The reputation of bank-stock analysts, like the firms they cover, reached a low point in the immediate aftermath of the 2008 financial crisis. Stock-price forecasts were always problematic in a sector that is heavily, if not always effectively, regulated. But as bank-stock quotes moved below nominal asset values for many of the big players – in some cases under 50% of asset values – the forecasts of many leading analysts became so divorced from reality that they were barely worth reading.
The forces that drove the slump in bank-stock prices relative to book value have, almost paradoxically, resulted in a renewed demand for detailed analysis of bank balance sheets and business prospects.
Shareholders lost confidence in their ability to understand the real exposure of investment banks just as supervisors began to impose new regulations on segments such as derivatives trading that deliver a large portion of bank profits, but with limited earnings visibility or granular disclosure.
When assessing the direct impact of new regulations on business volumes and margins, the best that analysts can offer is an educated guess. Some key details of regulatory implementation in different regimes across the world have yet to be pinned down, and the ability of dealers to pass on higher costs to customers will only become apparent over time.
Analysts can do a much more effective job in assessing the impact of changing capital costs under incoming regulations on the business mix adopted by banks.
That is where analysts were able to play a role in the strategic about-turn by UBS, and where they can expect to have a growing impact on the decisions made by other banks in the future.
Analysts such as Kian Abouhossein at JPMorgan and Huw van Steenis at Morgan Stanley argued persistently that the best course for UBS would be to slash its fixed-income sales and trading activity in order to free up capital that would otherwise be consumed by incoming risk-weighted asset rules. The coming Basle III regime involves much higher capital allocations for fixed-income assets, especially in areas such as credit trading. The analysts contended that UBS should retreat to its traditional strengths of equity trading and underwriting, while repositioning its investment bank as a junior partner to its wealth management business.
Personnel issues at UBS probably contributed to the decision to go all-in on a restructuring, rather than tinkering with headcounts and capital allocations for different business lines. UBS CEO Sergio Ermotti has an equities background and the hiring in March of his former Merrill Lynch colleague, corporate finance expert Andrea Orcel, as co-head of investment banking was a sign that battle was about to commence with the senior bankers at the firm with a fixed-income track record, such as former Goldman Sachs partner Carsten Kengeter.
But while Ermotti was probably only too happy to stick his thumb on the scale in favour of a retreat to an equities focus, the case presented by outside analysts is likely to have eased his bid to convince chairman Axel Weber and key UBS shareholders to endorse his new plan.
Shareholders will have been delighted by the rally in UBS stock, which has probably bought Ermotti extra time to implement his plan to refocus the firm as an asset-gathering business and attempt to ensure that the remaining areas of investment banking – now under Orcel as sole head – can generate higher returns than their allocated cost of capital.
That is by no means a sure bet, given the ever-decreasing margins in the more liquid sectors of equity trading and the potential effect of loss of scale in rump areas of fixed-income activity, such as foreign exchange and precious metals.
While UBS will get some time to have a crack at Plan B (or at least the second plan within the last few years – it is also eerily similar to Plan A from the 1990s), other investment banks face questions about their commitment to full-scale fixed-income sales and trading.
The initial focus is on the firms that are just outside the top tier in fixed income, especially Credit Suisse and Morgan Stanley. JPMorgan’s Abouhossein put out a note in November arguing that economies of scale in fixed-income trading mean that banks with over $10 billion of annual revenues will dominate the sector in the future. That bulge bracket features market leader JPMorgan (go team) along with Bank of America, Barclays, Citigroup, Deutsche Bank and Goldman Sachs. Credit Suisse and Morgan Stanley form the tier just below this level, with likely fixed-income revenues for each of 2012 and 2013 of $6 billion to $7 billion. Credit Suisse is attempting a selective withdrawal from areas of fixed income that absorb excessive capital, while hoping to leave the bulk of its revenues intact.
That will be tricky to pull off and the bank is not helped in its attempt to convince shareholders about the benefits of this approach by its reputation for coming up with ingenious business plans that work well for its top managers but are difficult for outsiders to grasp.
A reorganization announced by Credit Suisse on November 19 received a tepid reception that was in stark contrast to the wholehearted applause for the UBS restructuring. It seems that investors would rather have the axe than the scalpel applied to problem areas within investment banks. Bank analysts who can back up arguments for bold business shifts with convincing forecasts could find a growing audience with both shareholders and CEOs.