Monday, 28 May 2018

Are investment banks working towards the wrong cycle?

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  • IFR Editor-at-large Keith Mullin

IFR editor-at-large Keith Mullin questions the timing of firms’ cost-cutting plans

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

THIS IS MAYBE an odd time to be asking this question. But have we launched headlong into another over-exaggerated cycle of downsizing in investment banking at the wrong moment? Might that leave banks wrong-footed and ill-equipped to deal with the upturn in M&A and capital markets activity as well as in trading volumes and velocity that will radiate from the economic stabilisation and subsequent recovery that policymakers and central banks are trying so hard to bring about?

The reason I ask is that I’ve just got this feeling that senior IB management have become a little addicted to the opium of negativity that’s afoot and are right-sizing, herd-like, for today when by definition today will recede relentlessly and unalterably into the past as each day passes. Banks could instead be wrong-sizing for the medium term. They obviously need to ensure they’re generating returns acceptably in excess of their cost of equity. But meeting those goals in a way that’s so heavily weighted to the cost side relative to the top line could come back to haunt them.

Part of the story is that they’re being badgered into action by regulators. There’s an odd irony here. The same policymakers who are forcing the financial sector into a maelstrom of regulatory convolution and risk-aversion don’t seem to have understood that their over-zealous actions here run almost directly counter to their intended economic policy goals, a centrepiece of which is the voluntary transmission of private-sector credit into the real economy.

Is the medium-term market outlook really as bleak as the current industry pruning suggests? I don’t think so. And the banks really can’t afford to think so. Most recently, not only Deutsche Bank and Nomura but a host of other banks too have been focusing on hitting deleveraging, restructuring and recalibrated performance targets by 2014–15, after which the expectation generally is that the outlook will be more propitious. That period gels quite nicely with the time needed to turn the economy around.

IN THE MEANTIME, however, banks are bringing about a massive reduction in industry capacity. But I think it’s too centred on today’s conditions: flat to negative economic growth; the eurozone crisis; the China slowdown, etc, and a sense that today’s depressed deal-making environment will remain in place for years to come. On the latter point, that’s not what I’m hearing from senior IB executives or corporates, whose expectations are much rosier – even accounting for the fact that by the nature of what they do bankers have to be seen to be thinking positive.

Is the medium-term market outlook really as bleak as the current industry pruning suggests?

Where headcount reductions are being targeted towards IT and operations, which had grown out of control in the years leading up to the global financial crisis and since, that’s fair enough. Ditto where they’re targeted towards products and businesses that have added either little or no franchise value or generated sub-standard financial returns. I’ve long argued in this column and elsewhere that that’s the right thing to do and that banks that clutter the landscape with pointless, mediocre offerings need to get out of the way.

But the numbers we’re all reading about how much banks are whacking senior client-facing bankers are scary in my view, anything from 5% to 10% to as high 20% of global capacity. Certainly, year to-date fee-take across M&A, ECM and syndicated lending doesn’t look good relative to the same period of 2011; wallet in those areas is down 20% to 30%. (By contrast, almost perfect technical conditions in the debt markets have pushed debt underwriting fees close to last year’s number.)

I don’t think I’ve met anyone who believes the low levels of activity seen in certain areas this year are anything other than an aberration that’ll give way in the medium term. Yet almost every firm involved in investment banking is working off fairly dramatic run-rate reductions. I have a suspicion that there’s a bit of contrived messaging in all of this geared as much to seeking regulatory, shareholder and stakeholder pleasure as it is a genuine effort to engender self-belief in the slimmed-down and not-as-well-paid client and product business model. But still…

THIS IS AN issue of confidence. Once the perception takes hold that we’re over the hump of the economic slowdown, I don’t think it’ll take too much to push confidence up and for the feel-good factor to feed on itself. Look at what’s happened to peripheral eurozone bond yields since Mario Draghi took his “save the euro” stance. Look at what happened to the US stock market on Thursday when Ben Bernanke unveiled QE3.

Are we close to a positive confluence of events? Follow my line of thinking here: Mario Draghi’s massive “I can if I want to” bond-buying programme and full ESM ratification squeeze peripheral bond yields durably below danger levels. Their actions save Spain’s irritatingly dithering prime minister from himself and so Mariano Rajoy avoids a full-scale bailout (though his banks are still knackered). All of this signals a turning point of sorts in the eurozone crisis.

Meanwhile, the Fed’s purchases of agency MBS have the intended effect and signal the beginning of a recovery in the US housing market and send broadly positive signals into the US economy. China’s landing is a managed broadly soft one rather than an unmanaged hard one.

Republicans and Democrats reach a compromise on US fiscal policy and healthcare reform – OK, I bet you were with me until this last point; that of course will never happen. But my point is we’re moving in the right direction and a sustained economic recovery is not a pipe-dream. Either that or it’s me who’s on the opium.

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