Investment banking: The coming boom in FICC revenues
The business is consolidating rapidly and survivors might enjoy rising market share and healthier margins.
Investors’ risk aversion and slowing deal activity among issuers and acquirers hammered the results of the corporate and investment banking divisions of all banks in 2011. The consensus forecast for 2012 is that it might be just as bad, or even worse. Deutsche Bank, for example, predicts a further 10% decline this year in the revenue pool for debt and equity markets sales and trading, underwriting and M&A from last year’s $235 billion.
Although the markets got off to a reasonable start in January, boosted by the European Central Bank’s Long Term Refinancing Operation, many risks lie in store, not least from rising credit costs as fiscal austerity in developed Europe slows economic growth. It remains to be seen whether those industries worst affected by the withdrawal of credit from banks now fast shedding assets they can no longer fund – such as the French banks swiftly reducing dollar loans in trade, commodity, autos, real estate and aircraft financing – will suffer a rise in default rates.
But while this is all bad news for the short term, it might hold out great longer-term promise for some banks. The investment banking business is consolidating much faster than is widely realized and that throws up the possibility for stronger banks to grow market share quite rapidly and, possibly, at low incremental cost. It also suggests they might stand a better than appreciated chance of repricing their services even when volumes rise.
Deutsche Bank analyst Matt Spick conducted some revealing research into this in a 2012 outlook report entitled "Concentrate to win". One of his most intriguing findings is that the market shares of the leading firms in FICC are concentrating quite rapidly, even more so than in equities.
At first, this sounds surprising. Many of the recent official announcements from banks on exiting markets businesses have highlighted withdrawals from sub-scale cash equities operations. RBS said it would quit this business last month. UniCredit outsourced its cash equities business last year and Crédit Agricole withdrew from equity derivatives. But by parsing the announced risk-weighted assets reductions in FICC, Spick finds the withdrawal of capital there is far more pronounced.
And this makes sense. Much higher capital charges for counterparty risk and stressed value at risk make it far harder for banks to earn a return on capital above the cost and incentivize banks to withdraw. These charges also act as a barrier to entry, discouraging new entrants from making a bid for market share suddenly up for grabs.
While none of the very biggest players, such as JPMorgan, Barclays Capital and Deutsche Bank, are cutting back in FICC, many in the next tier down are doing so all at the same time. These include Credit Suisse and UBS, as well as French banks BNP Paribas, Société Générale and Crédit Agricole, and also Nomura. RBS will cut back selectively, although it might also increase investment in the most promising FICC businesses. Many analysts expect that Bank of America will have to unveil a European-bank-style RWA-reduction plan before long.
That’s a big chunk of the second tier all in withdrawal, including some, such as UBS and Nomura, that invested heavily in FICC following the spread-widening and volume increases in 2009 but failed to generate strong returns for investors. They provide a warning to others. And some of the stronger banks, such as Standard Chartered, might stick to their emerging markets speciality rather than chase share in developed markets.
In 2007, Deutsche estimates, the combined market share of the top-five firms in FICC sales and trading was 35%. Last year, it was close to 50%. Deutsche sees it going to 60% quite quickly. In addition, if European banks continue to shrink their balance sheets to fit reduced availability of bank funding, capital markets will become a far more important channel for borrowers, boosting new-issue fees, secondary trading volume and hedging revenues for surviving FICC players.
For banks that can stay the course, the business two years from now might be quite rosy, with the prospect even of close to oligopolistic pricing.
It’s just getting through the next six to 12 months that is the hard part.