With interest rates moving up, debt underwriting revenue came down in the third quarter for the largest U.S. investment banks.
In aggregate, third-quarter debt underwriting revenue fell 11.4% year over year and 13.8% quarter over quarter for Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley. The 10-year U.S. Treasury yield finished the third quarter at 3.05% after starting the period at 2.87%, a rising trend that typically deters companies from issuing debt because it makes the funding more expensive.
Morgan Stanley was the only investment bank in the group to produce a year-over-year gain in its third-quarter debt underwriting revenue, which was up 14.9% to $508 million. During Morgan Stanley's earnings conference call, CFO Jonathan Pruzan noted that high-yield financing slowed from an active second quarter, while investment-grade issuance activity improved. Financing to support M&A also helped boost Morgan Stanley's results.
He added that the leveraged loan market has seen some repricing, but deals are still getting done. At BofA, though, CFO Paul Donofrio said leveraged finance was an area of underperformance for his company, which saw its third-quarter debt underwriting drop 28.9% year over year. He noted that nonbank entities compete in the leveraged finance business and that riskier terms and structures have entered the market. But Donofrio said BofA has tried to grow responsibly.
"We're not chasing the market," he said according to a transcript of an Oct. 15 earnings conference call.
Donofrio also noted that BofA underperformed in the M&A business, where its advisory revenue was down 29.9% year over year. But he said the business has rebounded in the early weeks of the fourth quarter, with BofA seeing a pickup in announced transactions.
In total, the largest i-banks saw advisory revenue fall 6.3% year over year in the third quarter. Citigroup was the only one of the five largest i-banks to manage a year-over-year increase greater than 1% in advisory revenue. However, weakness in underwriting led Citigroup's total investment banking revenue to drop 7.7% year over year in the third quarter.
CFO John Gerspach said he expects better results in the fourth quarter. "Given our current backlog, we expect revenues to be up both sequentially and year over year," he said according to a transcript of the company's Oct. 12 earnings conference call.
Citigroup CEO Michael Corbat noted that the fourth quarter is traditionally a strong period for investment banking revenue as clients work to close M&A deals and financing transactions before year-end. But market volatility often slows the pace of deal closings, and the early portion of the fourth quarter has seen increased volatility.
The VIX, which measures investor expectation of implied volatility in S&P 500 index options, has seen an average close of 17.6 in the fourth quarter through Oct. 22 after producing an average close of 12.9 in the third quarter. The higher VIX has reflected a steep sell-off in stocks that began in earnest on Oct. 10.
Equity capital markets activity is the i-banking business line that is most susceptible to market fluctuations, said JPMorgan CFO Marianne Lake. She said her expectation is that the equity capital markets might just see a temporary pause in activity.
"No good ever comes of trying to predict what a quarter will look like after a couple of weeks," Lake said according to a transcript of the company's Oct. 12 earnings conference call.
In the third quarter, JPMorgan saw its equity underwriting revenue increase 40.0% year over year. The performance was driven by work on initial public offerings, particularly in the technology and healthcare sectors, Lake said.
Equity underwriting results were strong across the board, with the business line booking an aggregate increase of 44.2% year over year in the third quarter at the five i-banks. Goldman Sachs saw its equity underwriting revenue increase 103.8% year over year.
Goldman Sachs CFO R. Martin Chavez noted that follow-on volumes fell, but an acceleration of IPO activity boosted results. Goldman's advisory revenue was essentially flat year over year in the third quarter, and debt underwriting revenue was down 6.2% year over year.
Chavez said his company's investment banking backlog is down from second-quarter levels but is up significantly from a year ago.
"Clarity from U.S. tax reform, a supportive economic backdrop, solid equity market valuations, significant private sponsor interest as well as corporates' desire for strategic M&A across sectors are all supporting healthy activity," he said during an Oct. 16 earnings conference call.
Read more on bank earnings or i-bank revenue:
NIM expansion enables big banks' earnings beats in Q3
I-banking outlook faces a confidence game
Market volatility, higher interest rates put damper on Q1 i-banking revenues
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