.16.
Frank Braddock, a financial adviser at JHS Capital Advisors, which manages $3 billion of investor assets, is warning his clients against purchasing bank stocks even with that apparent discount.
"At the end of the day they have got to generate earnings from loans and sales, and that's just not happening," said Braddock. "For our clients, the risk in bank stocks is just too big right now. Yeah they're going to have to cut jobs, but how much can they afford to cut and how is that really going to help their profitability long-term? They can't cut their way to revenue growth."