At the end of an anaemic Wall Street earnings season, US investment bankers and traders grumbled that Europe had disrupted the best-laid American plans.
They blamed Italian elections for the lack of mergers and acquisitions, took aim at turmoil in Cyprus for sapping investor confidence and – most of all – pointed the finger at Mario Draghi, the European Central Bank president.
It was not that Mr Draghi did anything wrong. But back in 2012 he had restored market confidence by flooding eurozone banks with liquidity, sparking a renewed appetite for risk and demand for investment banking.
“That tailwind wasn’t there this year and made the comps tougher,” said Brennan Hawken, analyst at UBS.
Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley – the five banks with the biggest trading operations – all reported lower revenues in fixed income trading. During the boom years these divisions – which buy and sell bonds, currencies, commodities and more complicated debt instruments – used to be the engine for Wall Street’s out-sized earnings. Four of the five reported lower revenues from equity trading too.
“More clients were more confused as the quarter went one,” says the head of fixed income at one of the five. “We saw volumes start to drop off. Confused people don’t trade a lot.”
Underwriting was healthier as companies continued to raise debt and equity. Equity underwriting revenues were up 28 per cent in aggregate, debt underwriting up 23 per cent, according to CLSA. Financial advisory for mergers and acquisitions, meanwhile, was lacklustre.
“At the end of the day there’s a lot of easy money but there’s not a lot of confidence,” said the head of investment banking at one of the big five. Corporate treasurers were happy to take advantage of low interest rates to refinance debt but their bosses were less enthusiastic about doing transformational deals.
“You wound up with a quarter where if you had good market share in equity and debt underwriting you did pretty well and the M&A business was softer than people had hoped for,” says the senior banker.
If, in aggregate, that adds up to treading water, there was plenty of variety among individual institutions. On trading, Morgan Stanley failed to energise its fading fixed income franchise while Citi’s continued to provide out-sized benefits.
Morgan Stanley was a distant fifth on fixed income, with its $1.5bn in revenues, half the level of fourth-placed Goldman. European banks, including Deutsche Bank and Barclays, are also expected to surpass it when they report earnings.
In some ways, this is not a disaster for Morgan Stanley. The bank is deliberately de-emphasising trading and betting on its retail platform, the brokerage that offers investment advice and trades stock and bonds to affluent Americans across the country. That business is improving, beating a target for profit margins in the quarter.
But Brad Hintz, analyst at Alliance Bernstein and a former Morgan Stanley partner, points out that the fixed income division devours 60 per cent of the bank’s capital and is a key reason why Morgan Stanley’s return on equity was 6 per cent in the first quarter, half the level of Goldman’s. “Goldman Sachs is beating its cost of capital. Morgan Stanley is not,” he says.
James Gorman, chief executive of Morgan Stanley, is aware of the problem and is reducing the division’s risk-weighted assets, which means less capital and should mean higher returns.
However, he told investors it was not a quick fix: “It would be easy to reduce it faster but you would also destroy revenues and destroy good businesses. If we see more sensible opportunities which don’t destroy value obviously we’d be all over it.”
A senior executive at a rival says: “They are the widest credit spread of any derivatives counterparty. They probably have the least amount of balance sheet to devote to this type of business. Comparatively they struggled and my assumption is they’ll continue to struggle.”
Meanwhile, Citi, which is also involved in an uphill struggle for investor confidence under new chief executive Mike Corbat, enjoyed positive results from its fixed income business. Citi’s stock is the best performing of the big five Wall Street banks this year and the only one of the five to cling on to positive territory for the week.
Rivals believe it was helped by its traditional strength in currencies, an area that enjoyed a burst of activity when the Bank of Japan’s easing actions pushed investors out of yen and into dollar-denominated assets.
“How often does Citi stand out?” says another analyst. “Certainly compared with the fourth quarter when people left them for dead, Citi is the clear winner for the quarter.”
Citi’s outperformance is often attributed to a decision to add bankers two years ago, betting on bulking up the investment bank that already had a strong track record thanks to the legacy Salomon Brothers business.
But such moves are no longer the order of the day. Common to all is a renewed focus on cost control, from the 400 jobs cut at Goldman to the 4,000 at Morgan Stanley and bonus accruals that were generally flat to slightly down.
Like many of their clients, when they are not looking across the Atlantic to explain their soggy revenues, US bankers are pondering how to protect profits closer to home. Most often they are reaching for expense savings rather than audacious new schemes to boost the top line.
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