Dec 18 -
-- Cost cutting and deleveraging by investment banks in our view are likely to continue for several years once regulatory uncertainty dissipates, especially for businesses without sufficient scale and strength, leaving stronger market shares and possibly margins for the "flow monsters."
-- We believe that capital market revenues will be just over 5% higher this year than in 2011, and between 5% higher to 5% lower next year than our expectation for 2012, with U.S. banks generally outperforming their European competitors.
-- In most cases, we do not envisage rating actions in the near term specifically arising from restructuring actions, since we currently have negative outlooks on most of the major global investment banks, linked to tough macroeconomic conditions and negative outlooks on some sovereign ratings.
-- In the longer term, investment banks that fundamentally restructure and derisk their business models and balance sheets may increasingly underpin, and possibly enhance, their stand-alone credit profiles.
Continued cost-cutting and deleveraging at the world's big investment banks this year appear much more than a temporary phenomenon, said Standard & Poor's Ratings Services today in the report, "Today's Shrinking Investment Banks Might Leave Stronger Shares And Margins For A Few Giants."
"Above all, tougher regulatory requirements for capital and leverage are set to lower the industry's return on equity potential, causing banks to reassess the scale of their capital market activities," said Standard & Poor's credit analyst Richard Barnes.
In response, most investment banks to date have focused on selective downsizing, like Citigroup Inc. (A-/Negative/A-2), which in December 2012 said it plans to cut about 1,900 jobs in its institutional clients group. A few banks are aiming for more transformational cuts, especially UBS AG (A/Stable/A-1), which announced a deep restructuring of its fixed-income division in October 2012.
Standard & Poor's considers that these uneven restructuring measures principally reflect inconsistencies across the world in the scope and timing of new regulations. For example, while countries such as Australia, Japan, and Switzerland are due to implement Basel III on schedule in January 2013, it will be delayed in the EU and the U.S. In addition, details about proposed structural reforms such as the U.S. Volcker rule and European ring-fencing plans are still in the works.
In these circumstances, most investment banks have fewer incentives to reposition their business models, which is prolonging competitive distortions. Once the industry has greater certainty about future regulations, we believe it will likely proceed with deeper restructuring measures. Although institution-specific factors and Switzerland's relatively stringent regulations were reasons for UBS' strategic move, we also see a read-across to similar businesses at other banks that lack the competitive strengths, particularly scale, to achieve acceptable returns on enlarged capital bases.
"Eventually, continued consolidation of the industry may result in stronger market shares and possibly margins for the leading 'flow monsters,'" said Mr. Barnes.
In the near term, we expect that the weak global economy will continue to constrain investor activity and risk appetite, despite periodic upticks. Toward the end of the first half of 2012, we assumed that the revenue pool would fall by 0%-10% this year (see "The Weakness In Capital Markets Revenues Appears More Structural Than Cyclical," published on July 2, 2012). In fact, markets were more buoyant in the third quarter than we had expected, largely because of unprecedented policy intervention by the European Central Bank (ECB) in support of the euro and the U.S. Federal Reserve's continued monetary easing. This quarter, market activity probably moderated because of the U.S. presidential election and Hurricane Sandy, as well as occasional investor concerns over the looming U.S. fiscal cliff and developments in the eurozone. Still, fourth-quarter revenues should exceed those from the same period last year, when extreme risk aversion took hold because of worries about the future of the eurozone.
"Taking all this into account, we now believe that capital market revenues will be just over 5% higher this year than in 2011, with U.S. banks generally outperforming their European competitors," Mr. Barnes said.
"Barring a material deterioration in economic conditions, we expect market trends to follow a broadly similar pattern in 2013, resulting in aggregate revenues between 5% higher to 5% lower than our expectation for 2012," Mr. Barnes added.
We see more downside risk to this view than upside potential owing to global macroeconomic and regulatory uncertainties. For example, the ECB's actions underpinned confidence in the eurozone over much of this year, but this may not be the case in 2013.
RELATED RESEARCH AND CRITERIA
-- 2013 U.S. Bank Outlook: Accept Lower Profits Or Take On More Risk, Dec. 4, 2012
-- Industry Report Card: U.S. Large, Complex Banks Search For Revenue As Net Interest Margins Are Likely To Decline, Nov. 14, 2012
-- UBS AG Ratings Unaffected By Strategic Announcement, Nov. 2, 2012
-- For U.S. Bank Ratings, The Volcker Rule's Impact Depends On The Final Details, Oct. 22, 2012
-- The Weakness In Capital Markets Revenues Appears More Structural Than Cyclical, July 2, 2012
-- Revised Market Risk Charges For Banks In Our Risk-Adjusted Capital Framework, June 22, 2012
-- Basel 2.5 Increases The Squeeze On Investment Banking Returns, May 14, 2012
-- Banks: Rating Methodology And Assumptions, Nov. 9, 2011