Wholesalemarkets are expected to continue being extremely tough for European and U.S.investment banks, as the forthcoming earnings season is likely to reveal.
Littleappears to have changed since fourth quarter 2015, with its cyclical headwinds ofslow growth, disruption in emerging markets and low interest rate as by Goldman Sachs CEOLloyd Blankfein in February. "This is a sober time for everybody,"he said.
Anew analysis from S&P Global Market Intelligence emphasizes thedifficulties faced by European and U.S. investment banks and shows whyBlankfein is not alone in his concern.
"Themain revenue headwinds that we see are within the global marketsbusiness," Iain Mackay, CFO of HSBC Holdings Plc, Europe's largest bank, said in lateFebruary.
However,U.S. banks' outperformance over European peers in this area will likelycontinue. It may be due increasingly to regulation that favors U.S. banks giventheir better leverage ratios and stronger domestic economy, Société Généraleanalysts suggested in a January note. Moreover, the analysts expected Europeanbanks to shrink their fixed-income, currencies and commodities businessesrelative to equities.
Thishas happened with some visible success at UBS Group AG and is being undertaken at some cost byCredit Suisse GroupAG.
appears to beone of the few European investment banks resisting this trend although it iscutting selectively. The German bank has said it wants to risk-weighted assets by 20% by2020 partly to offset regulatory compliance costs and to bolster its leverageratio. Like other banks, it is strengthening its position inequities. Yet equities were not encouraging for it in the fourth quarter.
Cyclical, structural or both
Onekey worry for U.S. and European investment banks is that the market decline isnot purely cyclical but also structural, said JoeDickerson, a bank analyst at Jefferies, in an interview, noting: "The factthat the first quarter is going to be weak in fixed income should come as asurprise to no one."
Liquidityappears to be an issue on both sides of the Atlantic. A negative cycle isoperating in credit markets, characterized by Blankfein as "higher risk,less liquidity, hard to get out of certain positions; people don't have thesame kind of inventories."
Theinability to deal means that "certain positions" can involvemark-to-market losses.
Globalrevenues from FICC have halved during the last five years, Bernstein bankanalysts observed in a March 17 note. The analysts highlighted their concernthat the ECB's monetary policy, which embraces negative rates along with thepurchase of corporate and government bonds, will reduce liquidity in corporatebond markets. The central bank's buying of government bonds has already seenmarket liquidity reduce and forced broker dealers to cut capacity.
Thesepressures have combined dramatically at Credit Suisse. Blaming a deterioratingglobal markets performance in 2015, a "disappointing" fourth quarterand ongoing pressure from challenging markets and low client activity in thefirst quarter of 2016, Credit Suisse has accelerated its restructuring, writingdown "outsized" credit and illiquid positions, while announcing itsexit from distressed credit, European securitized products and long-term illiquidfinancing. Overall, the Swiss bank is cutting both its risk-weighted assets andits capital in global markets while strengthening its equities position.
Q1 and beyond
Asfor what to expect in the forthcoming quarterly results season, Citi analysts remarkedthat Credit Suisse management expected to see a further loss in global marketsin the first quarter. Admittedly this should be lower than in the previousquarter when fixed income and equities saw dramatic year-over-year revenuefalls.
ChristopherWheeler, a bank analyst at Atlantic Equities, predicted in March 22 and March23 notes that first-quarter earnings from Goldman Sachs Group Inc. and would be less than halfthan that of the prior year. (The improvement thatMorgan Stanley recorded in the fourth quarter, Wheeler added, was due to thevaluation change on own debt; otherwise, the FICC figures would be negativeyear over year.)
Wheeleradded in an interview that several investment banks had good or reasonableperformances in the first three months of 2015. This means that thefirst-quarter results released in the coming weeks could look especially bad incomparison.
Thebleak outlook for 2016 could provoke further scrutiny of investment banks'strategies. Bernstein analysts foresee FICC incurring a 25% drop in income inrates and credit in Europe in 2016, a figure that could be much worse given theliquidity pressure created by ECB actions.
Nonetheless,Dickerson is not ruling out the possibility of positive change, pointing outhow primary issuance for the European investment banks picked up in March,following the statement earlier that month from ECB chief Mario Draghiannouncing further monetary easing. "Maybe the second quarter will bebetter than the first quarter," he said.
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