The banking industry does like to obsess about itself.
Perhaps in recent times, it has had every reason to do so. One of many current obsessions is the performance of investment banks’ market businesses, generally known as FICC or fixed income, currencies and commodities.
The reason for this particular obsession is clear. The segment is not performing well at a time when regulatory pressures, particularly higher capital ratios, are making it ever more difficult to achieve satisfactory returns.
According to a March 28 note from Christian Bolu, a bank analyst at Credit Suisse, FICC revenues “are now down 45% from 2009 levels, primarily led by weaker G10 rates and commodities revenues (both down some 65% from 2009 levels).”
That trend has broadly continued into the first quarter of 2014 as SNL Financial’s survey of published results shows. Income from FICC in the prior-year quarter was higher and the great white hope — equities — has not surged overall to compensate. Morgan Stanley analysts reported April 16 that FICC trading revenues in the first quarter were down between 15% and 21% year over year; the former figure was treated as encouraging because it showed a market share gain. Even within typically volatile markets, these are not great figures and as our charts show, very few banks are coming through the FICC experience unscathed.
Yet as Andreas Venditti, a bank analyst at Vontobel, pointed out to SNL, the FICC segment embraces a number of often completely unrelated businesses. Some are faring distinctly better than others.
This results in the strikingly different individual income performances of the banks that have reported first-quarter results. According to SNL figures, Credit Suisse Group AG clearly lagged its U.S. peers, and Venditti expected that UBS AG would do the same. He said: “In the first quarter, the commodities business was relatively good compared to others. Goldman Sachs Group Inc. and Morgan Stanley are strong there, for example, and they were somewhat better than others. For the Swiss banks, commodities is just not an important business.”
“FICC is not just one business,” Bolu said. “In the first quarter, those banks which are more heavily weighted towards the rates business, emerging markets and forex did worse.” Here he named JPMorgan Chase & Co. and Citigroup Inc. as suffering. He also emphasized the current strength of commodities and credit businesses, highlighting the performance of Morgan Stanley with “Goldman Sachs coming in somewhere between the two groups.”
To complicate things further, each individual house has its own characteristics within FICC. For example, Morgan Stanley is “recovering from a lower base,” Bolu said. As SNL’s figures show, its FICC results have been very volatile in recent years.
The upshot is a complex picture. Yet at its most basic, Morgan Stanley and Bank of America Corp. look to have outperformed the FICC competition year over year and quarter over quarter in terms of income from equities and fixed income — or at least, to have improved on previous figures when others were seeing significant declines.
Nevertheless, the outlook is poor for 2014 as a whole. The first quarter, traditionally the strongest because companies seek to transact and refinance, tends to set the tenor for the year, hence investment bankers like to insist at the start of the year on the strength of their forthcoming or pending or possible M&A deals — the so-called pipeline. Enthusiasm is thought to engender enthusiasm. Investment banking fees in the first quarter did offer some hope to support this tack, notably at Goldman Sachs.
A key question is whether the FICC business is undergoing secular change and, if so, whether the market is profitable enough to support the number of players and the capital committed. Returns are the critical issue, and they depend upon FICC revenues that continue to decline. Bolu pointed out that G10 rates (down 65% in 2013 compared to 2009), G10 credit (down 38% over the period) and commodities (down 64%) are driving the shrinkage.
Received wisdom says the best place to be in such circumstances is in strong market positions — to rank No. 1, 2 or 3 in rates or foreign exchange, for example. Yet even market leaders suffer if their key markets turn against them, as the first-quarter experience of JPMorgan and Citi shows.
“In general it feels like the market consensus at the quarter beginning was for a growth story which didn’t transpire,” Marianne Lake, JPMorgan Chase CFO, told analysts April 11 pointing to a “challenging environment and lower client volumes.”
A turning point for FICC in general could be at hand. Questions have been raised in particular about the European investment banks’ ability to sustain their competitive position in FICC given market, capital and regulatory pressures.
As remarked, Credit Suisse is unlikely to be the worst first-quarter performer. Barclays Plc admitted April 24 that its FICC business saw “a significant year on year reduction” in income “reflecting difficult market conditions,” and it promised “further actions” to improve returns. It is expected to reduce significantly its commodities business — an area where Deutsche Bank AG, JPMorgan and Morgan Stanley have also announced cuts.
European banks’ market share had fallen to 36% at the end of 2013 from 43% at 2010-end. All banks are cutting back on resources committed to FICC, but European banks are of necessity reducing more strongly.
“Resource allocation to FICC has fallen sharply — both headcount and FICC trading assets are down by between 20% and 25% from post-crisis peak levels. With respect to the competitive landscape, the U.S. commercial banks now dominate the industry and hold the top 3 market shares,” Bolu said.
All banks will surely look to reduce assets and capital committed to FICC. This might involve “capital light” models whereby banks aim to serve their clients first and foremost, as Credit Suisse has hinted. Probably, it means that there will be less liquidity available for market-makers and that investors will thus face higher trading risk.
Something surely has to give. Yet it does look as if the European investment banks are destined to cut further and faster now.
