Fixed income is likely to be less of an engine for profit growth for Wall Street firms as the United States housing market growth shows signs of slowing after two years of Federal Reserve interest rate hikes.
All is not lost for investment banks, which are still making big profits from corporate bonds and other types of fixed-income trading not related to home mortgages, as well as from other areas entirely, like mergers and acquisitions.
But mortgage-related markets comprise more than a third of the U.S. bond market. Brokers' profits from the area already may have peaked, analysts at independent research firm CreditSights Inc. said.
Wall Street firms have owed much of a record profit streak in recent years to a fixed-income boom, the longevity of which has so far confounded skeptics. Bear Stearns Cos. Inc., only the No. 5 Wall Street investment bank by market value but the industry's mortgage-backed bond powerhouse, recently reported its best nine-month earnings run ever.
Fixed income generated $2.93 billion, or 43 percent, of Bear Stearns' net revenue during the first nine months of its current fiscal year that ends Nov. 30.
During the same period in 2000, fixed income revenue was $752 million, or 18 percent of net revenue.
One crucial catalyst for fixed-income revenue has been record mortgage lending volume. Wall Street packages home loans together and sells them to bond investors, collecting fees in the process.
But mortgage rates have crept higher after two years of rate hikes, cutting into home sales and mortgage demand.
An industry report on Monday said existing home sales slowed for a fifth straight month in August, and prices dropped from year-earlier levels for the first time in more than 10 years.
That threatens to reduce the amount of raw material that Wall Street investment banks can use to manufacture investment products.
A BETTER FOOTHOLD
I thought the bond market would have fizzled out a couple of years ago, said Ken Crawford, a portfolio manager at Argent Capital Management LLC, which has $600 million in assets under management.
Crawford, based in St. Louis, said it hasn't, partly because homeowners have proved resilient.
Also, beyond the housing market, corporations still have large incentives to raise money via the debt markets.
Rather than just sitting on cash, corporations face pressure to make acquisitions and other strategies to maximize shareholder returns, Crawford said. The cost of borrowing money remains relatively low.
David Ritter, an analyst at Argus Research, says the outlook for fourth quarter bond issuance looks strong, because September is shaping up as a record month for the issuance of investment-grade bonds, with some $60 billion scheduled as of the end of last week.
But the outlook for mortgage lending may not be as rosy, said Richard Bove, an analyst at Punk Ziegel & Co.
It's clear the housing market is coming down, he said. It's also clear the competition is increasing because Morgan Stanley and Merrill Lynch purchased divisions to get into the business.
Merrill Lynch & Co. Inc. this month agreed to pay $1.33 billion for National City Corp.'s First Franklin Financial Corp. In August, Morgan Stanley agreed to acquire mortgage lender Saxon Capital Inc. for $706 million.
Bear Stearns, for its part, is not concerned. Chief Financial Officer Samuel Molinaro Jr. told Reuters his company also benefits when homeowners convert adjustable rate mortgages to fixed-rate loans, to avoid the possibility of getting stuck with higher interest rates.
That means more product needs to be originated and securitized, Molinaro said.