The investment banking minefield

Investment banks are climbing back from the depths of the financial crisis only to face regulatory challenges and a public hostile to fat profits and paychecks.

In addition, high U.S. unemployment and low consumer spending have banks nervous about their most basic business: lending money.

"There's no question we're in a recovery," said Michael Nix, portfolio manager at Greenwood Capital Associates in Greenwood, South Carolina. "The question becomes, what happens from here?"

Over the summer, several of the biggest banks paid back billions of dollars received from the U.S. government's bank bailout program. But historically low interest rates and other initiatives to prop up the economy, such as mortgage modification plans, are providing a vital crutch to financial institutions.

"As we look into next year and the government stimulus does start to wane, the private sector has got to pick up, and a big part of that is going to be related to these banks' ability to lend and support economic growth," said Nix.

As the government begins to grapple with removing support from the industry, regulators and lawmakers are attempting to formulate rules to prevent another crisis. Some early proposals, such as regulating derivatives trading, have banks spooked about losing profitable business.

LOAN BOOK WORRIES

U.S. regional banks reported last month that their loan books shrank further as they trimmed loans to riskier customers.

On top of revenue concerns, investors remain worried about loan losses, particularly at smaller lenders such as Zions Bancorp and Synovus Financial Corp, where increasingly troubled commercial real estate makes up a large chunk of loan portfolios.

"The issue remains the balance sheet and the quality of loans and assets on the balance sheet relative to reserves (against losses)," said Robert Lutts, chief investment officer at Cabot Money Management in Salem, Massachusetts.

Losses from credit card portfolios are weighing on JPMorgan Chase & Co and Bank of America Corp, and both banks are relying on revenue from their investment banking units to offset rising losses on consumer credit.

Goldman Sachs Group and other investment banks have ramped up trading activity to make up for the lasting slump in mergers and acquisitions that has cut fees earned from these transactions.

These larger banks have reported record revenue from underwriting as companies return to capital markets, but it is not clear how long the capital-raising rush will last.

Meanwhile, Bank of America and Citigroup Inc, which have yet to repay their $45 billion government bailouts, face a battle to retain employees while meeting restrictions on pay. 

Kenneth Feinberg, the Obama administration's "pay czar," has slashed pay for the 25 highest-paid executives at companies that received extraordinary assistance during the financial crisis. He is now preparing rules on compensation for the 26th to 100th best-paid workers at those firms.