A small corner of Wall Street trading exploded in 2019 with more than 500% revenue growth, and that's helped bring big bank bond-trading back from the dead
- Wall Street's top bond-trading houses have reported stellar revenues in fixed-income trading for the fourth quarter and strong results for all of 2019.
- Part of the explanation is a low baseline: 2018 was a lousy year for bond trading overall, and the fourth quarter was especially challenged.
- But the firms also benefitted from an unexpectedly strong performance from a small corner of the fixed-income market: agency mortgage bond trading.
- Industry experts say mortgage-backed securities trading topped $2 billion in 2019 across the industry - the largest tally since before the Great Recession, and a more than 550% gain from 2018.
- With bonus season here, agency mortgage traders are licking their chops. They're expected to be among the best-compensated in FICC this bonus cycle.
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Wall Street's top bond-trading houses have kicked off earnings season with a bang, thanks in part to a small trading desk that grew revenues more than 500% across the industry in 2019.
JPMorgan Chase and Citigroup were first out of the gate to report fourth-quarter earnings for the industry's top investment banks, beating analyst expectations more broadly on Tuesday but also posting especially eye-popping numbers in fixed-income, currencies, and commodities (FICC) trading.
JPMorgan increased FICC revenues 86% in the quarter compared with last year and 13% for the full year, to $14.4 billion. Citi saw a 49% increase in the quarter and 10% for the full year, to $12.9 billion.
Goldman Sachs released earnings on Wednesday, reporting a 63% jump in FICC trading for the quarter and 6% for the year, to $7.4 billion. Bank of America also reported on Wednesday, posting a 25% gain in fixed-income trading in the quarter and roughly flat for the full year, with $8.4 billion.
Part of the explanation for the staggering improvement resides in a low baseline. FICC revenues have been contracting for years, hitting a five-year low of $64.2 billion in 2018 among the 12 largest banks, according to industry consulting and data firm Coalition.
The fourth-quarter of 2018 was particularly abysmal, amid jolts of volatility that spooked investors and sent markets into tailspin. Amid the chaos, JPMorgan posted its worst bond-trading results since the financial crisis.
So a rebound was baked into expectations, to a certain extent.
But the firms also benefitted from an unexpectedly strong performance from a small corner of the fixed-income market: agency mortgage bond trading.
Known by investors as agency residential mortgage-backed securities (RMBS), these bundles of home loans are issued by government-sponsored agencies like Fannie Mae and Freddie Mac, and they're generally considered high-quality assets - not to be confused with the sub-prime securitized housing products that helped sink the economy and spark a financial crisis more than a decade ago.
While final numbers are still settling, Coalition estimates revenues from agency RMBS trading to finish at more than $2 billion in 2019 across the industry. That's the largest tally since before the great recession, and a more than 550% gain from 2018, when the top-12 banks combined for roughly $300 million.
In its earnings presentation, Bank of America attributed its fourth-quarter fixed-income trading gain to "improvement in most products, particularly mortgages."
"Last year mortgage products across wall street had a sort of difficult quarter," Paul Donofrio, Bank of America's chief financial officer, said in an earnings call with media. "This year was the opposite of that," he continued.
Goldman also attributed its FICC gains in part to mortgage trading, both for the fourth quarter and the full year. JPMorgan and Citi weren't as specific, but each called out strong performance the broader divisions in which their mortgage trading desks fall under.
"This is the best year we've seen in the past decade," said Amrit Shahani, research director at Coalition, characterizing the agency RMBS performance in 2019.
Representatives for the banks declined to comment for this story.
Fed rate cuts spurred mortgage trading
The Federal Reserve, by cutting its benchmark rate by 25 basis points three times in the latter half of 2019, played a critical role in the RMBS rebound.
Like most bonds, mortgage-backed securities tend to increase in value when interest rates decline, as investors can benefit from the increasing spread between the security they hold and the lower market rates.
That can especially be true for specified pools - mortgage bonds packaged to offer certain characteristics, such as particular geographies or loan sizes, which can account for how quickly the loan is repaid.
Amid the crush of refinancings in 2019 from homeowners who also wanted to cash in on the dropping rates, investors worked up a ravenous appetite for such mortgage assets that protected against quick repayments - since an early loan payoff means fewer interest payments to the investors and a potentially lower return.
JPMorgan and Citigroup had the strongest performance in agency mortgage trading for the full year, according to multiple industry insiders, followed by Bank of America, Goldman Sachs, and Morgan Stanley, which reports earnings on Thursday.
An industry source told Reuters in October that JPMorgan was on pace to eclipse $500 million in revenues from agency RMBS trading in 2019. A source familiar with the firm's results told Business Insider the bank finished with more than $700 million - more than double the entire industry haul in 2018.
With bonus season here, agency mortgage traders are licking their chops. They're expected to be among the best-compensated in FICC this bonus cycle, according to a compensation white paper by Wall Street executive recruiting firm Options Group.
"With bonuses being announced at some of the biggest US banks this week, we anticipate agency mortgage and linear rates trading to be the biggest winners in FICC compensation," Jennifer Montalvo, a partner at the firm and the author of the white paper, told Business Insider.
Montalvo also warned that "there may be compensation inflation this year" amid the "the robust hiring across the securitized product sector."
But it's unclear how much value the agency RMBS trade will have in 2020. The Fed signaled in October that it was pausing its rate cuts and is likely to hold rates steady throughout the coming year.
