Don’t get them wrong. Rating agency Standard & Poor’s appreciates investment banking.
“Global banks need to service their client base with an investment banking arm,” they write in a report out on Thursday. It’s just that, well, they think its dominance in bank earnings is rapidly declining.
It’s not necessarily a bad thing, they note:
Investment banking has dominated the earnings of the world’s large universal banks since 2009, but the other main business divisions–retail and commercial banking and asset and wealth management–are regaining traction and catching up. Over the next several years, the earnings of these three major divisions are likely to strike a better balance, more because of their cyclical nature than any drastic change in the risks these universal banks might undertake. From Standard & Poor’s Ratings Services’ credit perspective, a diversified business mix with a solid base of recurrent revenues and long-term customer relationships leads to a stronger business position and better quality earnings for a financial institution.
Indeed, it’s basically the recovery of retail and commercial banking (what S&P calls ‘RCB’) as crisis-induced loan losses start to ease, combined with new regulation aimed at shifting banks away from corporate and investment banking (CIB), that will lead to banks ‘rebalancing’ their earnings, S&P says.
So less of this:
And more of this:
Perhaps the most interesting thing here is S&P’s data set. For the first time they’ve used their ‘standardised segments’ to compare the earnings of the world’s major banks. The standardised data, we’re told, allows S&P to illustrate what’s happened — and what will happen — to bank earnings.
The story is an interesting one in investment banking:
Earnings for most of the 13 financial groups began to recover in the recession year of 2009 and rebound more strongly in 2010 and the first quarter of 2011. Investment banking, fueled by a strong contribution from fixed-income lines, led the way. In addition, favorable capital markets broadly supported profits from debt sales and trading. Investment banking earnings in the first half of 2009 and first quarter of 2010 were particularly good due to high volumes of debt issuance, particularly from sovereign governments, emerging markets, and speculative-grade industrial companies. Bid-ask spreads were far wider than historical averages in 2009 and the first part of 2010, due in part to a drop in the number of investment banks active in the markets and considerable market volatility and uncertainty. The policies of the U.S. Federal Reserve Bank, the European Central Bank, and the Bank of England to keep interest rates low, along with the Fed’s massive purchases of securities on the open market, pumped liquidity into the markets and boosted prices for certain classes of securities from their 2008 lows. In 2010, revenues from fixed-income lines in investment banking constituted more than half of total revenues from CIB (table 3). For the peer group of 13 banks, CIB revenues measured 37% of aggregate revenues in 2010, and constituted a high 61% of aggregate pretax income.
Bank analyst Meredith Whitney called this “the great government momentum trade” back in 2009, the idea being that authorities were helping banks inflate their earnings to lift them out of financial crisis. Now, however, S&P suggest that state of affairs is swiftly changing.
Their conclusion:
With investment banking under the gun, global banking groups may respond by shifting more capital and resources to traditional RCB lines. Stable client-centered commercial business such as treasury services (cash management, transactions, payments, custody, payroll) and trade finance may become the favored son, pushing aside more volatile securities sales and trading operations that feed on high trading inventories and balance sheet financing. Indeed, several global trends favor the development of treasury services, securities custody, private banking, and asset management: namely, the aging of the population in rich countries, expectations for future growth of the world’s capital markets, expansion of global trade, and high GDP growth in developing markets. The returns on these lines are relatively stable and low-risk, and they consume minimal regulatory capital. In the recent past, these more dependable lines of business complemented earnings from investment banking. In the future, we believe the tables may turn.
Full report in the usual place.
Related link:
Unwinding the US Treasury trade - FT Alphaville
Whitney: “I call this the great government momentum trade” – FT Alphaville, 2009