Bank of America’s second quarter results are out today. Its investment bank did OK: fixed income sales and trading revenues rose by 22% year-on-year, M&A revenues rose by nearly 27%; and debt capital markets rose by 5.1%.
Bank of America Merrill Lynch staff in these business areas can give themselves several pats on the back.
“This was the best second quarter we have had in the past five years,” said BofA CFO Paul Donofrio, refering to the bank’s global markets business. For the moment, therefore, it looks like Brexit is giving banks a boost. Unless you have the very great misfortune to work in equity capital markets.
This is what you need to know.
1. The full service banks are winning
In challenging markets, it seemingly makes sense to work for a big investment bank with a cross-product presence. BofA benefited from its breadth, said Donofrio: “We increased our relevance [in difficult markets post the EU referendum]…We showed our clients that we would be there when they needed us most. – There with thoughtful advice as well as the strength and confidence to be there when they execute.”
This bodes well for Goldman Sachs, which has long argued for the virtues of maintaining a broad presence across all markets in order to ‘be there’ for clients when necessary. It doesn’t bode so well for banks like Credit Suisse, which has cut product lines to improve capital efficiency.
2. Brexit hasn’t made much difference to the regional or product mix in sales and trading
It wasn’t just macro (rates and FX) trading businesses that had a great Brexit quarter. Nor was it just credit and securitised products trading. It was both, said Donofrio.
As the charts below (representing the entire first half) show, nothing much has changed for Bank of America’s global markets business. In a six-month context, there hasn’t been a revenue shift towards Europe over the past year; nor has there been a revenue shift towards macro products. The regional distribution of revenues is just as it was, as is the product split in fixed income sales and trading.
3. Sales and trading businesses are inching forwards but sliding back
If sales and trading is all about generating more revenues with a smaller trading book and lower risk, Bank of America is succeeding. Sales and trading revenues at the bank rose by 12% year-on-year in the second quarter, even as risk weighted assets fell by 7% and Value at Risk (VaR) fell by 16%.
This looks like the correct direction of travel. In fact, things are not so simple. Although ‘trading-related assets’ at BofA fell year-on-year in Q2 (from $442bn to $411bn in Q215), capital allocated to the global markets business actually rose from $35bn to $37bn over the same period.
This might be why the return on average allocated capital in BofA’s markets business is still low at just 11%. Admittedly, this is up from 9% in Q2 2015, but five years ago the return on average equity in BofA’s global markets business was 15%.
4. Revenues need to stay high in global banking to offset higher costs
In percentage terms cost-cutting programmes in BofA’s investment bank are working though. In both global markets (sales and trading) and global banking (capital markets, advisory, transaction services and lending), costs accounted for a lower proportion of revenues in the second quarter of 2016 than one year earlier.
This does not mean that absolute costs are falling though.
While BofA trimmed $166m of costs from its global markets business over the past year it actually added $40m of costs to its global banking business – costs that were offset by rising revenues. If this additional expense is to be justified, BofA’s global bankers need to hope their revenues remain elevated in future.
Where did those elevated revenues come from? M&A bankers contributed an additional $96m. The corporate loans business contributed $220m. Did those two businesses benefit from ‘synergies’? Maybe. Will they suffer from post-Brexit pre-U.S. election uncertainty? Possibly so. From a cost perspective, BofA needs to hope they don’t.
5. Asia is the fly in the ointment when it comes to equities sales and trading revenues
As the chart below shows, BofA’s equities sales and trading business did exceptionally badly last quarter. The bank is blaming Asia. More to the point, it’s blaming its exceptional performance in Asia during the first quarter of 2015, when there were “stock market rallies in the region”. Absent those Asian rallies, equities sales and trading revenues at BofA fell by nearly 8% last quarter compared to the prior year.
This doesn’t bode well for Morgan Stanley, which reports on Wednesday. Equities sales and trading revenues at Morgan Stanley were up 28% in the second quarter of 2015. In today’s more challenging market conditions, this might prove hard to match.
6. However you look at it, ECM bankers are having a terrible time
There’s nothing much to add here: just take a long look at the chart below.