Revenues rise for US banks as litigation costs taper off

New York

IT WOULD have been a good year for the biggest US banks if it were not for US$30 billion in legal costs.

Revenue at the six largest firms, which start reporting results this week, probably climbed to US$413.6 billion in 2014, second only to a record set in 2010, based on results from the first nine months of last year and analysts' estimates for the fourth quarter. That is providing hope that an increase in profit will follow once banks move past 2014's record legal expenses.

Litigation and investigations dominated a year that also saw a revival of commercial lending, a rebound in mergers and acquisitions and a US economy that probably expanded by 2.3 per cent.

Investors looked beyond the legal expenses as shares in all six banks rose in anticipation of interest rate increases that could boost earnings from lending money to customers.

"We've finally moved into the eighth or ninth inning of legal costs," said Paul Miller, an analyst at FBR Capital Markets. "I don't think you'll have another US$30 billion in legal costs. That doesn't mean you can't have another US$2 billion to US$5 billion, but that's almost a rounding error at this point."

The record legal costs probably will result in a 5 per cent slump in profit for the six banks, the first decline since 2008, according to data compiled by Bloomberg.

Bank of America Corp and Citigroup Inc led the drop after spending more than US$25 billion combined as they tried to put the biggest disputes behind them, including probes into mortgage bond sales and currency manipulation.

The banks, which also include JPMorgan Chase & Co, Wells Fargo & Co, Goldman Sachs Group Inc and Morgan Stanley, saw higher revenue in investment banking last year as initial public offerings jumped more than 50 per cent. They also posted increases in asset management, which benefited from a rising stock market. That helped push up shares of the six firms, led by Morgan Stanley's 24 per cent gain and Wells Fargo, which soared 21 per cent. The Standard & Poor's 500 Index rose 11 per cent.

Morgan Stanley probably had the biggest annual increases, with an estimated 7 per cent rise in revenue and profit that more than doubled to US$6.3 billion. The New York-based bank, led by chief executive officer James Gorman, had a 14 per cent gain in trading and investment banking revenue in the first nine months of 2014, the most of the nine largest global firms. It also was helped by tax benefits and an accounting gain.

JPMorgan, which kicks off earnings season on Jan 14, is projected to report the only decline in revenue for the year among the six biggest banks. The firm, headed by CEO Jamie Dimon, had a 25 per cent slump in mortgage banking revenue in the first nine months as refinancings fell. Fixed income trading dropped 12 per cent, the most of any of the banks, as competitors gained share amid low volumes and industry revenue decreased in interest rate trading, where JPMorgan is the biggest.

The bank probably will report adjusted fourth-quarter profit of US$4.98 billion, a 13 per cent drop from a year earlier, on revenue of US$24.1 billion, according to analysts' estimates compiled by Bloomberg till last week.

The six banks' combined US$4.8 billion revenue gain for the year was overwhelmed by legal costs. Bank of America's legal expenses jumped almost fourfold to US$16.9 billion in the first nine months, while Citigroup's full-year total probably more than tripled to US$9 billion.

The US$30 billion legal bill is based on banks' reported costs for the first nine months and the US$2.7 billion charge that Citigroup said it would take in the fourth quarter. Absent that total, an amount that dwarfs the annual budget for the National Aeronautics and Space Administration, the banks probably would have topped their record profit in 2006 of US$82.6 billion.

"Banks have paid out a tremendous amount of money in fines and settlements," Anton Schutz, president and chief investment officer of Mendon Capital Advisors, said in a Dec 31 Bloomberg Radio interview. "The big banks have still been hoarding capital because they don't know what fines they'll have to pay."

Banks ran into other regulatory difficulties last year and had to make changes to their businesses. Goldman Sachs, JPMorgan and Morgan Stanley sold units that owned physical commodities amid a Federal Reserve review and a congressional probe.

JPMorgan, the biggest US bank, had its required capital ratio increased by two percentage points, meaning that the New York-based lender may need more than US$20 billion in additional capital.

Citigroup had to curtail plans for shareholder payouts after failing the Fed's stress test, known as CCAR, in March, and Bank of America had to scrap a stock buyback after it made errors in its submission.

At the beginning of last year, "a lot of us said, 'I think we're finally going to get real clarity on regulation'," said Fred Cannon, a KBW Inc analyst in New York. "Then what happens? Citi fails CCAR, we get higher buffers, we get continued litigation."

The banks have said that their largest legal exposures have been addressed, and the firms have a better sense of the most important rules, according to analysts.

Citigroup CEO Michael Corbat said that his New York-based bank, the third largest in the US, is taking its fourth-quarter charge to "try and really shoot for a clean 2015". BLOOMBERG