Colin Barr

Following the money in banking, economics, and Washington

Fans flee bloated megabanks

January 19, 2011: 12:43 PM ET

Have the too big to fail banks gotten too fat to succeed?

That's one takeaway from a round of mushy earnings reports this week. The KBW bank stocks index fell 1% or more for the second straight day Wednesday, after Goldman Sachs (GS) and Wells Fargo (WFC) joined Citigroup (C) in underwhelming anxious investors.

A second straight selloff

Each bank had its own drab story to tell. Citi let fans down by admitting it won't buy back stock or increase its dividend this year; Goldman posted poor trading numbers, blaming skittish markets; and Wells posted numbers that were merely in line with estimates, disappointing fans who expect more from its premium valuation.

But the consistent theme among all three banks was of expenses marching higher while revenue struggled to keep pace.

That's because the easy gains of the 2009-early 2010 period, driven by falling interest rates and huge trading volumes, have begun to dry up. Meanwhile the cost of investing for future growth, amid continuing uncertainty over new rules, is starting to kick in.

"Competition just got much tougher in 2010," Goldman finance chief David Viniar said on a conference call Wednesday, explaining some of the bank's 37% annual earnings decline.

Goldman's soft fourth quarter was driven by a 48% decline in revenue at its fixed income business, which had been the engine behind its record profit performances in 2009 and earlier in 2010. Viniar blamed worries about the global economic recovery, saying trading action in December "was just dead" and that the firm wouldn't see a robust bounceback till customers "want to be active in the market."

But weak revenue was only half the story. Goldman bulked up in 2010, expanding its full-time staff by 9% in a bid to grab increasing share of more markets. The bank squeezed its compensation expenses, bringing the pay of its average worker down 14%, but it spent 14% more on things like legal costs, technology and market development expenses.

Noncompensation expense came in $150 million above what Barclays Capital had forecast, for instance.

Goldman wasn't the only bank struggling to contain costs. Expenses at Citi came in about $1 billion above the target set by Oppenheimer analyst Chris Kotowski, prompting him to say "the performance on expenses was somewhat disappointing in light of revenue trends," though he stressed the overrun isn't a "game changer" for his buy rating.

Nonetheless, Citi finance chief John Gerspach was asked repeatedly about cost controls on the bank's Tuesday morning conference call. He urged listeners not to worry, saying the bank has the flexibility to delay investing in new products and facilities if revenue continues to disappoint. That is hardly a reassuring line for those who view Citi as having brought itself to its current troubled state by having neglected investment priorities.

Even Wells, viewed as one of the best-run banks, was hit by a bigger-than-expected cost line in its latest quarter, as noninterest expense came in some $750 million above the forecast of Morgan Stanley analyst Betsy Graseck. She downplays the development, saying about half the damage is attributable to a one-time charitable contribution.

Fair enough. But with Wells down 2% and Goldman off 3%, it's clear that not everyone is feeling very charitable toward the banks.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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