Intermittently, the banking team at JPMorgan will produce an exceptional report on the state of the industry. They did it in November and they did it in February.They’ve just done it again. Their report is huge, at 232 pages. This is what you need to know.
FICC businesses remain the primary driver of banking revenues, with a 51% share of the total. However, FICC revenues are forecast to decline 2% over the next 2 years. Equities are forecast to increase 2%. IBD revenues will decline the most: a 6% drop is forecast.
Remember the years after 2000, when the creation of new products drove growth? Following the crash, innovation has died. Revenues are suffering. “We see no real innovation within the industry to create new products which will drive the growth story in IB revenues,” says JPMorgan.
Emerging markets (BRIC countries and the MENA region and South Africa) are growing, say JPMorgan’s analysts. But they’re still small. JPMorgan estimates that IBD revenues across emerging markets were $7.6bn between 2009 and 2011, vs. $39.8bn for North America and Europe. “We do not expect any near term closure of the gap between relative levels of activities in the markets, and therefore we do not believe that IBs EM Growth strategies will be sufficient,” says JPMorgan. “Given the size of the revenue wallet we do not expect EM to be a material driver of IB revenue wallet over the next 5-7 years and see over-capacity building in the region,” the analysts say. Translated: EM revenue growth will be no panacea for slower growth in developed markets and redundancies in emerging markets may become necessary.
There will be no real growth for the next two years in a low GDP environment. 2005-2006 should be seen as a normalized revenue world.
There will, however, be massive growth in structured credit and fair growth in equity derivatives. Structured credit revenues recently have been hammered by risk-related losses, say JPMorgan. This is changing: “Q1 12 has seen material improvement in the credit market environment.” Revenues will rise as credit spreads come in, inventories are marked up and trades are monetized.
Further cost cutting will be necessary everywhere. “In our view, the whole industry including the Tier I names will once again need to re-visit the cost base and staffing levels in order to increase operational efficiency, as market share adjustments and legacy asset disposals will not be enough to attain market acceptable returns,” say JPMorgan’s analysts. However, banks with a high proportion of fixed compensation costs will need to make the largest number of redundancies. Credit Suisse, BNP, SG and Barcap are in the firing line.
With lower salaries and less in the way of deferred compensation, JPMorgan thinks Tier 1 banks will be able to manage their cost base better. Equally, Tier 1 FICC players will have the advantage of the big revenues generated by their FICC businesses, which operate at comparatively high margins. “We believe the winning model in a more polarised IB environment should be Tier I institutional players and Boutiques with a high profitability model with Tier II agency players in the middle,” say JPMorgan’s analysts.
As FICC moves to electronic trading programmes and becomes more execution only focused, big players with heavy technological investment in FICC platforms will be the beneficiaries “These platform builds in our view are high barriers to entry due to the heavy technological investments involved which will likely only be supported by large-scale FICC revenue players generating c.$10bn+ (i.e. Tier I players). Tier II IBs generating about $5bn will struggle to compete in our view,” says JPMorgan. Tier 1 players will also need to commit capital to their FICC businesses, and Tier 2 players could lose out because of an unwillingness to do so. Tier I FICC IBs are considered to be Goldman Sachs, Deutsche, Citi, BofA, and BarCap. Tier IIs such as UBS and Credit Suisse are already restructuring. JPMorgan suggests that Morgan Stanley may need to follow them. The table below indicates which banks fall into each category and how market share will (probably be allocated by 2013). Anything in Tier II Institutional is probably to be avoided.
If you must work for a French investment bank, make it BNP Paribas. “Société Générale would be one of the most impacted by regulatory changes, with CIB ROE decline from 14.6% to 5.5% in our sensitivity scenario on 2013e estimates,” say JPMorgan’s analysts.