Last Man Standing Means Europe Investment Banks Resist Cuts
Europe’s failure to resolve its sovereign-debt crisis will force investment-banking chiefs in the region to consider shuttering entire businesses rather than rely on piecemeal job reductions to revive profit.
Dealmaking fees may drop 25 percent this year from 2009, when the crisis began in Greece, research firm Freeman & Co. estimates. European banks, including UBS AG and Barclays Plc (BARC), have cut about 172,000 positions since then, according to data compiled by Bloomberg, the same strategy they used after Lehman Brothers Holdings Inc. collapsed in 2008.
The game plan won’t work again as rising capital requirements and declining business alter the investment-banking landscape, investors and analysts say. New rules will reduce return on equity by 6 percentage points from about 14 percent in the first half of 2011, according to consulting firm Bain & Co. Banks that relied on record low interest rates and a flood of cheap funding from the European Central Bank to delay deciding which units to close will be compelled to make choices.
“Investment banks have to shrink and do more than cut a little bit here and there,” said Lutz Roehmeyer, who helps oversee 10 billion euros ($12.5 billion) at Landesbank Berlin Investment in Berlin. “There’s too much politics and too little economics going on. They want to keep certain businesses for as long as possible.”
Some firms are cutting deeper. UBS, Switzerland’s largest lender, is reducing its fixed-income operations to focus on wealth management because of stricter capital requirements imposed by regulators and a weak revenue outlook linked to the continuing debt crisis. Still, even for all the job cuts, most European investment banks haven’t made significant changes since the upheaval that accompanied the collapse of Lehman Brothers, said Joao Soares, a partner at Bain in London.
“Banks often play the last-man-standing strategy of maintaining capabilities until others are forced to leave,” Soares said. “They need to reinvent their core.”
The Bloomberg Industries European Investment Banks Index (BIIBNKE), which tracks UBS (UBSN), Barclays, Deutsche Bank AG (DBK), and Credit Suisse (CSGN) Group AG, has dropped 4.7 percent this year compared with a 13 percent gain in the 329-member MSCI World Financials Index. (MXWOOFN) European banks that have investment-banking businesses trade at an average of 62 percent of book value, while European financial firms trade at about 90 percent.
The five U.S. lenders with investment-banking and trading units -- Bank of America Corp., Citigroup Inc. (C), Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS) -- reported their lowest first-half revenue since 2008 and have stock prices that value the firms at a lower percentage of book value than banks without capital-markets units.
“We’re at an inflection point,” said Steve Hussey, a London-based financial-institutions analyst at AllianceBernstein Ltd., which oversees about $400 billion. “Some banks need to come out and say we need 30 percent to 50 percent fewer people. The hit has to be more severe than 1,000 people here and there. Second- or third-tier players have to get out of certain businesses and focus on niches -- either products or geographies.”
Deutsche Bank, Germany’s largest lender, and Barclays, Britain’s second-biggest by assets, are among those best-placed to benefit because they can exploit their dominant fixed-income, currencies and commodities operations, traditionally the heftiest revenue generators for firms, said Kian Abouhossein, a bank analyst at JPMorgan in London.
The U.S. investment-banking industry is “more consolidated,” resulting in higher fee levels for the top firms, Abouhossein wrote in a March report. Those companies that have a presence in the region, including Citigroup, stand to gain if European banks exit or shrink businesses, he said.
Deutsche Bank has the biggest share of the U.S. fixed- income trading market this year, taking the top spot from JPMorgan, consulting firm Greenwich Associates said last month. Fixed-income revenue at the 10 largest global investment banks dropped at least 25 percent in each of the past two years to $73 billion in 2011, according to Coalition Ltd., a London analytics firm. Deutsche Bank also boosted its share of a shrinking European equity-underwriting market to about 12 percent this year from 9.3 percent in 2011, data compiled by Bloomberg show.
Still, even the Frankfurt-based lender is shrinking its investment bank. The company said July 31 it will cut about 1,500 jobs at the unit and at related infrastructure functions by the end of the year after reporting a 63 percent drop in second-quarter investment-bank profit. It will announce further details about changes to its business model, including scaling back in some regions, at a presentation next month, co-Chief Executive Officer Anshu Jain, 49, said on a call with investors.
“The European crisis has developed closer toward our more grim scenario than our better-case scenario over the course of the past two years,” Jain said. “Our prospects and our future view on profitability is different today than it was in 2010.”
While revenue at Barclays’s fixed-income, currencies and commodities unit rose 11 percent in the first half to 4.4 billion pounds ($6.9 billion), making it the biggest source of income for the investment bank, the lender is under pressure from regulators and politicians to shrink its securities unit.
The government-backed Independent Commission on Banking recommended in September that lenders partially separate their consumer and investment banks. Barclays has come under greater pressure to curtail its securities unit after being fined a record 290 million pounds in June for manipulating the London interbank offered rate, or Libor, the benchmark interest rate for about $300 trillion of securities worldwide.
CEO Robert Diamond resigned following the fine, as did Chairman Marcus Agius. Diamond had overseen Barclays’s purchase of Lehman’s U.S. business and subsequent expansion beyond fixed- income into equities and merger advisory. The securities unit employed about 24,000 people at the end of December, more than three times as many as when Diamond took over.
“We expect Barclays to adopt a more conservative strategy than it has in the past, which could see the aggressive expansion story that has been pursued by the investment bank being de-emphasized,” Gary Greenwood, an analyst at Shore Capital in Liverpool with a hold rating on the shares, said in a Aug. 10 note. “Investment banking is likely to be a low-return industry over the long run, given planned regulatory change.”
UBS and Credit Suisse, the country’s second-biggest bank, may have to shrink their investment banks more than competitors because Swiss regulators set capital requirements higher than international levels. The two lenders will have to hold total capital, including common equity and contingent capital, equal to about 19 percent of risk-weighted assets starting in 2019.
Under Basel III rules, banks worldwide must have capital ratios of 10.5 percent, while stricter rules can be imposed by national regulators, and firms deemed systemically important will need more.
Both Swiss banks will have to reconsider their positions in sub-scale or money-losing businesses, where costs can be reduced and capital released, according to Huw Van Steenis, a banking analyst at Morgan Stanley in London.
UBS’s investment-banking business posted a pretax loss of 130 million Swiss francs ($134.9 million) in the three months ended June 30 compared with a pretax profit of 383 million francs in the same period a year earlier as revenue fell 32 percent on reduced client business and a loss related to Facebook Inc. (FB)’s initial public offering.
The bank, based in Zurich, said in November it would exit macro-directional trading, asset securitization and complex structured products within its fixed-income business, as well as proprietary trading in stocks. It is cutting risk-weighted assets at its securities unit by more than half under Basel III rules from the level at the end of September. The division already has reached its 2013 headcount-reduction target.
“If you remember back in November of last year, I don’t think that even a pessimistic outlook for the next 12 months would tell you what we are living in right now,” CEO Sergio Ermotti, 52, said July 31. “The environment has completely changed. We have been very proactive in accelerating taking down cost as we saw the new environment developing, and we will not be shy to continue to do so as we see the market changing, as I do believe that many of our competitors will have to do.”
Investment banking will look more like it did in the mid-1990s than in the past decade, Ermotti said.
“The people who have succeeded in this business are the ones who took risks at the right time,” said Peter Hahn, a finance professor at London’s Cass Business School and a former managing director at Citigroup. “The growth lasted too long. Now the biggest business segment for investment banks, the financial industry, is under pressure to shrink. The realization that the biggest client has gone probably hasn’t hit some.”
Credit Suisse said in November it will cut risk-weighted assets at its investment bank by 37 percent from levels at the end of September to boost returns. The bank said it would end origination of commercial mortgage-backed securities and downscale or exit long-dated unsecured trades in rates, emerging markets and commodities and less capital-efficient businesses in securitized products. The company also has reduced headcount at the unit by 1,500.
The Zurich-based lender, led by CEO Brady Dougan, 52, said last month it plans to cut costs at the investment bank by an additional 550 million francs, declining to specify whether that would result in job cuts. It said it would “rationalize” the securities unit’s advisory and underwriting businesses to bring them “in line with market environment,” get rid of duplications between country, product and industry teams, and consolidate execution into hubs in the U.K. and Hong Kong.
The bank, which last month also announced plans to boost capital by 15.3 billion francs to appease regulators, should have made bigger cuts in fixed-income instead of raising capital, JPMorgan’s Abouhossein said in a July 18 note. “We see potential for Credit Suisse to shrink further,” he wrote.
Spokesmen for Credit Suisse, UBS, Deutsche Bank and Barclays declined to comment.
“There is more to come as regulators make it a more capital-intensive business, including in fixed income,” said Philippe Bodereau, the London-based head of research for financial firms at Pacific Investment Management Co., the world’s largest bond investor. “For the smaller guys, some of these businesses are becoming very debatable.”
UniCredit SpA (UCG), which employs about 8,900 people in corporate and investment banking, exited the European equity- brokerage business. The bank, the largest in Italy by assets, is now studying a partnership with Credit Agricole SA (ACA), France’s third-largest by market value, for managing stock offerings.
Credit Agricole is in talks to sell its European equity- brokerage business to Kepler Capital Markets SA and sold Hong Kong-based CLSA last month to China’s Citic Securities Co.
Royal Bank of Scotland Group Plc, Britain’s biggest taxpayer-assisted lender, said in January it would eliminate about 3,500 jobs at its investment-banking division and sell or close the unprofitable cash-equities, mergers-advisory and equity-capital-markets divisions. BNP Paribas SA (BNP), France’s largest bank, is cutting 79 billion euros of risk-weighted assets, mostly within the corporate and investment bank.
“As investment banks strip their businesses in the face of a poor economy, poor revenue and higher regulatory capital, it’s the survival of the very, very fittest,” said Kevin Burrowes, U.K. head of financial services at PricewaterhouseCoopers LLP. “We could see just three to five global investment banks.”
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