Goldman Sachs is the only big US bank planning major changes to its bond-trading division this year, as fixed-income bosses in other corners of Wall Street bet that a tough fourth quarter was an anomaly and that the post-crisis decline in their businesses is coming to an end.
After a worse-than-peers 23 per cent fall in fixed-income revenues over the past three years, Goldman has been upfront about its plans to “reallocate” capital from some fixed-income activities to less capital-intensive pursuits, such as the investment banking division where David Solomon, its new chief executive, spent most of his career.
The exercise, which is likely to involve cost cuts and withdrawals from some activities, is part of a wider review by Mr Solomon, whose October succession marked a historic changing of the guard at the bank after the 12-year reign of Lloyd Blankfein, who was a product of Goldman’s fixed income, currencies and commodities side.
“We're looking at all of our businesses, including fixed income, with a clear eye, [and] we're going to size FICC based on the opportunity set,” James Esposito, Goldman’s co-head of securities, told the Financial Times, adding that the bank had been “re-allocating capital to other, higher-returning businesses over the past five years”.
Analysts expect more dramatic changes and say these are overdue, since Goldman continued to nurture big businesses in areas such as commodities even after post-crisis regulation prompted other banks to tweak their operations. Morgan Stanley, for example, reshaped its FICC business and cut 25 per cent of headcount in 2015.
Mr Solomon is in a strong position to push for action after a fourth quarter when rival JPMorgan hit its lowest fixed-income revenue in history, Citigroup’s fixed-income revenue fell to a seven-year low and Morgan Stanley posted a worst-in-class 30 per cent fall in fixed-income revenues year on year.
Still, despite the grim industry backdrop, Mr Solomon will be an outlier among his peers when he wields the axe.
Asked if trading in the fourth quarter, or in 2018 overall, would prompt banks like his to rethink their fixed income business, JPMorgan corporate and investment bank boss Daniel Pinto replied: “No”.
“This a cyclical business and you have to have some ability to withstand the downturn in parts of the business,” said Paco Ybarra, head of Citi’s Global Markets business.
The argument from the JPMorgan and Citi executives — echoed by senior trading executives at Morgan Stanley and Bank of America — is that the fourth-quarter decline stemmed from an unusual combination of market forces in December.
Specifically, the mounting turbulence in financial markets led interest rate expectations to oscillate wildly. Markets swung from pricing in two Federal Reserve rate hikes in 2019 to betting on a rate cut. The average yield of US corporate bonds climbed to an eight-year high of 4.37 per cent, and riskier high-yield bonds suffered their worst monthly drop in five years.
Those conditions rendered it harder for banks to make money in their credit businesses, which facilitate clients’ trading in debt, and in their rates businesses.
“Volumes were actually OK. In some cases they were up. It was more about our ability to monetise that client value while managing risks associated with the volatility,” said Troy Rohrbaugh, JPMorgan’s markets head, describing how assets could fall in value in the short time between banks’ taking them from one client and selling them to another one.
The timing of the market moves was also problematic. Big swings can inspire opportunistic investors to take a punt on recovery, cushioning the impact of the swings — just not in December, when hedge funds and banks take extra care to manage their positions so their year-end accounts look good.
Mr Esposito said Goldman’s fourth-quarter performance was “completely correlated to our client franchise”.
“We’re not shying away from supporting our clients’ risk intermediation needs,” he said. “We’re in the risk management business.”
The bank bosses all see the fourth-quarter woes as separate from the structural decline that has followed the financial crisis. Fixed-income revenues across the big five banks fell 15 per cent from 2013, thanks to regulation banning proprietary trading and making some other activities prohibitively expensive.
JPMorgan’s Mr Rohrbaugh said regulation had been “roughly the same for the last several years” and that he did not expect material changes. Morgan Stanley’s fixed-income boss, Sam Kellie-Smith, believes industry revenues are “pretty close” to the low point, though he does not think “the wallet is going to race away”.
Guy Moszkowski, an analyst at Autonomous, said he does not see the fourth quarter as evidence of wider malaise. “Most of the other firms [beyond Goldman] have a business that is reasonably well suited for today’s FICC environment,” he said.
The big banks cite many reasons for optimism. They argue that technology will be a key determinant of future success, as fixed-income trading follows equities to a more digital future. “There is a race playing out in the global banking industry around technology investment,” said Mr Esposito. “I’m not sure that every bank can afford the investment required to keep up.”
The industry’s fees have already become more concentrated. In 2006, the top three players — Goldman, Citi and Deutsche — shared 35 per cent of the top 12 banks’ FICC revenue, according to data from industry monitor Coalition. By the first half of 2018, the top three — calculated as Citi, JPMorgan and the average of Bank of America and Goldman Sachs, who were in joint third — had grown their share to 45 per cent.*
“2015 and 2016 were very good years for FICC for the people who chose to stay,” said Mr Rohrbaugh. “While the wallet was declining overall, those who still had diverse big FICC business in 2015 and 2016 . . . grew market share.”
Technology offers the banks the potential of more profitable fixed-income businesses, as they cut headcount by automating processes and deploying AI trading desks. “It’s a big deal,” said Mr Kellie-Smith. “I’m not sure you’re going to have a copy and paste of equities but there are a lot of similarities.”
He added that parts of FICC, including foreign exchange and some of the rates market, were already “very similar to equities . . . In markets such as credit, the adoption of e-trading has been slower. But in 2018 we reached an inflection point. We and our clients are taking that change very seriously.’’
Capital efficiency is the other area where the big banks say they are making progress, as they have learnt the best ways to optimise their businesses for the changed regulatory environment, a process that takes years.
“People are getting smarter about the capital piece, returns are getting better, even if the revenues are slightly less,” said Bernie Mensah, co-head of global FICC trading at Bank of America. “After the regulations, it takes a while to bed down.”
The bankers say there will always be demand for FICC activities such as hedging foreign exchange rates and offering derivatives that give companies and institutions certainty that they can meet their long-term obligations.
All of which means that big FICC cuts now would be an “irrational move” for most banks, in the words of Mr Pinto.
“The marginal returns in our FICC business are quite positive: they exceed the cost capital,” he said, adding that, “if you cut back now, you would be left with some of the costs and dilute returns, ie, you’re not going to release a lot of the capital, and you’ll still be left with the infrastructure costs”.
At Goldman Sachs, Mr Esposito declined to give specifics on where cuts would fall. He said there would be a “laser focus” on optimising resources in commodities and elsewhere. But he added that commodities “has been an important business at GS for decades and, despite recent reports suggesting otherwise, will remain so”.
He remains an optimist on his division’s prospects. “I can't recall a time in the last 10 years where the macro opportunity set is this interesting,” he said, listing everything from trade wars to rising populism to a more complex geopolitical backdrop as “macro themes that will lead to a lot client portfolio rebalancing and overall activity”.
“As the sugar rush of quantitative easing fades, we should start to see a more normal environment for volatility and interest rates. For me, it is not a question of if, only when.”
Additional reporting by Robin Wigglesworth in New York
*This story has been amended to reflect the fact that Bank of America was joint third in the first half of 2018
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