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Opinion

Macaskill on markets: An unhappy new year for corporate activity

Banks face tough decisions on how hard they should fight to retain sales and trading market share in different sectors, as the great deleveraging drive of 2012 gets under way.

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

The focus of this imminent deleveraging has been on its potential effect on lending. Rightly so. Morgan Stanley analysts recently predicted as much as €3 trillion of deleveraging in the European banking sector alone during the next two years, with more than €1 trillion of lending at risk, or between 3% and 5% of total loans in Europe.

Deleveraging on this scale could cause a self-reinforcing loop of damage for bank earnings if it starts to impact the health of clients, and is one of the many reasons why bank stock prices are likely to remain depressed.

Another reason is the potential ancillary impact that deleveraging could have on the sales and trading businesses that provide the bulk of revenue for investment banks.

Senior bankers are understandably keen to convince investors that they will be slimming down, perhaps by cutting compensation – it could happen – and paring low-margin business lines. This will be difficult to manage without undermining key franchises, and the lack of fundamental business-unit reform at most dealers after 2008 does not inspire much confidence that it will be handled smoothly now.

Even taking a relatively rosy view of likely trends this year and beyond, there are few dealers capable of generating meaningful revenues from individual sales and trading business lines.

Taking a look at how many banks can generate revenues above $1 billion, $2 billion or $3 billion in a particular sector shows the ranks thinning noticeably when it comes to the higher totals, even if a mild contraction of around 5% in overall revenue is assumed from 2011 totals.

Rates trading might see Barclays Capital, Deutsche Bank, Goldman and JPMorgan hit $3 billion of revenue, but possibly no other dealers. Equity derivatives is likely to see only Goldman and Société Générale generate $3 billion or more of revenue, and going by current trends the only dealer likely to hit $3 billion of FX revenue is Deutsche Bank.

Credit-trading revenues can breach $3 billion at top houses – such as Goldman and JPMorgan – in a good year, but these numbers rely on the positioning and hedge timing that is becoming more problematic for dealers as new regulations take effect. The roster of firms with sales and trading business lines that will exceed $1 billion and $2 billion is longer, of course. Rates should generate $1 billion or more for each of the top 10 dealers, while both cash equities and prime brokerage could generate $2 billion or more for sector leaders such as Morgan Stanley, Goldman and Credit Suisse.

The challenge for leading dealers next year will be to ensure these revenue numbers can be hit while compensation and staffing numbers are reworked against a potential backdrop of deterioration in relationships with client groups.

Relations between dealers and hedge-fund clients depend on market-making ability, which banks should be able to maintain even if there are some strains on liquidity provision.

Corporate business could be much harder to defend if banks cut back on core lending to individual companies and sectors. Bankers tend to spend their daily lives in a siloed environment, however much senior staff might extol improvements in the collaborative spirit.

A missed trade in fixed income does not necessarily bother staff in equities, and vice versa. However, executives in real-economy companies typically take a corporate rebuff more personally, and the decision-making line for financial transactions is often short and concentrated at the top of the firm. Banks that are cutting lending to individual corporates could find that pitching for hedging and underwriting business gets a lot tougher this year.

Banks could also find that the gloomy economic and political backdrop causes corporate clients to dig in to try to weather the storm. Unlike many banks, most corporates used the three years after the last credit crisis to strengthen their balance sheets. That could tempt them to avoid both the debt and equity markets this year.

With little sign of a fall in European sovereign-credit spreads, corporates in the region might decide that the sovereign floor, in terms of a minimum spread for their own debt, is not worth paying, even if absolute rates remain low.

 

And recent attempts by corporate finance staff at banks to talk up the prospects for M&A business in 2012 have a hollow feel, as though the bankers are trying to convince their own managers that there is no need to cut staff. By many traditional metrics, such as target valuations, the backdrop for M&A might indeed look reasonably bright. But the penalties for inaction are likely to seem much lower than the prospect of missing out on a compelling deal to many corporate CEOs this year.

Animal spirits are sorely lacking in the markets and there is the prospect of increased cross-border regulatory tensions to further dampen morale in the coming year. The abandonment in mid December of AT&T’s $39 billion bid to buy T-Mobile from Deutsche Telecom provided an appropriate bookend to 2011, as an indication of how the outlook for corporate activity and related investment banking changed during the year.

When the bid was announced at the end of the first quarter, it felt like the good old days of deal-led banking were making a return. JPMorgan, the new top dog on Wall Street, announced with a swagger it would be sole lender on a $20 billion bridge facility to fund the deal — the biggest individual corporate-loan commitment ever made. AT&T was so confident it would be able to get the deal past regulators, despite some obvious competition issues, it agreed a deal break-up fee of upwards of $3 billion that seems ridiculous in retrospect. And other banks looked on with a combination of envy and anticipation of similar business from their own clients.

Nine months later, the prognosis for corporate activity is much grimmer. Grinding efficiencies out of key sales and trading businesses might be the best prospect investment banks have for coming anywhere near the return on equity targets that bank CEOs were touting as feasible until relatively recently.

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