Meredith Whitney and Mike Mayo are not the only analysts who see a quick end to investment banks’ first-quarter profitability.
Alastair Ryan of UBS has leapt onto the bear bank bandwagon this week — slapping neutral or sell ratings on every ‘market heavy’ European bank except SocGen.
His reasoning, in short: The first-quarter’s been boosted by some powerful — but temporary — market developments, legacy assets still have to be dealt with and regulatory drags on capital requirements are about to start. In other words, rights issues could be coming.
First, here’s the kind of stuff that’s been propping up banks in the first quarter of the year.
That’s a slide from Barclays’ recent Q1 presentation. Taken with the positive rumblings coming out of Citi, Deutsche Bank and others, you can see where the optimism is coming from. But why the sudden rise in fixed income? Here’s Ryan:
Firstly, while Q1 09 saw robust revenues in certain areas of fixed income, one key theme was the introduction of quantitative easing (QE), which drove up the price of government bonds. We believe rates are set to stay low for as long as QE remains in place, but that the gains banks will have made during the period running up to QE are over: it is easier to make money when a government is telling you which way rates are going than when rates are typically stable. And as recent UK government bond auctions highlight, it is possible for small things to cause disproportionately large changes in yields from here:…
We are great believers in the ability of markets to find revenues somewhere. Much of the structured credit bubble was inspired by investors’ inability to find yield in plain vanilla, investment grade bonds — and by investment banks experiencing spread compression in traditional business areas and seeking new, more esoteric and higher margin markets. As structured credit recedes into the background for some time (oddly, the CDO market does always seem to come back sooner or later), volatility allows for spreads back at levels not seen in years. As bank lending declines, corporate and government bond issues boom. If one starts fresh, opportunities abound. But who starts fresh?
Indeed. Banks are starting from a place that can only be described as “rotten”. Some balance sheets are still ridden with nasty things like CMBS and CDOs, etc. And those aren’t going to disappear quickly — or at least, at prices banks would want for them. (Though we should note the PPIP could help here).
At the same time you will likely have higher capital requirements as per the suggestions in things like the FSA’s Turner Review. Back to Ryan:
Capital calls are not a thing of the past. Few investment banks have equity tier 1 ratios substantially above those with which they entered this crisis. We believe that, given their wholesale funding dependence, all would prefer to have significantly higher ratios were that option reasonably available. Higher stock prices potentially do make the option available again, through rights issues.Related links:
Meredith Whitney speaks on bank profitability — FT Alphaville
Move over Meredith… – FT Alphaville
The Turner guide – FT Alphaville