* Dire year for fixed income prompts bank rethink on scale
* FICC 2013 income down 10 pct at top banks after H2 slump
* Central bank policies hurt, but tougher regulation is main
By Steve Slater
LONDON, Feb 13 Have the mega-buck years of bond
and interest rate trading gone for good, or will normal service
resume after an ugly 2013?
That's the question facing investment bank chiefs as they
try to squeeze costs and improve returns. Some are clinging to
the hope that diving revenue from a "complex, messy business"
will be temporary, and they need to keep trading teams together
for when the market recovers.
However, many are already changing, and the likes of
Deutsche Bank, Barclays and Morgan Stanley
look set to make deeper cuts to their fixed income
divisions to deal with weak volumes and tough regulation.
Investment banks are reshaping themselves to increase their
profitability, and the trading desks that buy and sell interest
rate and credit products are under most scrutiny.
Revenues from fixed income, currencies and commodities
(FICC), particularly in interest rates, suffered badly last year
as the tighter regulations imposed following the financial
crisis started to hurt. Switzerland's largest bank, UBS
, is largely pulling out of fixed income and the
pressure on its peers could get worse.
"The problem in fixed income is being sold by investment
banks as cyclical, but it's a structural one," said Chirantan
Barua, analyst at Sanford Bernstein. "Everyone is just solving
around the edges, no-one other than UBS has taken a sword to the
balance sheet, just in case the market turns and they don't want
to be caught without capacity."
FICC trading accounts for about half of investment banks'
income but the sums are falling. Across the top 11 banks which
have reported their 2013 results so far, it fell 10 percent from
2012 to $83 billion last year, according to analysis by Reuters.
Most alarming for the banks is that revenue in the second
half of the year crashed 40 percent from the first half and was
down almost a fifth from a year earlier.
That's why the pressure is on FICC. By comparison, equities
income rose 17 percent last year and advisory revenues grew by
just over a tenth across the 11 banks.
The slump has been blamed on low volumes after the Federal
Reserve said it would start putting the brakes on buying bonds
under its programme to stimulate the U.S. economy.
But tougher global rules forcing banks to hold more capital
against risky assets also squeezed margins and threatens to
cause more long-lasting damage. "Last year was a double whammy,"
said Seb Walker, partner at investment banking consultancy
Governments across the world are determined avoid a repeat
of the crisis which exploded in 2008 when taxpayers had to bail
out a series of banks at huge expense.
"Basel III" rules being phased in require banks to squirrel
away more of their profits and hold more reserves so that they
can absorb future losses without seeking public help.
They also apply higher risk weightings to loans, and require
banks to trade more through exchanges and central counterparties
rather than directly between each other. These exchanges require
them to put up more collateral.
Interest rates revenues were particularly hit by these
rules, especially for repurchase agreements ("repos"),
government bonds and swaps, which are some of the most heavily
traded derivatives contracts.
Activity in 2014 already looks to be down on the strong
start seen last year, unsettling bankers who know that often the
first quarter is the busiest period. Kian Abouhossein, analyst
at JPMorgan, estimated this week that FICC revenues will be down
16 percent in the first quarter.
"The challenge for a bank is that fixed income is a complex,
messy business," Tricumen's Walker said, citing the wide variety
of products and their different risk profiles and capital
"To make the right decisions you have to have a lot of good
data about your business and predict the actions of others. So
they need to look at their businesses segment by segment and
decide where to compete and to what extent, and where to leave
the market for others," he said.
Analysts said few fixed income businesses are likely to have
delivered a return on equity (RoE) last year above investment
banks' cost of equity, estimated at about 12 percent, meaning
they are not putting their share and bond holders' capital to
Walker estimated that fixed income business typically had
pre-tax RoE of between 7 and 12 percent, although individual
segments could range from negative to more than 17 percent.
NO LONGER A REVENUE CHASE
Executives at several banks have recently acknowledged when
announcing results that the fixed income landscape could be
reshaped - but none thought it would be at their expense.
"We expect that fixed income after some adjustment will be a
good business," JPMorgan boss Jamie Dimon told analysts.
"We think a lot of these trends are cyclical, not secular and
that's how we are positioned for it."
Banks such as JPMorgan and Bank of America benefit
from their large balance sheets, which give them greater
capability to maintain fixed income desks during lean periods.
But European rivals such as Deutsche Bank and Barclays are
under pressure to meet tough capital and leverage rules earlier
and appear to be losing share to the big U.S. names.
The rates market malaise has also been deeper in Europe than
in the United States. Positive effects of when the European
Central Bank pumped more than 1 trillion euros of cheap
three-year loans into the banking system in late 2011 and early
2012 are fading, hitting banks based in Europe harder.
Deutsche, Barclays, Credit Suisse, HSBC
and BNP Paribas are expected to continue to pull back
from lines that were unprofitable or where they lack sufficient
size, analysts and bankers said.
Anshu Jain, co-CEO of Deutsche Bank, admitted that after
years of chasing revenues across all products to win market
share, there has been a shift in focus.
"We could afford to carry those businesses in the past; we
no longer can. We are utterly focused now on bottom-line
performance of fixed income," he told analysts. "Revenue impact,
yes; market share, client impact, no."
Last week's results from UBS - which racked up huge losses
during the financial crisis that prompted a state bailout - may
have offered some encouragement to others to take action.
Only 18 percent of revenue at UBS's streamlined investment
bank last year came from FICC, compared with 45 percent in 2010.
But equities income has jumped, and operating profit was up
slightly from three years ago as expenses tumbled 36 percent in
a division that now has 5,200 fewer staff.
Bankers said firms face a delicate balancing act in search
of the "sweet spot" where they have enough scale and resources,
but are not too bloated and carrying hefty costs that hurt
returns. As ever, they also have eyes on the competition, and
the likes of JPMorgan and Goldman Sachs appear confident they
will win more business at better margins when rivals retreat.
"A lot of products weren't making money and all banks are
cutting back in areas they are not strong. So a lot are thinking
whether to get out or stick it out," one senior banker said.
FICC PERFORMANCE 2013 (in millions of dollars):
BANK FICC INCOME UP/DOWN Q4 INCOME
2013 VS 2012 VS YR AGO
JPMorgan $15,468 0 +1%
Citi $13,107 -6% -15%pp
Deutsche Bank $9,400 -25% -31%
Barclays $9,100 -17% -16%
Bank of America $8,882 +1% +22%
Goldman $8,651 -13% -15%
Credit Suisse $5,400 -11% -16%
BNP Paribas $4,900 -21% -13%
Morgan Stanley $3,594 +52% -15%
SocGen $2,970 -21% -39%
UBS $1,800 -11% -2%