The dark art of IB earnings

IFR 2092 18 July to 24 July 2015
6 min read

I was looking forward to seeing the second-quarter numbers emerge from the US banks last week. For all sorts of reasons, but specifically to gauge the impact of bond market volatility, bearing in mind the vol we had earlier in the year had provided such a boost to first-quarter revenues.

But having perused the statements from JP Morgan, Bank of America Merrill Lynch, Citigroup and Goldman Sachs, I’ve got to say any sense of anticipation around the numbers was once again undermined by how difficult it has become to engage in simple industry read-across.

I’m not suggesting any attempt at deliberate obfuscation, but figuring out what the numbers mean for the industry has become something of a dark art. First of all, you have things like CVA/DVA/FVA silliness that just follows accounting convention. Then you have to deal with a mountain of notes to the accounts – not just relating to the current quarter, but also on a look-back basis to get a proper perspective; there’s a ton of other non-business items; a wave of one-off expenses and charges; and an array of inter-divisional shared costs that can be impossible to track through to group level.

Even if you have the patience to drudge through all of that, you’re then confronted with the reality that you don’t really know what each bank includes in line items that are – or sound – the same. Converting everything to constant currency rates to facilitate cross-border comparisons is another tedious burden.

And even while US investment banks all report advisory, debt and equity underwriting, and fixed-income and equity trading numbers, not all separate out, say, transaction services, business and corporate lending, principal revenues, trade solutions, etc. Is that because they don’t have revenue streams relating to such items or they just tack them on to something else or embed them somewhere else?

WHAT AM I blathering on about? Here are just some of the things that necessitated further enquiry: Bank of America Merrill Lynch reported Q2 debt underwriting net revenues of US$371m in its global banking division. My immediate reaction, comparing it with JP Morgan’s US$907m, was to think: “OMG, what the hell happened here?”

But on a group basis, BofA Merrill’s debt underwriting number was a much more respectable US$887m. Why the difference? Because 60% of debt underwriting revenues go to the traders following a revenue-sharing agreement. But that’s not reported in the global markets segment (that I could see).

Here’s another example: JP Morgan’s Q2 lending number of US$302m was a third lower quarter-on-quarter and year-on-year. That’s pretty dramatic and it took total banking revenue down 3%. So did the bank just pull up the drawbridge and dramatically curtail lending, a data point that would have provided a fascinating – if alarming – narrative?

No, the lower number was the result of (unquantified) losses on securities received from (unnamed) restructurings. Similarly, JP Morgan’s FICC number of US$2.92bn was 21% down year-on-year, but the rider on that was FICC would have been down just 10% if business simplification elements – whatever that means – were excluded.

At Citigroup, equity markets revenues of US$653m were 1% lower year-on-year because they included a US$175m charge for “valuation adjustments related to certain financing transactions”. If you exclude that, equity trading would have been up 26%. (Taking a leaf out of BAML’s book, shouldn’t the traders have batted some of that back to the financiers in banking? Or perhaps they did, but it’s just not reported in banking). At group level the bank was, of course, stuffed with that US$3.8bn Q2 2014 charge to settle legacy RMBS and CDO-related claims, skewing direct comparisons.

So with that massive disclaimer, what did I glean from the Q2 numbers?

  • There’s good volatility and there’s bad volatility. Broadly speaking, Q1 evidenced the former; Q2 the latter.
  • FICC is looking like it’s coming in on average around 10% lower year-on-year. Rates trading did very well although lousy credit, mortgage/securitised products, EM and commodities trading conspired to undermine the overall number. Goldman underperformed (28% down year-on-year).
  • Equity trading was a good earner – up around 25% in the quarter, with BofA Merrill off the pace. Worthy of note here: equity derivatives look like they may be seeing a resurgence.
  • In the origination businesses, revenues followed the pace of activity. Completed M&A volumes were up 36% in the first half of this year compared with the same period in 2014. As you’d imagine, this benefited Goldman Sachs whose Q2 advisory number was 62% higher, a clear outperformer (Citigroup deserves an honourable mention here at plus 34%).
  • H1/H1 DCM volumes were down 6% and reported revenues came in broadly double-digits better on the quarter and flat year-on-year. Goldman was an outlier on the downside here thanks to lower leveraged finance activity.
  • ECM showed the most variances across the firms to have reported so far. Even though overall activity was flattish, IPOs are having a bad year: down more than 16% globally (–20% in EMEA and –34% in the US). So on a reported revenue basis it was horses for courses: Goldman (as you’d expect) plus 9%, JP Morgan 5% down, BofA Merrill 19% down (off record levels a year ago) and Citigroup down 25%.

Let’s see what the rest of the year brings. One thing I’m looking forward to seeing is whether the US banks are starting to pull away from their European counterparts in both IB returns and quantum of revenue.

Finally, a shout-out to Anthony Peters, market-watcher and fellow IFR scribbler, for a speedy recovery following his dreadful accident. Keep swigging the whisky, mate, and don’t worry about Greece: that story is going nowhere fast.

Keith Mullin