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UBS Fixed-Income Capitulation Boon for Deutsche Bank

Global investment banks such as Barclays Plc (BARC) and Deutsche Bank AG (DBK) will probably increase their market share after UBS AG (UBSN) decided to scale back its trading arm in the face of higher capital requirements.

UBS announced an unexpected pretax loss of 2.87 billion Swiss francs ($2.7 billion) at its investment bank yesterday and job cuts totaling 10,000 across its business. Deutsche Bank reported an eight-fold surge in its pretax profit from investment banking, and adjusted pretax profit from the business at Barclays more than doubled, the London-based bank said today.

“It’s positive for the banks that remain active as new business will be split among fewer players,” Daniel Hupfer, who helps manage 36 billion euros ($46 billion) including Deutsche Bank shares at M.M. Warburg, said in a phone interview yesterday. “Investment banking and lending margins will rise if fewer banks offer those services.”

The world’s biggest investment banks, which also include JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C), are facing less competition for business after UBS became the latest of Europe’s lenders to shrink its operations, saying it will reduce fixed- income trading. Royal Bank of Scotland Group Plc, which said in January it would close or sell equity and mergers advisory divisions, was also among victims as Europe’s debt crisis roiled markets and tighter capital rules made some businesses unprofitable.

Global Consolidation

The 10 biggest investment banks shared $22 billion of fixed income, currency and commodities sales and trading revenue in the second quarter, according to data compiled by Bloomberg Industries. JPMorgan ranked first, followed by Barclays, Citigroup and Deutsche Bank while UBS came in at second to last, the data show.

“There will be fewer large, globally-active investment banks,” Olgerd Eichler, who helps manage 1.4 billion euros at Main First Bank AG in Frankfurt (SX7P), said by telephone. “The bonanza of the last decade is over. Other industries like cars or telecommunications went through such a global consolidation, and the banks are long overdue.”

Regulators have ordered lenders to raise capital to prevent a repeat of the taxpayer-funded bailouts that followed the 2008 collapse of Lehman Brothers Holdings Inc. Banks will hold more reserves against riskier assets under the rules, known as Basel III. Swiss capital rules, applicable to UBS and Credit Suisse Group AG (CSGN), are among the most stringent.

Dominant Players

UBS may be realizing it can’t compete in products such as fixed income trading, which lenders such as JPMorgan and Deutsche Bank already dominate, said Christopher Wheeler, an analyst at Mediobanca SpA in London.

Zurich-based UBS rose 0.5 percent to 13.96 francs at the close of trading, while Deutsche Bank gained 0.5 percent to 34.97 euros in Frankfurt. Barclays slid 4.7 percent to 227.5 pence in London.

UBS is “recognizing that under the new capital rules they can’t make the kind of profits as a sub-scale player,” Wheeler said in an interview on Bloomberg Television’s “Surveillance” with Tom Keene and Scarlet Fu. “They’re effectively exiting most of their fixed income businesses.”

UBS Chief Executive Officer Sergio Ermotti said the cut- backs would give his bank a competitive edge and rivals may be forced to follow.

“Change is necessary for the entire banking industry,” Ermotti said in a memo to staff yesterday. “By acting now we are getting ahead of our competitors and reshaping our business so that it can deliver sustainable results over the long term.”

Firing Staff

UBS is eliminating about 30 fixed-income jobs in Japan as part of the reductions, said two people with knowledge of the matter, who asked not to be identified because the details are private.

Stefan Krause, Deutsche Bank’s chief financial officer, said the bank stands to gain as rivals scale back.

“As a market-leader in fixed income, a reduction in capacity is obviously a good thing,” he said on a conference call with analysts yesterday. “We anticipated that some competitors would leave.”

The increase in profit at Deutsche Bank, announced yesterday, was primarily driven by a surge in revenue from trading debt and other products for clients, filings showed.

Deutsche Bank’s earnings were driven by a “flight to quality,” Kinner Lakhani, an analyst at Citigroup in London, said in an e-mailed report to clients yesterday.

Barclays said today that third-quarter pretax profit at its corporate and investment banking unit, excluding provisions and accounting losses from revaluing the firm’s own debt, rose to 1.04 billion pounds ($1.67 billion) from 501 million pounds in the year-earlier period.

Buoying Markets

European Central Bank President Mario Draghi has buoyed markets and spurred sales of securities in the third quarter by pledging in August to conduct bond purchases to prop up some EU countries.

ECB action helped revenue from fixed income, commodities and currencies, known as FICC, at Barclays rise 10 percent from a year earlier to 1.58 billion pounds. JPMorgan’s fixed-income trading revenue, excluding accounting adjustments, rose 33 percent in the third quarter, while Citigroup’s climbed 63 percent. Deutsche Bank saw revenue from sales and trading of debt and other products jump 67 percent in the period.

UBS, which posted a pretax loss of 2.87 billion francs at its investment bank in the three months to September, will keep its advisory business, as well as equities, foreign exchange and precious metals, and will maintain facilitation capabilities in rates and credit, it said yesterday.

Banks would be making a mistake by closing down whole business units, Hupfer said.

“As an investor I like diversified banks as they’re more balanced than specialized players,” he said. “Banks that give up whole business lines at the bottom of the cycle won’t benefit from a recovery. This is just not the right timing.”

To contact the reporters on this story: Nicholas Comfort in Frankfurt at ncomfort1@bloomberg.net; Annette Weisbach in Frankfurt at aweisbach1@bloomberg.net

To contact the editor responsible for this story: Frank Connelly at fconnelly@bloomberg.net

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