This week sees the third-quarter reporting season close for the large global trading and universal banks (GTUBs). Performance has been mixed, but has generally been slightly better than in the second quarter and substantially improved on the very weak results a year ago. Concerns over the eurozone crisis and the "fiscal cliff" in US continue to depress customer volumes. A consistent story is the ever-increasing focus on costs, as revenue prospects are proving even more difficult to predict than ever in a world of shifting regulation.
Costs are hitting banks on many fronts: building regulatory infrastructure, segregating businesses and holding higher capital and liquidity needed to actively participate in almost any securities business - particularly fixed-income. This now makes it imperative for the GTUBs to focus their business models. We expect the banks to revise their rationalisation plans as regulations evolve and rules are finalised.
Banks are concentrating on areas where they have a competitive advantage and benefit from capital efficiency - and cutting back on those where they do not. Businesses that will generate insufficient earnings in relation to the risks they incur will be downsized or exited.
Most GTUBs are already undergoing some degree of restructuring. At the extreme end, UBS is accelerating the downsizing of its investment bank, effectively exiting fixed-income to focus only on advisory, research, equities, FX and precious metals. These are areas where the bank has strength and which have more natural synergies with its substantial global wealth management franchise. Earlier this year, RBS announced its exit from cash equities, corporate broking, equity capital markets, and mergers and acquisitions advisory businesses.
Other GTUBs with more rounded established investment banking franchises have less dramatic plans. For example, JP Morgan, Deutsche and Goldman Sachs are targeting costs, primarily their overweight central cost bases. Where investment banks are being kept relatively intact, a broad range of strategies are being pursued, such as expanding balance sheet-light businesses and downsizing non-core operations.
The strategy shifts are evident in the GTUBs’ year-to-date results, where costs of business exits or shrinkages are a common feature. Restructuring costs are hitting profits at the same time as infrastructure investments necessary for the new regulatory environment. We expect it may well take around two years for such investments and restructuring to filter through to lower cost/income ratios and higher returns on equity.
Earnings are also suffering from stubbornly low transaction volumes in the securities industry as a whole, reflecting uncertainty about global economic development. Banks with operations more focused on Europe are being hit harder by persistently low market activity than those active in the US or Asia. We do not see this situation changing until clarity emerges on resolution of the Eurozone crisis.
All else being equal, our ratings favour universal banks with a strong traditional banking businesses or wealth management franchise, where the business mix is supportive of more stable earnings and a lower risk profile, over those with a concentration on securities operations. We placed UBS’s Viability Rating of ’a-’ on Rating Watch Positive following announcements to accelerate its restructuring and reducing risk-taking in the investment bank on 1 November 2012.
