Tough Times for Investment Banks

March 30th, 2016 9:27 pm | by John Jansen |

Via the FT:

Global investment banks suffered declines of as much as 56 per cent in their trading businesses in the first three months of the year, analysts believe, stoking fears of further lay-offs for staff and lower dividends for shareholders.

Europe’s shrinking investment banks bore the full brunt of 2016’s difficult environment for the buying and selling of assets such as bonds, stocks and commodities on behalf of clients. Their woes were highlighted by Credit Suisse’s admission last week that its trading revenue fell by 40-45 per cent in the period.

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Not only are many of Europe’s banks reorganising and trying to sell assets into a falling market, but they also have less exposure to the US market, which has fared better than Europe and Asia.

But Wall Street’s biggest banks are suffering too, with analysts predicting first-quarter falls in trading revenue of up to 48 per cent for Goldman Sachs and 56 per cent for Morgan Stanley as slowing Chinese growth, stubbornly low oil prices and fading hopes of a US interest rate rise weigh heavily on client activity and market performance.

The difficult first quarter shows the continuing challenges faced by investment banks as they try to create sustainable profitability now that post-crisis reforms have limited opportunities and raised costs.

Jon Peace, banks analyst at Nomura, said the trading slump would have practical implications for European banks who still need to build capital to satisfy new regulations. “Weaker trading profits will delay the return of normalised cash dividends for the weaker banks, and limit the absolute dividend payouts for the stronger banks,” he said.

Huw van Steenis, London-based banks analyst at Morgan Stanley, said it could take more than three years for investment banks to “structurally remove cost and capital” to deal with the new market realities.

Banks have already begun pruning. Credit Suisse has announced 2,000 extra job cuts in its markets division after a brutal first quarter and Morgan Stanley said late last year it would cull 1,200 jobs in fixed income and back- office functions.

In Europe, seven analysts polled by the Financial Times predicted that the top four investment banks — Credit Suisse, Deutsche Bank, UBS and Barclays — suffered an average collapse of about 25 per cent in trading revenues for the first quarter of the year.

Kinner Lakhani, analyst at Deutsche, said European banks had been hit by a “perfect storm” of concerns about China, energy and global growth. “From the sales and trading businesses we expect the ‘directional’ business to have struggled the most, namely credit, equity derivatives,” he said. “The cost of exiting non-core positions is also likely to have gone up sustainably as buyers demand a higher liquidity premium.”

Trading revenues are especially important to the European groups because they make up about three-quarters of their “investment bank” revenue. The category also includes fees charged to clients for advice on stock market listings, debt raising and mergers and acquisitions.

Credit Suisse was predicted to be the poorest performer, with the analysts pencilling in an average fall of 34 per cent in first-quarter trading revenues, in estimates compiled before the bank said last week that the actual numbers would be even worse.

The European analysts officially expect UBS to report a 26 per cent fall in trading revenues, Deutsche to report a 24 per cent fall and Barclays to be down 13 per cent. But some privately warned that the forecasts had been set weeks ago and did not take account of recent negative news.

UBS’s year-on-year fall is exacerbated by an exceptionally strong first quarter in 2015, when the Swiss central bank’s decision to stop pegging its currency to the euro drove a surge in trading. Deutsche’s trading business was hit hard by a jump in the cost of insuring against the bank’s own default, which drove some trading clients into the arms of competitors. Credit Suisse suffered losses from selling off illiquid positions that had been concealed from senior management until late last year.

Barclays is expected to be the relative winner but chief executive Jes Staley said earlier this month that its investment bank would probably produce less income in the first quarter of 2016 than a year earlier.

On Wall Street, the five leading investment banks — Goldman, Morgan Stanley, Citigroup and Bank of America — are expected to see trading revenues fall by an average of almost 25 per cent, according to six analysts polled by the FT.

Paul Gulberg, analyst at Portales Partners, expects overall year-on-year declines of about 25 to 30 per cent in trading revenues at the big five in the first quarter.

“Trading revenues at Morgan Stanley could be down 35, maybe even 40 per cent [year on year],” he said, pointing to the potential for “huge swings” in fixed income.

In past years, US banks have been able to compensate for poor trading results with strong income from “investment banking” activities such as advisory and underwriting fees from acquisitions, listings and fundraisings. But the markets have been quieter this quarter. As a result, banking chiefs have been openly gloomy, with several of them telling investor conferences to expect bad news.

John Gerspach, Citi’s chief financial officer, has warned of a 15 per cent fall in trading revenues and a 25 per cent fall in investment banking in the first quarter; JPMorgan said in February that its investment banking fees were down 25 per cent year on year; and Morgan Stanley warned in the same month of an “incredibly quiet” calendar for debt and equity raising in the first month and a half of the year.

“The external environment has been a real challenge,” Jonathan Pruzan, Morgan Stanley’s chief financial officer, said at the bank’s European Financials conference in London this month. “We can’t control what markets do … but we can control things like our expenses, things like our headcount.”

At the same event, Deutsche’s chief executive John Cryan warned that the bank would probably make a loss in 2016 and UBS’s usually ebullient chief executive Sergio Ermotti said there had been a sharp slowdown in the first quarter. Barclays’ Mr Staley said that returns at his investment bank were “not acceptable”.

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