Dirk Hoffman Becking, formerly of Bernstein Research, has resurfaced at SocGen where he is global head of bank research. In his new role, Dirk and his new colleague Sébastien Lemaire have written a large report on what they think is coming next for European investment banks. Their prognosis is not pretty.
Dirk and Sébastien say banking pay is still 35% too high compared to 100 year history. More specifically, securities industry pay is 50% too high. "A 29% reduction in compensation costs is feasible," they conclude.
"Headcount reduction to date stands at just 7% versus 19% in 1987 and 16% in 2001," say Dirk and Seb.
Compared to previous banking downturns, too few people were cut after 2008 and too many people were added in 2010.
(Source for us: SocGen)
"For the first time since 1998, industry revenues are below the long-term mean by 10-15%, but the cycle appears broken and structural growth opportunities (Euro DCM, competitor exit) are looking slow to assert themselves," Dirk and Sébastien say.
Following a downturn, a recovery in investment banking revenues is usually heralded by an upturn in fixed income as credit spreads narrow. "As the recovery takes hold and turns into a boom, equities, M&A and ECM take the lead on revenues," say Dirk and Seb.
This time is different: there's a balance sheet recession, the euro crisis is causing uncertainty and everything has become so correlated that diversification is pointless and risk either on, or off.
Much of banks' revenue morass may also be down to prop trading: now that it's not happening as much as it used to, banks can't use prop trading revenues to climb out of their hole.
Earlier, we suggested DCM bankers are well positioned to do well from the phenomenon known as disintermediation. Dirk and Sébastien agree, but they think this only applies to Italy and Spain. Unfortunately, Italy and Spain are not looking particularly well placed to develop a solid DCM pipeline at the moment.
"Deutsche Bank is best positioned to benefit from the scarce structural growth drivers due to broad product mix and strength in DCM, whilst UBS and in particular CS are heavily geared towards a return of the cycle."
Deutsche Bank is also well placed to cut costs by cutting bonuses rather than staff. 40% of its compensation costs are variable - compared to just 12% and 10% respectively at UBS and Credit Suisse.
Much has been made of the hiring apparently happening in the private banking industry.
Don't go there.
Margins are under pressure in private banking as clients go overweight cash, say Dirk and Sébastien. Growth is being skewed towards low margin emerging markets businesses and away from the high margin Swiss business. Operations are being, "streamlined", as banks focus their attention on Ultra High Net Worth clients.
(Source for us: SocGen)
"In our view the industry strategy should be based on revenue levels no more than 10-15% above current levels and target leverage of 20-25 times," say Dirk and Séb.
If banks want to achieve return on equity of 12%, Dirk and Seb say they will need to cut costs a further 26%.
(Source for us: SocGen) Click to expand
Banks awarded lower compensation last year, but no one noticed because of deferrals from previous years. As previous years' deferrals play out, pay will start to fall a lot more rapidly.
The exception to this trend appears to be Barclays Capital, where the burden of deferred compensation is actually increasing.
RBS and Unicredit have pulled out of cash equities and Calyon has pulled out of equity derivatives. However, while there's been a lot of downscaling, no one's actually pulled out of structured credit.
"Winding down an FICC operation is a long and complex process, mainly due to the long maturity of a lot of the (derivatives) positions. Hence we doubt we will see wholesale exits from the business even if times get tougher. The more likely process is a gradual withdrawal of some banks from businesses in FICC," say Dirk and Seb.