IFR Editor-at-large Keith Mullin
UBS’S DECISION TO shut most of its FICC division and eliminate 10,000 jobs over three years certainly threw the cat among the pigeons. Even though much of the news had been telegraphed well in advance, some UBS employees and many in the market reacted with shock and horror.
But not investors: UBS’s firm commitment to return capital to shareholders, the prospect of a total payout ratio of 50%-plus and an RoE of at least 15% from 2015 caused some cheer and UBS shares put on weight into the end of the week. In fact, the shares are up 25% in the year to-date and by Friday they were trading at levels not seen for 16 months.
For market participants away from UBS, any shock or horror may have been tinged with that guilty pleasure you can only feel at someone else’s misfortune. But at the same time, I picked up a strong cross-current of disquiet about what UBS’s decision means for FICC and the investment banking industry as a whole. There’s a distinct “there but for the grace of God go I” anxiety afoot.
If UBS is exiting FICC because it believes the returns to shareholders on the business are destined to be below the cost of funding it given punitive capital charges, the question is: Is the Swiss bank so different to anyone else? If the answer is “not really” – and by the way that is the answer – that should be a serious concern. What’s particularly worrying industry participants and industry-watchers is that we’re talking here about a business that has been and continues to be the biggest contributor to investment bank earnings.
Deutsche Bank’s FICC revenues of €2.5bn in Q3 and €8bn in the first nine months of the year represent around half of total revenues in the corporate and investment bank. Given the importance of CIB to the group, that’s about 30% of total group revenues. Even at UBS, FICC represents almost half IB revenues; at Barclays, it accounted for a slightly disconcerting 65% of the investment bank’s income in the first nine months of 2012 and 27% of total group revenues. And just to drive home the point, at Goldman Sachs, FICC represented 53% of Q3 institutional client group revenues and 27% of firm-wide revenues.
EVER SINCE THE UBS news, the talk has been about who’s going to follow suit and downsize or reconfigure FICC. Those most actively mentioned in dispatches are Deutsche Bank and Barclays. In the circumstances, even though Barclays reported an 11% increase in FICC revenues for the first nine months of 2012 relative to the same period of 2011, the 19.7% decline between Q2 and Q3 and the 34% decline between Q1 and Q3 really set tongues wagging.
There’s a distinct “there but for the grace of God go I” anxiety afoot
CFO Chris Lucas’s explanation – “in general, our flow business model is designed to protect us from downside market risks. As a result, we may outperform in weak markets and underperform in strong markets” – was unconvincing.
Deutsche, by contrast, had its best-ever FICC Q3, which it put down to improved market sentiment and higher client activity. Deutsche’s CFO Stefan Krause may have been guilty of expressing the Schadenfreude I referenced above over the UBS news, which cut right across Deutsche’s Q3 earnings announcement. It was one of the first things he referenced on the call.
In answer to a question from a Goldman Sachs analyst about the impact of UBS shuttering FICC, he reiterated his belief that more players would exit and that a reduction in industry capacity was a good thing. Krause foresees a bar-belling of the investment banking landscape where mid-tier firms will find it difficult to achieve adequate returns. (My January 2012 blog “The futility of being second-rate” said pretty much the same thing – I argued that sub-standard players should get just out of the way.)
Krause clearly implied that there would be a gravitation of business towards an ever-smaller bulge-bracket, which of course includes Deutsche Bank. While his comments were reasonable – and by the way I don’t see DB radically rethinking its FICC strategy – I’d probably caution senior bank executives against implying that they’ll reap benefits from freed-up capacity when the industry is confronting fierce headwinds, and particularly when they’re in the midst of restructurings.
DEUTSCHE BANK AND Barclays are both in the FICC premier league but they’re also in the midst of sweeping restructuring initiatives: Barclays with its TRANSFORM programme; Deutsche with Strategy 2015+. Both of these are in process and we won’t know if they’ve been successful in changing business trajectory or hitting recalibrated performance targets for some time.
Indeed, for an industry in the midst of one of its most radical restructurings and still far from sure what constitutes an optimal business model, organisational structure or business-line mix, UBS’s step out of a major business does pose some fundamental questions. No-one knows yet what investment banking’s “new normal” is; UBS’s decision just made figuring that out a lot harder.
If firms can’t make a decent turn on their biggest generator of revenues, doesn’t that just undermine the current industry structure and the business model? More to the point, has more stringent regulation just killed an entire industry? That may not have been the intention, but I fear UBS’s radical decision could be the clearest sign yet that the baby has been thrown out with the bath water.
