Beware banks' bragging on earnings
J.P. Morgan Chase and Goldman Sachs have used their superior results this quarter to try and steal business from rivals. But are they really as strong as they look?
(Fortune) -- Wall Street earnings are usually a snooze but banks and brokerages are using their third-quarter results as part of a thoroughly Darwinian power play aimed at grabbing business from rivals that stumbled badly in the quarter.
J.P. Morgan Chase and Goldman Sachs (Charts, Fortune 500) have used their earnings, and the public conference calls that accompany those results, to paint a clear picture of themselves as institutions that are capably riding out the credit storm.
This helps their stocks move higher, but it also sends a clear message to clients and would-be clients: Move business to us, and reduce exposure to the firms that could have a hard time recovering from the horrendous hits they've taken from troubled loans and mortgage-backed bonds.
Investment banks operate on very high leverage, so any questions about their strength can quickly cause an exodus of business to banks that are perceived to be in better shape.
Most likely to lose out in this battle are Bear Stearns, because of its imploded hedge funds and bond losses; Merrill Lynch, because of its high exposure to toxic securities called CDOs; and Citigroup, which is struggling to sort out what happens to $83 billion of off-balance-sheet bond funds, called structured investment vehicles, or SIVs.
After reporting a blowout third quarter in September, Goldman was seen to be perfectly positioned to take business from its competitors.
And this week, insight into the battle for clients can be gained by comparing results from Citigroup (Charts, Fortune 500) with those from J.P. Morgan Chase (Charts, Fortune 500), whose CEO, Jamie Dimon, worked at Citigroup till a power struggle that led to him leaving in 1998. Wednesday, Dimon went out of his way to tell the world that J.P. Morgan Chase had largely sidestepped those things that tripped up rivals.
"We did avoid some of the potholes of SIVs, subprime, and C.D.O.s," Dimon said, and then reminded listeners of his intention to "build the best investment bank in the world."
Compare that with utterances Monday from Citigroup's CEO, Chuck Prince, who acknowledged that his bank's performance was "disappointing" for reasons that went beyond dislocations in the credit market. On the Monday conference call, poor Prince then had to take questions from two analysts that effectively asked how much longer he'd be employed at the company.
The distinction between banks this quarter is clear to see. And because this is Wall Street, the banks that see themselves as stronger would be foolish not to try and snatch business.
Bear's CFO, Samuel Molinaro, admitted that questions about its strength had led some customers to reduce business with Bear, shifting to other banks they felt were doing better during the mortgage meltdown. Speaking about their prime brokerage business - basically the providing of a range of brokerage services to hedge funds and other types of investors - Molinaro said: "What we really saw were clients trying to be more defensive and moving balances in many cases into the hands of the banks where they felt there was a stronger hand if you will."
Molinaro added that this migration slowed as confidence returned, but you can be sure Bear's rivals did all they could to keep any new business that defected.
This cutthroat battle for clients is more than just diverting theater, though. Knowing that it's going on helps Wall Street outsiders question more thoroughly the results of banks that are claiming to be strong. If, in a bid to grab turf, a bank goes out of its way to show how smart it was, it might be tempted to overstate its achievements and its strength. Arrogance carries risks.
And you can see how this could all backfire for a bank that projects itself as being stronger than rivals. Take J.P. Morgan Chase's involvement in the plan to set up a new healthier SIV to bail out the sick SIVs, including Citigroup's. Of course, the party line from the firms involved has been that this is not a bailout for the SIVs but an industry-wide effort to jumpstart the market for short-term corporate bond issuance - something that would benefit all involved.
But when questioned about it on the call Wednesday, Dimon conceded that the new so-called super-SIV may have "asymmetric benefits." That looks like his way of saying that J.P. Morgan Chase, which has no SIV exposure, would enter the new SIV from a position of strength.
Unlike Citigroup? J.P. Morgan spokesman Joseph Evangelisti says Dimon was not referring to "any particular institution" when he mentioned "asymmetric benefits."
But a key question has to be: Would J.P. Morgan Chase risk getting tied up in the SIV mess simply to gain fees and intelligence on the SIVs' contents? Unlikely. Maybe J.P. Morgan needs the SIVs, in all their dysfunction, to stay afloat so they can keep buying bonds that J.P. Morgan helps issue.
A person close to the banks involved in the new SIV said the aim is to prevent a disorderly unwind of the SIVs, adding that the banks would probably be comfortable with an unwind at some time in the future that doesn't lead to a firesale of assets.
So, it's the fear of a firesale - and the downward pressure it might put on bond prices - that seems to be a big motivation for a bank like J.P. Morgan to take the risk of setting up a new SIV. The last thing banks want is more markdowns on their balance sheet, especially after vaunting their ability to do well in downturns.