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Investment banking: Earnings raise dividend hopes

Halfway through the second quarter of 2013, global investment banking revenues had reached $25.7 billion, some 14% ahead of the average year-to-date total over the past 10 years. Debt capital markets revenue is running at a record level, having hit $9.2 billion between the start of 2013 and mid-May. Syndicated loan revenue is markedly up on the same period in 2012, as is global equity capital markets revenue for the banks as IPOs return. Only M&A remains quiet.

The banks are clearly benefiting from strong primary capital markets and from good secondary market trading volume. Presenting at the UBS global FIG conference on May 14, JPMorgan disclosed that to that point in the second quarter in both FICC and equities, trading volumes and revenues were 10% to 15% ahead of the same period in 2012.

As risky credits, from high-yield corporates to peripheral sovereigns and emerging market banks, sell big, long-dated deals investors should remember that even as regulators force the banking system to shrink, shoving borrowers into the debt capital markets will still benefit banks that are big arrangers of bond deals.

There were other encouraging noises at the UBS conference, with a number of US banks noting a recent pick-up in commercial loan growth since the dip in the first quarter of this year, as well as rebounds in credit card volumes and in mortgages. It’s not just a US phenomenon. UK banks were predicting loan growth in the second half of the year.

Is there anything more to all this than the benefits being passed on to bank earnings from an unsustainable boom in financial markets that are now utterly dependent on central bank stimulus?

Certainly stock analysts, recompensed, let’s not forget, for the turnover their ideas generate, are suddenly finding reasons to be positive on bank stocks, even if these are sometimes rather technical. Morgan Stanley, for example, cites bank stocks as its favoured overweight for playing a switch in the equity markets from growth, of which banks promise little, into value, where they offer more, given prevailing discounts to book value.

Morgan Stanley points out that value stocks tend to do well when the overall market’s PE ratio rises, peripheral spreads decline and economic surprises are low, as is the case now. Whether central banks’ quantitative easing can keep those surprises low and usher the developed world economies back to self-sustaining growth remains to be seen.

Investors might reason that even if persistent low growth threatens an increase in banks’ loan losses, at least they are now far better capitalized to cope with it. Analysts at Citi expect the European banking sector to close the €250 billion capital deficit identified at the end of 2011 before the end of this year, and then reach a surplus of almost €200 billion by 2015, on a Basle III fully loaded basis

It is worth noting that Deutsche Bank’s share price had risen by just over 10% by the end of the third week of May in apparent welcome of a potentially dilutive share offering at the start of the month that took its Basle III common equity tier 1 ratio to a peer-group-leading 9.5%, up from just 6% three years ago. Investors welcome strong capital levels even if, in theory, such high levels limit potential returns.

If banks can continue to cut costs, benefit from improving revenues and have enough capital to protect against downside risks, then one step remains to make them finally look like normal companies suitable for equity investors to risk their money in again now that five years have passed since the sub-prime crisis.

With certain US banks now talking once more about returning capital through share buy-backs, the focus will fall on dividends. Deutsche has declared its aim to be a progressive dividend payer, as have other European banks, such as Swedbank and HSBC.

HSBC chairman Douglas Flint stressed this in a speech at his bank’s own FIG conference in May. The information content in a bank’s dividend policy, dividends paid and dividend progression, all of which must ultimately be blessed by its regulators and can only be paid out of real profits rather than so-called earnings from accounting revaluations, is higher than in any other single metric.

Boards can only recommend dividend payouts in light of expected profits and capital needs derived in part from their forward view on likely loan impairments.

Dividends might soon become the key metric on which banks are judged.

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