US financial players look to investment banking again for profits

Wells Fargo move heralds resurrection of Wall Street
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The Independent Online

When Wells Fargo, the North Carolina-based bank whose logo of a horse-drawn carriage speaks to its traditional conservatism, leapt in to buy the collapsing giant Wachovia last October, it hinted that Wachovia's investment banking business would be scaled back. What Wells Fargo really wanted was the national retail banking network, and much of the raciest Wall Street business conducted by Wachovia was out of step with Wells Fargo's "values", its chief executive, John Stumpf, suggested at the time.

But it was the same Mr Stumpf who promised yesterday to "grow and invest" in the inherited investment bank, which will drop the Wachovia name and be rebranded Wells Fargo Securities. "Clearly one of the great benefits of the Wachovia merger was the strong investment banking and capital markets platform that we gained," Mr Stumpf said. "We have an enormous opportunity to become one of the top customer-focused investment banks in the country by focusing on the basics and on those businesses that directly serve our customers."

Investment banking looks rather marvellous right now, relative to retail banking. Loans to consumers and to businesses are still going bad at an alarming rate, as the effects of the recession continue to grind, so banks with large commercial banking operations are having to pile up reserves against those future losses. On the investment banking side, renewed activity in the capital markets, creaking back to life after the crisis, is straight away fattening the bottom line.

"The major investment banks do not have to contend with a long tail of loan portfolio losses that will drag on earnings for the next two years and they should start showing 'normal' returns later this year and by 2010 at the latest," Chris Kotowski, an analyst at Oppenheimer & Co, told clients in a bullish research note. He rated investment banking stocks as buys, saying: "Why wait? If investment banks are likely to show good results in 2009 and 2010, why not own some?"

The resurrection of investment banking is likely to be confirmed by results from the big Wall Street players in the coming weeks, beginning with Goldman Sachs a week from today. Business arranging the sale of bonds and equity is booming again, a dearth of competition is leading to enormous trading profits for the banks that remain, and the likes of Goldman, which had the financial strength to keep funding "proprietary trading" (that is, trading its own money, rather than just broking for clients) are likely to have done best of all.

Meanwhile, behind the scenes, there are even stirrings again in the business of structured finance – the creation of credit derivatives, built from parcels of loans which have been "sliced and diced" for onward sale to investors.

Goldman Sachs has been experimenting with the creation of new structured products, it was reported yesterday, and Barclays Capital is already out of the blocks with significant amounts of new business in this area. People with knowledge of BarCap's activities say that it has so far created only very simple securities, cutting a pool of easy-to-understand loans into just one or two tranches of securities. That is – so far – very different from the enormous complexity and dangerous opacity of the vast structured finance market that grew up during the boom, and which imploded so catastrophically, but it is a remarkable return from the dead for a business that used to bring easy profits for investment banks. BarCap has rebranded it "smart securitisation".

Staging an even bigger comeback, corporate issuance of bonds and, increasingly, equity. Companies are finding the capital markets are more friendly than the banks when it comes to raising money. The commercial banks, of course, are busy rolling back their lending activities to cope with bad loans from the past; the capital markets are full of optimistic investors, high on the green shoots of economic recovery.

Matt Warren, at Morningstar, predicted that the second quarter of 2009 would continue the positive trends of the first, when Goldman Sachs alone was able to set aside $4.7bn to pay salaries and bonuses – 18 per cent more than in the first three months of 2008. Goldman could be headed towards paying its employees record amounts this year.

Simply put, there is less competition driving down prices for investment banks' customers, says Mr Warren. "Ever since the collapse or the forced sale of investment banks last year – which affected Merrill Lynch, Bear Stearns and Lehman Brothers – there has been significant dislocation in the market. Even plain vanilla securities are trading with really wide spreads, for people who are willing to commit capital to trading," he explained.

"This is the sort of customer-facing trading that used to be a commodity business, a simple business which didn't make you much money because this stuff trades for tiny spreads. Now they are making a killing."