Credit markets are arguably enjoying a very late ‘hurrah’, argue Dresdner Kleinwort’s Stefan-Michael Stalmann and Susanne Knips, in what is a multi-year bull market. This rather steely analytical duo – last seen fretting in these pixels about the Great Unwind coming for investment banks and hedge funds – have now turned their attention to what it means for the banks when the credit cycle inevitably takes a turn for the worse.
“Credit is a cyclical asset class,” write the pair, “(which we believe is not a controversial statement),” they add – a pop perhaps at the la-la land type optimism around in today’s market. “And if investment banks derive anywhere between 25% and 40% of their revenues from credit-related activities, then investment banking should be cyclical too.”
Consensus view at DK is that credit-related activities look cyclically very advanced. Volumes, tight credit spreads, deterioration in covenant protection, subprime, etc. Yes, say DK: “Credit (and by implication, investment banking) does look very toppy indeed.”
And when benchmark yields rise and credit spreads blow wider, the question is who’s going to suffer most egregiously among the banks?
Their bet, notwithstanding the generally patchy disclosure, is Deutsche Bank, which they estimate derives about one-third of group profit from credit-related business. The runners-up are Credit Suisse and UBS with about 20 per cent and up to 10 per cent respectively.
Stalmann and Knips also argue that average leverage numbers for corporate debt arguably understates the substantially higher leverage in the bottom 20 per cent of corporate borrowers. And earnings growth has not been able to match the growth of debt even at the average leverage level.
Stand by for the casualties.