Rising Rates, Currency Crises Shine Harsh Light on Trading
Klinkerman, Steve, American Banker
Once, not so long ago, big trading operations were perceived as perpetual revenue machines for the banks that ran them. But perceptions have changed almost as fast as the Fed could say "rate hike."
Following a horrific 1994, the risk of derivatives, currency, and bond trading has taken center stage. And to the discomfiture of major players, that picture apparently will not change anytime soon.
Driving home the point, Moody's Investors Service on Tuesday downgraded $5.4 billion worth of J.P. Morgan & Co. debt, citing concerns about the company's involvement in currency and sovereign debt markets. Moody's additionally lowered ratings on $140 million of debt issued by Bankers Trust New York Corp., citing the volatility of derivatives trading.
These demotions follow similar moves by Standard & Poor's Ratings Group - which has a negative outlook on Morgan debt - and by equity analysts. And they compound the challenge facing major trading institutions in 1995. Not only must they cope with all the financial and operational consequences of continued adverse market conditions, but they must also contend with heavy investor skepticism.
"We are assuming trading will rebound modesty in 1995, but last year's reversals taught us assumptions can be wildly wrong," said Diane Glossman, a banking analyst with Salomon Brothers Inc. "So long as investors feel low confidence, the earnings stream from trading will be given a low valuation."
The picture certainly wasn't this gloomy a few years back.
Aided by steady declines in interest rates and the value of the dollar, the six largest banking players parlayed currency and derivatives trades into $8 billion of revenues in 1993, up nearly 60% from 1992.
But the dark side of trading volatility burst into full view in 1994. Skyrocketing rates blew up derivatives-aided investing strategies. And the Mexican peso crisis has further roiled currency and sovereign debt markets.
In the fourth quarter alone, the six largest traders among U.S. banking institutions suffered a $1.64 billion, or 82%, decline in trading, revenues. Capping a tumultuous 1994, the fourth-quarter rout profoundly affected investor views of money center banks, experts say.
On Wednesday, for example, Bankers Trust closed at $63.25, down 25% from a 52-week high of $84.25. Partly owing to trading weakness, Chase Manhattan Corp. was changing hands at $34.625 - an embarrassing discount to its Dec. 31 book value of $39.28.
The damage doesn't stop there. Citing concerns about trading revenue declines, Standard & Poor's Ratings Group last month down-graded $5.6 billion of Bankers Trust debt. And the agency still may follow Moody's lead in lowering debt ratings of J.P. Morgan & Co.
To be sure, not all trading institutions share the exposure of Bankers Trust and J.P. Morgan, which respectively derived 34.3% and 33.8% of total 1993 revenues from trading. The comparable ratio was 13% at Chemical Banking Corp.; 12.1 % at Citicorp; 10.9% at Chase Manhattan Corp.; and 4.9% at BankAmerica Corp.
Still, analysts say trading can be a swing factor in earnings even at lesser-involved institutions, simply because of high fixed costs. Sophisticated teams and expensive computer systems can't be instantly cut back when revenues dip. And banks may limit chances to capitalize on the next upturn if they cut deeply when times are bad. …