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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
By Dominic Elliott
LONDON, Nov 9 (Reuters Breakingviews) - UBS UBSN.VX has presented rivals with a quandary. The Swiss bank’s shares are up 20 percent since the plan to amputate most of its fixed-income unit emerged last week. That seems an enticing prospect for seven other firms with lacklustre share price performance and subscale debt businesses that seem to need surgery.
Unlike other more closely contested areas of investment banking, fixed income, commodities and currencies (FICC) is a two-tier game. The six existing scale players - JPMorgan (JPM.N), Citigroup (C.N), Deutsche Bank (DBKGn.DE), Bank of America Merrill Lynch (BAC.N), Barclays (BARC.L) and Goldman Sachs (GS.N) - collectively have about 60 percent of the market. There’s then a steep drop to the second-tier banks: Morgan Stanley (MS.N), Credit Suisse (CSGN.VX), BNP Paribas (BNPP.PA), Royal Bank of Scotland (RBS.L), Credit Agricole (CAGR.PA), Societe Generale (SOGN.PA) and Nomura (8604.T). They have an average market share of below 4 percent.
There’s unlikely to be more than a marginal boost for second-tier banks from UBS's pull-back, given the dominance of the big six. JPMorgan reckons there’s at best $2 billion of UBS annual revenue up for grabs of what was a roughly $5 billion-a-year franchise. That would not be enough to bump any of the next seven into the top tier, even if one bank picked up the entirety.
At best, UBS’s departure will make it easier for the second-tier firms to slash pay in fixed income, and reduced competition may push spreads slightly wider, somewhat helping profitability.
In spite of their subscale position, many of the second-tier players have placed fixed income at the heart of their investment banking strategies. It’s easy to see the temptation to stick with it. FICC will generate about half of an estimated $240 billion revenue pool for investment banks globally this year, according to Deutsche Bank. The business is seen as providing diversification at the bottom of the economic cycle. Credit Suisse’s wealth business lacks the heft of its Swiss rival; Morgan Stanley’s new retail brokerage model is yet to purr. Meanwhile, RBS and Nomura have targeted cut backs on equities and M&A.
But without scale, it’s still hard to make the business viable. FICC works for the top six players largely because they have big lending, custody, cash management and even retail businesses that shower orders down to their trading desks. Most other banks have fewer of these golden geese. Yet the second-tier competitors need almost the same infrastructure to operate, without the revenue to match. In turn, that makes it harder for their FICC businesses to earn their cost of capital.
New regulations including Basel III and Dodd-Frank in America are compounding the issue as they demand banks hold a capital cushion against a wider range of risky assets than before. Indeed, risk-weighted assets could increase by an average of 60 percent under the new rules, according to JPMorgan.
It all goes to explain why these firms have been more active at restructuring their FICC business than their larger peers. In the past 12 months, Credit Suisse has cut its fixed-income department’s risk-weighted assets by $99 billion to $131 billion – more in absolute terms than UBS’s retreat will achieve. Morgan Stanley shed 17 percent of its RWAs in the same period and aims to shed at least another fifth by 2014, leaving it with $255 billion.
The big question is whether cutting capital costs – and, by extension, the ability to put capital to work for clients – will hit revenue. Credit Suisse’s decent third-quarter performance in fixed income suggests that it is possible to make money even after hacking back at RWAs. Moreover, at Morgan Stanley, average quarterly revenue in the U.S. bank’s securitised products desk increased by 8 percent over the past couple of years, even as its holdings of asset-backed securities dropped 42 percent. But it’s hard to know if these examples are exceptions resulting from unusually fine trading conditions.
Another approach is to exit particular business lines within FICC. Credit Suisse has dropped commercial mortgage bond securitisations and correlation trading, for example.
All seven in the second tier will be hoping the reduced competition from UBS’s pull-back gives their fixed-income businesses a reprieve. But to varying degrees they can expect shareholder pressure to restructure in the coming year. For now, Credit Suisse and BNP Paribas are off the hook after decent third quarters. Morgan Stanley has reaffirmed its commitment to the business, but will need to cut further. Nomura has boxed itself in after cutting heavily outside FICC, while Societe Generale has made ground, albeit off a low base. That leaves RBS, where low returns persist, and Credit Agricole, which is the weakest of the three French banks after posting terrible third-quarter numbers. The seven are using benign trading conditions as air cover to make changes slowly. But if markets sour, shareholders may demand they put their foot to the metal.
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- Credit Agricole reported a 2.85 billion euro loss in its third-quarter results on Nov. 9, with writedowns relating to its exit from Greece and overhaul of its retail and investment banking units.
- While Wall Street and European banks reported improved investment banking results, Credit Agricole’s net profit in the division fell 15 percent on adjusted basis on the same period last year.
- Swiss banking group UBS announced a radical restructuring of its investment bank on Oct. 30 that will lead to thousands of job losses and the withdrawal from some trading businesses by the end of 2015.
- UBS is exiting some fixed income businesses to concentrate on advisory, research, equities, foreign exchange and precious metals. - For previous columns by the author, Reuters customers can click on [ELLIOTT/]
(Editing by Chris Hughes and David Evans)
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