Earlier this year, Euromoney highlighted the likely boost to commodity revenues from Russia’s invasion of Ukraine and, later, the extent to which markets income could offset a collapse in fees from deal launches for banks.
Second-quarter earnings results for Wall Street banks confirmed these predictions. Strong growth in trading revenues compared with the same quarter in 2021 helped to balance the trend of fees from deals that were either down – as with debt underwriting – or virtually disappeared, as with key equity capital markets such as IPO launches.
Goldman Sachs and Citigroup led the trading pack in the quarter, with markets revenues that were up by 32% and 25% respectively, compared with the second quarter of 2021.
Most Wall Street firms delivered reasonable equity trading growth in the second quarter … while related new-share issuance deal flow collapsed
Fixed income dealing, especially in rates, currencies and commodities, drove this outperformance.
Goldman’s second-quarter fixed income revenue rose by 55% compared with the previous year, to $3.61 billion, while at Citi the increase was 31%, to just over $4 billion.
It may be a coincidence that Goldman and Citi both retain veteran fixed income dealers in senior executive positions, though it clearly doesn’t hurt.
Goldman’s co-head of global markets, Ashok Varadhan, started with the firm in 1998 as a swap dealer, while his counterpart at Citi, markets head Andrew Morton, was also a rates trader, first at Lehman Brothers and then at Citigroup after 2008.
Both Morton and Varadhan combine a strong academic background with roughly a quarter century of dealing experience, through various market cycles.
New tricks
But building on the strong recent performance of markets groups at banks isn’t just a matter of retaining dealing veterans who know when to hold them and when to fold them.
Experienced executives who are still learning new tricks about managing risk can also help their banks to convince investors that the longstanding prejudice against placing a higher multiple on trading revenues should be revisited.
Some of this work can be done simply by pointing to metrics.
Banks are now in a third year of delivering much stronger markets revenues than were expected by equity analysts.
The returns in 2020 after central banks and governments rescued markets from the initial effects of the Covid pandemic could reasonably be described as a trading windfall.
The performance in 2021 and now in 2022 is starting to look like a trend.
Repositioning by clients across markets may slow down later this year, but trading revenue is increasingly looking less volatile than fee income from deal launches.
Most Wall Street firms delivered reasonable equity trading growth in the second quarter, helped by equity derivatives revenue, while related new-share issuance deal flow collapsed, for example.
There is also an opportunity to promote potential synergies and risk management opportunities that banks can use to advance the thesis that trading is becoming a more stable revenue source – one that bolsters income generation in other areas.
Goldman, as ever, has been quick to adopt a new marketing line.
There is no reason for trading to be a dirty word for investors in bank shares
Its chief executive, David Solomon, and chief financial officer, Denis Coleman, both stressed the contribution to second-quarter results made by fixed income financing on the bank’s earnings call with analysts, even though the financing revenue total of $768 million remained much lower than related debt trading at $2.84 billion.
This served to accentuate the performance of fixed income financing as a revenue line that was not historically split out in results by Goldman or its peers, and to seed the idea that advances are being made towards income stability, as well as growth.
“We have been very focused over the last three years or four years on really improving our approach to our clients,” said Solomon, “really improving our market share with our clients, adding financing as a capability to our clients, which is much more resilient and therefore puts a base on the revenues that did not exist before.”
Coleman added that this also presents a market share growth opportunity.
“As an example,” he said, “in our FICC [fixed income, currency and commodities] financing business, there are a number of clients who are looking for financing. They have important transactions to execute, attractive assets to have financed.
“And to the extent that there is less availability of financing across the Street (by competitors), that presents an opportunity for us, given the way that we are currently positioned.”
At Citigroup, chief executive Jane Fraser was more cautious about using the firm’s strong second-quarter markets results to make any forecasts about a new base for revenues.
“The volatility we saw in foreign exchange, rates, commodities and equity derivatives favoured our mix, and we were more efficient in our capital usage,” Fraser said on Citi’s earnings call with analysts. “And while this level of activity is related to where we are in the current cycle rather than a new baseline in markets, I believe we are helping our clients navigate this environment quite well.”
The trend she mentioned towards more efficient capital use by bank markets divisions is clear.
A study by Oliver Wyman and Morgan Stanley last year found that each dollar of revenue generated industry-wide across investment banking divisions consumed 21% less balance sheet in 2020 compared with 2010, and generated 34% lower value-at-risk than it had a decade before.
Results in the first half of 2022 indicate that this shift towards more efficient use of capital continues.
Good v bad
The bigger question of whether ‘good’ volatility will eventually be replaced by ‘bad’ volatility for banks has not yet been answered.
The last three years have delivered good volatility, in the form of large market shifts that boosted client activity without causing any serious systemic threats such as dealing counterparty failures.
There have been some near misses, nonetheless. The sudden erosion of $2 trillion of nominal crypto asset value this year had a limited systemic impact partly because important market players, including banks, were restricted from participation by regulation.
A bizarre nickel trading disruption in March ended up costing some money for JPMorgan, which has the biggest markets business among global banks, but did not cause contagion in the broader commodity-dealing sector.
And there is obviously a risk that the current battle to contain inflation by central banks will tip economies into recession, with related credit losses for banks. It is notable that the strong second-quarter fixed income performance in what are called macro products by Wall Street banks – rates, FX and commodities – was not matched by credit trading revenue, which fell compared with the same period last year.
But many of the apocalyptic volatility scenarios for banks, such as a broadening of the war in Ukraine or a renewed pandemic, would threaten all aspects of the global economy.
In the world of relative value that matters to financial services participants, it seems more likely that banks will be able to continue to deliver on their goal of generating markets revenues sustainably, helped by increased electronic dealing and improved management of trading inventory.
That in turn argues for a shift in the premium placed on trading revenue compared with deal-making fee income, and a more fundamental upgrade in the equity values placed on banks compared with competitors such as exchanges or fintech firms.
There is no reason for trading to be a dirty word for investors in bank shares.
