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Monday, 28 July 2014

Steady as she goes for IB earnings

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So with JP Morgan, Citigroup and now Goldman Sachs having reported second-quarter results, is there anything new to glean from the numbers? Well, they prove beyond doubt that while all banks are in the process of attempting to right-size headcount relative to current activity and future business outlook, optimise strategy, focus on where they can create real value at the same time as imposing durable expense reduction, such actions only slowly filter down to the bottom line.

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

If you depend absolutely on deal flow and on trading volume and frequency (which of course investment banks do) to make the numbers, it’s pretty much impossible to engineer your way out of a marked decline or slump – even with ruses such as share buybacks. FICC and equity trading revenues continue to track lower.

This is unlikely to be a cyclical phenomenon. For sure, investors are in a funk at the moment, what with all that’s going on in the eurozone and uncertainty in the US. But we’re not going back any time soon – or potentially ever – to the kind of high-volume and flighty trading turnover we saw before the 2008 financial crisis. In the 2Q numbers, Goldman’s trading desks underperformed Citi and JPM, but all of the numbers were predictably poor.

Looking at investment banking, completed M&A deal volume in the second quarter of 2012 amounted to US$535bn, 31% up on the first quarter but 24% lower than the second quarter of 2011. In aggregate, JP, Citi and GS came out with an average 35% rise in advisory net revenues in the second quarter relative to the previous quarter, and a 22% decline relative to the same period of 2011, almost perfectly tracing the broad market.

But averaging the numbers masks some real differences: JP Morgan broadly followed the market line in Q2, reporting a better than average 27% 2Q/1Q increase, but the bank posted a hefty 41% 2Q/2Q decline as it slipped from first to fourth in the M&A league tables over that period.

On a numbers basis, though, Goldman was the advisory under-performer in the most recent quarter, posting a US$20m 2Q/1Q decline in net revenues to US$469m at the same time, though, as it regained top spot in the completed M&A league table for the first half of the year. Citi appeared to defy gravity in advisory, reporting an impressive 83% 2Q/1Q rise to US$201m and coming in flat to 2Q11, outperforming on both counts.

JP Morgan and Goldman’s equity underwriting numbers broadly tracked the overall decline in ECM (-13% 2Q/1Q; -41% 2Q/2Q), but Citi grew its ECM revenues by 8.5% from the first to second quarters of 2012 to US$167m – although it’s important to point out that the bank has significant ground to make up in revenue terms to JP (US$250m) and Goldman (US$239m)

Investment bankers talk continuously of healthy M&A and ECM pipelines and a whirlwind of pitching for mandates but some of that optimism is poorly placed and little more than an attempt to talk themselves and the market up. A lot of companies will wait for confidence to return before launching event-driven activity.

JP Morgan and Goldman’s equity underwriting numbers broadly tracked the overall decline in ECM (-13% 2Q/1Q; -41% 2Q/2Q), but Citi grew its ECM revenues by 8.5% from the first to second quarters of 2012 to US$167m – although it’s important to point out that the bank has significant ground to make up in revenue terms to JP (US$250m) and Goldman (US$239m). DCM net revenues showed marked declines for JP Morgan and Citi, while Goldman pushed up its numbers in the most recent quarter by 21% to US$495m putting it ahead of Citi’s US$486m.

So far, however, the numbers haven’t been too awful given the uncertainty at play in global financial markets. The bigger issue at play is how banks are going to push up ROE in an environment where cost of capital remains high, business volumes remain depressed and margins continue to be squeezed.

I still sense a mismatch between the reality of the numbers and future prospects for the investment banking business with analyst and investor expectations. I don’t think the business is just trundling along in a down-cycle; it’s at the beginning of a more elemental process of change.

I imagine the other banks will come in more or less tracking the broad market – although I’m sticking my neck out and predicting that Bank of America Merrill Lynch (reporting Wednesday) has the potential to surprise to the upside in segments of its investment bank.

Famous last words?

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