…and why have they not already done so? Time may be running out for banks but for their shareholders the road to recovery is paved with broken promises and jam tomorrow. My column for Financial News.
“Beware the fury of a patient man”, wrote the 17th-century English poet John Dryden. He might as well have been describing the frustration of shareholders in investment banks, whose patience is once again being taken for granted – and stretched to breaking point.
The latest set of results from the big investment banks has underlined what many investors have feared for some time. Cut through the calamitous headlines about a collapse in fixed-income trading volumes and you have an industry which, five years on from the financial crisis, has still failed to come to grips with its problems and to plot a realistic path to recovery.
Investment banks and their parents have again been forced to promise shareholders jam tomorrow. Having been patient for so long, it will be interesting to see how much longer shareholders in the banks will put up with this thin gruel of empty promises.
Take Goldman Sachs. It bent over backwards in the third quarter to bring its costs under control after its fixed-income trading revenues virtually halved. It showed admirable flexibility, slashing compensation costs by more than one third (relative to revenues, pay has come down to its lowest levels since the crisis) and cutting overall expenses by a quarter. That’s great, but even after those contortions, Goldman Sachs only managed a single-digit return on equity. This wouldn’t be a problem if it were a one-off, but it was the eighth quarter out of the last 14 that Goldman Sachs has failed to generate an ROE above its cost of equity.
Goldman Sachs is not alone. Of the 10 big investment banks that have so far reported their results for the third quarter, just one – the corporate and investment bank at JP Morgan – managed to post a double-digit ROE (see table).
The others managed an average ROE of just over 6% between them in the third quarter. You have to pay a lot of money for that sort of performance.
Bumps in the road
From a shareholder perspective, the performance is even worse than it appears. In order to make the numbers look better and to draw a line under the crisis, several investment banks have created non-core or legacy divisions. These flatter the divisional numbers, but shareholders do not have the liberty of pretending the nasty stuff doesn’t exist just because it’s been hidden under the bed. If you fold the legacy assets back into the investment bank, at UBS you get a negative ROE of -10% in the third quarter, according to my calculations, and Deutsche Bank’s investment bank almost certainly made a loss as well.
These sorts of hiccups are bound to happen. Sergio Ermotti, chief executive of UBS, said there would inevitably be “bumps along the road”. The problem is when the entire road seems to be made of nothing but bumps for as far as the eye can see.
In fairness, it is not as if the investment banks aren’t trying to do something about it. They are dumping risky assets overboard as fast as they can find them, firing thousands of staff, and pulling out of businesses where they cannot hope to achieve some form of right to compete. And, to be clear, the third quarter was a particularly unpleasant few months. Over the first nine months of this year the average ROE at investment banks was around 13%, or just above their cost of capital. In other words, so far this year they are just about in the black in terms of creating value (or at least not destroying it).
This is more than can be said for their parent groups, which between them have managed to make an ROE of just 7% in the first nine months of this year – half of where it needs to be. The mighty JP Morgan Chase made an ROE of -1% in the third quarter and 8% so far this year. Not even Jamie Dimon can explain that away as anything less than destroying value.
Over at Deutsche Bank, the group made 0.3% in the third quarter and 5% this year, and while the sentiment was no doubt sincere, shareholders must be getting a little tired of chief executives such as Anshu Jain saying they are “not happy” with such meagre returns.
So far at least, shareholders have shown remarkable forbearance with the banks. They know that the burden of new regulation is making life difficult for them and that policymakers keep making it harder by moving the goalposts. They accept that there are lots of nasty assets and obligations hanging over from the financial crisis that cannot be magicked away, and that will take time to work through the banks’ books. And, to be fair, they have enjoyed an astonishing rally in bank share prices as they pulled back from the brink in the depths of the crisis.
Blessed are the meek
This patience is expressed by the meek reaction from shareholders to the billions of dollars in settlements for which they are being asked to foot the bill, their lack of anger over how much investment banks continue to pay their staff for such poor performance, and the surprising lack of shareholder activism in the banking sector. Knight Vinke’s polite suggestion that UBS might break itself up is notable both for its rarity value and for how little it is likely to rattle the bank’s rivals.
Shareholders also seem to be giving the banks the benefit of the doubt, at least for now. A glance at the price-to-book ratios of the big banks shows that they are higher than the banks’ ROE would suggest they deserve. They may believe that banks are still historically cheap, particularly given the prospect of rising interest rates and an improving economy. Maybe investors have been bludgeoned into submission by the slick presentations and the promise of better things to come tomorrow. Or, perhaps, active investors have long since abandoned the sector as investable.
Whatever the reasons, the extraordinary patience demonstrated by investors cannot go on forever. At some point it must be met with a sustainable improvement in performance, free from adjustments, optimisation, and smoke and mirrors.
If bankers thought life was tough today, they should just wait until their shareholders finally snap. As the late Baroness Thatcher once said: “I can be extraordinarily patient, provided I get my own way in the end.”
-This article first appeared in the print edition of Financial News dated November 4, 2013