Wall Street’s big firms enjoyed a solid first quarter, underpinned by strong profit growth and healthy balance sheets, but the fallout from hedge fund losses highlight hidden risks, says Moody’s Investors Service.

In a new report, the rating agency said that the big five U.S.-based global investment banks — Bank of America Corp., Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan Chase & Co. and Morgan Stanley — recorded a strong first quarter.

Combined, the banks reported pretax profits of US$50.9 billion, which was up 39% from the prior quarter and 254% from the same quarter last year.

“A busy quarter in capital markets and large releases of allowances for credit losses at the universal banks (BofA, Citi and JP Morgan) powered overall pretax profitability,” Moody’s said.

Capital markets revenues were driven by strong equity underwriting activity and client flows, the report noted.

However, two of the banks — Goldman and Morgan Stanley — reported losses stemming from their involvement with troubled hedge fund Archegos Capital Management, which Moody’s said “illustrate the dangers lurking in this extraordinary market environment.”

Goldman said its losses were not material, “which we believe may be a testament to its risk management and controls,” Moody’s said.

Alongside the strong capital markets revenues, the banks also enjoyed “strong contributions” from the less-volatile asset and wealth management businesses, it noted.

And the rebounding U.S. economy allowed the banks to release US$11.9 billion worth of loan loss reserves (US$11.7 billion of that at BofA, Citi and JPM), boosting their bottom lines.

Looking ahead, Moody’s said “[c]orporate and consumer asset quality continues to hold up broadly, with charge-offs likely to rise later in 2021 or in 2022.”

The banks’ capital positions remained strong in the first quarter, but Moody’s said that with share buybacks resuming, capital may have peaked. The firms are expected to return more capital to shareholders in the second half, “after the Fed’s current restrictions on payouts are lifted,” it said.