By Roy C. Smith and Brad Hintz
Though none have announced their results yet, European capital market banks will surely experience a quartus horribilus. Total 1Q investment banking revenues are down 36% from the prior year, the lowest since 2009, led by sharp declines in M&A, high yield and IPO activity.
It also appears that trading revenues will be disappointing. Several US banks have discussed the challenging market conditions that have impacted market making and Jefferies, which serves as a harbinger of FICC performance, announced dismal trading performance in its first quarter.
2015 looked like a year that would signify the end of the post-crisis slump for the banks - mergers, equities, debt and LBOs all were firing away, and the beginning of the long awaited recovery of profits in the banking industry was foreseen. But, it was not to be. The oil glut rattled stock, debt and currency markets and recession fears forced unexpected credit write-downs.
The quarter’s results, however, mask mighty efforts being made by the big European banks to restructure themselves after years of dithering. Only three European banks will be among the top ten firms ranked by investment banking revenues.
Eight years after the 2008 crisis most of them have become unviable relics drowning in a sea of tightened regulation and costly litigation, with little sense of what to do about it. But, by the end of 2015, all of the four largest Europeans had installed new management with no ties to past legacies and charged them with transitioning to a workable business model that could once again be attractive to investors.
Bailed out by a resentful Swiss government in 2008, UBS was the first to confront the need for major change, though it took four years to do so. Sergio Ermotti, former Deputy CEO of Unicredit, was appointed CEO in 2011, and decided to reduce the investment banking business (and its related risk-weighted assets) to minimal levels, choosing instead to build a new, lower-growth but less volatile, dividend-paying business centered on wealth management. This was an easy call because its wealth management franchise was so vast, and it has paid off. In 2015 UBS reported ROE of 11.5%, its stock was trading at 1.1 times book value with a dividend yield of 3.6% that will increase further when the bank reaches its near-term goal of a 50% dividend payout. However, there was a high cost to Mr. Ermotti’s strategic move: UBS is no longer ranked among the top ten global investment bankers by revenues.
The three European banks that have clung to their investment banking market shares and revenue steam – Barclays, Deutsche Bank and Credit Suisse (ranking 6th, 7th and 8th, respectively, by global revenues) remain in terrible shape, as they have been for most of the last eight years. ROEs were negative in 2015 for all of them, and today, on average, their stocks trade at a mere 43% of book value.
In July 2015, John Cryan, a former UBS finance chief, was appointed to replace Deutsche Bank’s ineffective co-CEOs. In October he announced a new “Strategy 2020” (that replaces a previous, but unaccomplished, “Plan 2015+”) that would rely on simplification, increased capitalization, less risk and better management. Risk-weighted assets (RWA) will be further reduced by 22% to 310 billion by 2020; capital and leverage ratios will be improved, some extraneous assets will be sold, and expenses and headcount will be cut further. Eliminating dividends for two years will fund these efforts. Returns on tangible assets will rebound (it is hoped) to 10% by 2018 (about 8% of book value), which, however, is still less than Deutsche’s continuing cost of equity capital. Deutsche Bank’s stock is down 27% since the new plan was announced – JP Morgan’s is essentially flat since then; UBS’ is down about 10%.
Tidjane Thiam, the former head of Prudential Insurance, became CEO of Credit Suisse in June 2015. He also announced a plan in October similar to Cryan’s to trim hard and cut back, but stick to the old business model and protect profitable market share positions in investment banking. Last month, however, Thiam announced a further tightening of the plan after the investment banking division blindsided him by adding assets to trading positions that then lost money. RWA will be cut a further 20% along with 2,000 more jobs in the global markets unit. Despite bringing his miracle worker reputation to the bank, Thiam now seems to be in over his head. Credit Suisse’s stock price is down 37% since last October.
The most recent of the new CEOs is JP Morgan Chase veteran, Jes Staley, who took over at Barclays Bank in December. He too has announced a simplification, cost cutting and balance sheet trimming plan that would involve selling assets in Africa and shutting some non-essential business. His plan, however, also included halving the dividend for 2016 and 2017, and focuses on preparing Barclays for the ringfenced regime it will face in 2019. This, he demonstrated in a presentation to investors, will involve transitioning Barclays into two separately capitalized (and ultimately separable) businesses – a global investment bank, Barclays Corporate and International, with RWA of £195 billion, and a much smaller Barclays UK, with RWA of £70 billion. Even so, Barclays’ stock is also down 37% since October.
The three new CEOs have now all had early lessons on how hard it is to turn around a large underperforming European bank under present regulatory constraints and unsettled market conditions. It may be that balance sheet “optimization” won’t work any better for them than it did for their predecessors, who tried versions of it too.
Ultimately, there may be only two ways out. One is to convince regulators that important players in the global capital market system (there are some Americans too) will be sidelined indefinitely unless there is some relaxation of the capital adequacy, leverage, liquidity and other rules to allow market pricing to adjust to regulatory shifts. This may happen in time, but not soon. The only other way out is to split off the investment banking units into separate companies, which market conditions may make difficult, but not impossible, to do.
The new guys need to be brutally objective about their situations. If the renewed cut, squeeze and trim approach doesn’t work within a year or so, then the more drastic spin off approach may be all that is left.
From: EFinancial News, March 31, 2016