By Christian Berthelsen and Jerry A. DiColo
Wall Street's commodity-trading gold mine is all but tapped out.
Once a booming source of bank profit, the business has been hit hard by tougher new rules and subdued markets. Revenue from trading the likes of oil, metals and soybeans dropped 16% last year at J.P. Morgan Chase & Co. (JPM) and 20% at Morgan Stanley (MS), according to securities filings.
At Goldman Sachs Group Inc. (GS), long considered the firm to beat in commodities, commodity revenue slumped to $575 million from $1.6 billion in 2011 and $4.6 billion in the bumper year of 2009. A survey by research firm Coalition of the largest global investment banks shows commodity revenue fell 24% from a year earlier in 2012, to around $6 billion, tumbling by more than 50% since 2008.
As recently as last fall, Morgan Stanley was considering a partial sale of its commodity business, which focuses on oil and energy. A bank spokesman declined to comment.
Goldman's chief financial officer, Harvey Schwartz, told analysts during the bank's fourth-quarter earnings call that client-activity levels "remain relatively low," despite an improvement from third-quarter levels.
A bank spokesman declined to comment beyond Mr. Schwartz's statement.
The downturn is compounding the challenges faced by large banks and securities firms, which have seen many businesses crimped by lackluster markets and new regulations aimed at curbing risks. The commodity crunch joins a low interest- rate environment that has cut into investment returns and a decline in currency trading, another onetime profit wellspring.
"We have seen the revenue pools of the past declining significantly in this space over the past few years," said James Malick, a partner and co-head of the Americas corporate banking practice at Boston Consulting Group.
The sharp fall in commodity revenue has already claimed some victims. UBS AG ( UBS, UBSN.VX), the Swiss bank that has been under pressure to cut costs and improve its performance, last year closed all its commodities-trading desks aside from those dealing in precious metals.
Goldman, UBS, Deutsche Bank AG (DB, DBK.XE) and Barclays PLC (BCS, BARC.LN) have all suffered departures of senior commodity traders to hedge funds and independent trading companies over the last several months.
Average staffing in commodities trading declined 5.9% last year at major banks, according to Coalition.
Kurt Harrison, head of the financial-services group at executive recruiter Russell Reynolds Associates, who has helped commodity traders leaving banks to find jobs, said traders are being forced out of the business because trading commodities is "simply less profitable now than it was in the past."
The shakeout is being driven by two main factors: new regulation and tepid markets. In the U.S., the so-called Volcker rule, aimed at banning banks from trading with their own capital, has put a damper on the business. The new rule is yet to be finalized, but many banks have already scaled back their proprietary trading.
In addition, regulators want to push much of the most profitable forms of the business--complex, over-the-counter structured trades--to public exchanges. The shift will make prices more transparent, limiting banks' ability to charge more for facilitating deals. At the same time, regulators are making it more expensive for banks to hold physical commodities by requiring more capital on their balance sheets to offset those assets.
Before the regulatory clampdown, banks' commodities businesses often generated a return on equity--a measure of profitability--of about 20%, according to consulting firm McKinsey & Co. After all the new rules take effect, the firm expects commodities businesses will have a return on equity of just 8%.
Markets haven't helped. The U.S. benchmark crude-oil contract rose 160% and the price of gold surged 370% over the past decade, but markets have been subdued for the past two years. That, in turn, has reduced activity and price volatility--a key driver of trading profits for banks.
Trading in oil and related securities has been hardest hit within the sector, according to people familiar with industry trends. By some estimates, revenue from trading oil is off by nearly half in the last year.
At Morgan Stanley, commodities revenue fell 20% last year after an 18% decline in 2011. Executives said during an earnings presentation that fourth-quarter commodity results were unusually low because of Hurricane Sandy. A bank spokesman declined to comment further.
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