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January 12, 2014 5:01 pm
Banks are becoming increasingly dependent on surging equity markets, generating nearly half of total investment banking revenues from equity trading and underwriting in the fourth quarter.
Rebounding stock markets and continued weakness in fixed income trading mean that equity trading and underwriting is expected to account for an average of 47 per cent of revenue in the fourth quarter, the biggest slice in three years, according to JPMorgan Chase data on a sample of major global investment banks including Goldman Sachs, Morgan Stanley, Credit Suisse, UBS and Deutsche Bank.
US banks will start reporting fourth-quarter earnings on Tuesday, followed by the European banks, amid a tough environment for investment banking on both sides of the Atlantic. Four of the five big Wall Street banks are expected to announce weaker profits year-on-year when they report earnings this week.
Legal costs are set to hit JPMorgan’s earnings, with core net income expected to fall from $6.6bn in the fourth quarter of 2012 to $5.1bn when it announces earnings on Tuesday, according to analysts polled by Bloomberg.
Bank of America is expected to report net income down from $3.2bn to $3.1bn, though with some of the same legal problems that have plagued JPMorgan still to resolve, BofA could have to take more charges, analysts said.
Goldman Sachs is forecast to endure another lacklustre quarter for fixed income trading, with overall net income down from $2.8bn to $2.1bn.
Fixed income trading, a historically high-margin business for the world’s biggest banks, is expected to continue its decline, though drops may be less severe than in the third quarter. While equity-linked business is unlikely to offset the decline, it may help fatten otherwise shrinking investment banking revenue.
“Over time there should be better balance,” said Kian Abouhossein, bank analyst at JPMorgan in London. “Equity capital markets underwriting is highly correlated with increasing equity prices; that’s also helping the secondary equity sales and trading business.”
Thanks to its nature as a low-margin business that requires scale and high volumes, the resurgence of equities trading is set to provide a boon for top players such as Morgan Stanley, Goldman Sachs and Credit Suisse.
But while some of those leaders can achieve 35-40 per cent return on equity, the area’s rise in absolute profits will not be enough for most banks to compensate for the recent weakness in the much higher-margin business of bond trading.
“The story you’re seeing is as much a story of fixed-income trading being severely challenged,” said one senior capital markets banker. “It’s not like equities is exploding, it’s grinding higher and fixed income is grinding lower.”
Analysts are also looking to wealth management as a potential bright spot for the quarter, benefiting banks like Bank of America, UBS and Morgan Stanley, which have prioritised the business.
Citigroup is the only one of the five Wall Street banks expected to do better in the fourth quarter with net income rising from $2.5bn to $3bn.
In consumer banking, lenders are forecasting another disappointing quarter for mortgages after a slowdown in refinancing felt last year continues to hurt earnings and prompt mass lay-offs at US banks from Wells Fargo to Citigroup.
But, for the investment banking arms, the shift from fixed income to equities is expected to stand out.
The story you’re seeing is as much a story of fixed-income trading being severely challenged. It’s not like equities is exploding, it’s grinding higher and fixed income is grinding lower
- Senior capital markets banker
“There’s no question that we’ve seen a rotation out of fixed income and into equities,” said Charles Peabody, analyst at Portales Partners in New York. “It’s most visible on the underwriting side with the robust IPO market.”
US equity capital markets volumes reached $308bn in 2013, the highest annual level since 2000 and the highest number of deals since 1997, according to Dealogic. Goldman Sachs led the equity capital market bookrunner volume with a 14.3 per cent market share, ahead of JPMorgan and Bank of America.
The shift in trading is also prompting consolidation. The top six banks in fixed income have already gained 6 percentage points in market share and the leaders in equities are up 5 percentage points in the past seven years, according to Citigroup.
While equity underwriting still accounts for a small slice of investment banking revenues, the gap is closing with debt underwriting, a business with lower margins.
In the fourth quarter, equity underwriting revenue could increase to 9 per cent of investment banking revenues, the highest share since the fourth quarter of 2010, according to the JPMorgan sample estimates. That compares to a 12 per cent contribution from debt underwriting.
Equity underwriting fees were up 50 per cent year-on-year and 72 per cent on the quarter, according to Credit Suisse estimates.
Additional reporting by Tom Braithwaite
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