Archive for Government and Legislation
J.P. Morgan Chase (NYSE: JPM) Figures to be Biggest Loser With New Derivatives Proposal
Posted by: | CommentsA proposal gaining ground on Capitol Hill to force banks to spin off their derivatives-trading operations would represent a severe blow to one of Wall Street’s most profitable businesses.
Passage would represent a particular setback for J.P. Morgan Chase & Co. (JPM), which ranks as the nation’s largest derivatives player, with a notional amount of derivatives contract of over $78 trillion according to data from the Office of the Comptroller of the Currency.
J.P. Morgan Chief Executive James Dimon said he supports a proposal to send standard derivatives contracts through an industrywide clearinghouse that can be monitored by regulators. He has opposed a requirement that all trades be moved onto an exchange, in part because it would inhibit the use of customized instruments.
Even those less-stringent proposals were expected to drain “several hundred million to a couple billion dollars” from the bank’s annual revenue (which totaled $109 billion last year), Mr. Dimon said in a conference call with analysts earlier this month.
Bankers scrambled Monday to learn more about the spinoff proposal, which gained momentum this weekend when Senate Democrats folded the derivatives plan into their broader financial-overhaul package.
Derivatives dealers need to hold a large chunk of capital, because clients want to be sure that dealers will be able to fulfill their obligations. Companies that purchase derivatives, ranging from airlines to farmers to oil producers, often strike multibillion-dollar contracts with dealer banks.
By breaking off derivatives operations from the banks, legislators hope to reduce the risk a meltdown in that market would threaten depositors and require a federal bailout.
Several Wall Street firms and industry experts maintain the proposal would do little to reduce risky behavior, while making the U.S. banking industry less efficient.
Without their derivatives business, “the big banks will contribute less systemic risk, so it may be better for the taxpayer,” said Morningstar analyst Matthew Warren.
Requiring spinoffs, they say, would throw derivatives trading into the hands of foreign institutions and lightly regulated hedge funds. They also said the new rules could force dealers to put up more capital, which could take capital away from lending to consumers and businesses.
Besides big banks, “who’s going to have the balance sheet to support these positions?” said Howard Simons, a strategist at Bianco Research. “You need someone who has the balance sheet.”
The Federal Reserve over the weekend tried to kill the provision, telling lawmakers in a letter that section of the overhaul bill “should be deleted.”
Paul Miller, an analyst at FBR Capital Markets, said he was swamped Monday with questions from clients who wanted to know more about the proposal. Mr. Miller estimates that banks could lose anywhere between 2% to 5% of their return on equity from the proposal, though he also acknowledges that “if Washington takes this away from the banks, [the bankers] are sure going to work very hard to find something else” to make up the lost revenue.
Critics have blamed derivatives as a culprit in the credit crisis, saying the lightly regulated and opaque markets froze up when traders feared some firms wouldn’t be able to make good on their promises.
The derivatives legislation would boost federal oversight and transparency of the market. The most controversial proposal is the provision to force banks that are eligible for financial assistance from the Federal Reserve and the Federal Deposit Insurance Corp. to spin off their derivatives-trading desks.
If passed, that provision would represent one of the most dramatic shifts in how Wall Street works since the credit crisis struck.
This article (J.P. Morgan Chase (NYSE: JPM) Figures to be Biggest Loser With New Derivatives Proposal) was originally developed by and is property of American Banking News. Checkout American Banking News for up-to-date banking news and peer to peer lending news.
As Congress mulls over a financial reform bill, it may be the banks themselves that are providing the road map.
The argument: it’s not the size that matters. It’s the complexity.
Wells Fargo & Co. (WFC) does not have a large securities arm. As the banking industry goes, its main businesses are fairly standard It’s no surprise then, that out of the bank’s that have been reviled as “too big to fail”, Wells Fargo has posted the highest average return on equity over the past five years.
Between 2005 and 2009, here are the average returns on common equity for the leading banks:
• Wells Fargo – 14.25%
• Bank of America – 8.9%
• J.P. Morgan Chase – 8.2%
• Citigroup – 1.2%
Contrast that to Citigroup which at its zenith in 2007 had a staggering $2.2 trillion in assets scattered across a variety of disparate businesses. It spent the better part of 2009 trying to divest themselves of some of those businesses.
And, despite the U.S. government’s sale of 1.5 billion shares that they purchased in 2009, the government would still own just under 22% of the banking giant, down from 27% at this time last year.
Some may say that Citi was an isolated case. They would cite that regulators have still allowed mergers to occur throughout the credit crisis, such as Merrill Lynch and Bank of America (BAC). And these mergers have added size and complexity to the banks.
| 2006 | 2009 | |
| Bank of America | $1.46 trillion | $2.33 trillion |
| J.P. Morgan Chase | $1.35 trillion | $2.14 trillion |
As with Citi, J.P. Morgan Chase (JPM) and Bank of America managers face the challenge of consistently spotting risks in very different businesses from sprawling consumer-lending portfolios to complex trading operations.
While it’s fair to say that management at the megabanks is better than what existed at Citi in 2006, it should also be noted that their management teams were still complicit in either not seeing, or ignoring the asset bubbles of the last decade.
That alone should argue for a more streamlined model.
To be sure, many of the revisions in the banking overhaul will probably focus on the need to significantly increase common equity capital. And, reform should combine increased capital with stricter lending rules to minimize subprime lending.
Still, none of that would prevent the financial engineering that led to the creation of synthetic instruments such as collateralized debt obligations that caught many bank managers and regulators unprepared.
The best hope for stabilization of our financial markets is regulation that creates a simple, less complex model for all the banks. While not perfect, Wells Fargo may be the model that regulators point to going forward.
This article (The Case for Streamlined Banks. Wells Fargo and Co. (NYSE: WFC) Puts up High Average Return on Equity) was originally developed by and is property of American Banking News. Checkout American Banking News for up-to-date banking news and peer to peer lending news.
With trading revenue estimated to be over $28 billion, government regulations proposed by the Democrats could cut deeply into this lucrative business, causing banks to not only lose revenue, but continue to maintain high risk in spite of the regulation.
In other words, revenue and profits would plummet while risk stayed at its current levels in relationship to trading.
The proposed bill would mandate that the most actively traded derivatives be moved to trading platforms or exchanges, increase capital reserves on derivative trades and keep swaps trading desks at commercial banks separate from others.
While all of the $28 billion in revenue generated by the above banks may not all be at risk, a significant portion could be, and that would grow as banks increase their derivatives business.
Consequently, the cost of protecting debt at these giant institutions rose as investors are increasingly concerned about that as legislation moves forward. Swaps for all the banks mentioned above have been rising.
A credit swap is used to protect against defaulted debt, and pays the buyer the face value if the obligations of the borrower aren’t met. That’s minus the value of the actual debt defaulted on.
So the proposed legislation is already making it more costly for banks to do business, and when taking into consideration trading has been what has driven the revenues of the company while other segments suffer, it could be a disaster if legislation is passed which dramatically moves one of the more lucrative businesses the banks engage in.
The proposed measure will get a test vote today to see where it stands.
This article (Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC) and Morgan Stanley (NYSE:MS) Could Lose $28 Billion after Regulations Enacted) was originally developed by and is property of American Banking News. Checkout American Banking News for up-to-date banking news and peer to peer lending news.