March 16, 2016 / 2:09 PM / 2 years ago

Banks face slump in trading revenue as 'bad' volatility bites

The James Newman Woolwich Ferry crosses the River Thames in front of Canary Wharf, London's financial district February 6, 2015. REUTERS/Russell Boyce

LONDON (Reuters) - Banks are facing a slump of 15 percent in market trading revenue in the first quarter, spoiling what is normally the most lucrative period when investors put their money to work at the start of the year.

Investment banks are suffering after a steep decline in oil prices and worries about China’s economy triggered a wave of volatility that swept through financial markets in the first six weeks of the year.

Banks’ fixed income, currencies and commodities (FICC) trading operations are expected to have been hit hard, with revenue at nine of the largest institutions falling to $19.2 billion from $22.6 billion in the same period last year, according to data analytics firm Tricumen.

That would mark the worst first quarter in the four years that Tricumen has been compiling comparable records and a significant decline of more than a third from the $30 billion at the start of 2012.

The downturn comes as banks are having to comply with new regulations forcing them to hold more capital, reduce risk-taking and scale back market-making activities, all of which are squeezing liquidity from an array of capital markets.

“Q1 is normally our strongest quarter and it hasn’t been very strong,” John Cryan, CEO of Deutsche Bank told a financial conference in London on Wednesday.

“February was pretty tough,” he added, noting an end of quarter rush would not make up for a slow start. Cryan also reiterated that the German bank was unlikely to make a profit this year.

The first quarter of the year often accounts for more than 30 percent of annual income for investment banks.

Traders sometimes welcome what they deem to be “good” volatility which allows them to profit from pricing anomalies. But volatility characterized by thin liquidity, widening bid-offer spreads and sharp market falls is considered less healthy.

This is what happened in the early part of this year, when credit spreads widened dramatically and many major equity markets recorded their worst start to a year in decades.

This “bad” volatility, decline in revenue and increased compliance with new regulation is forcing banks to cut costs even further, resulting in tens of thousands of job losses across the industry.

“There are more and more signs of fragmentation and liquidity is drying up. Banks are still deleveraging and are required to hold greater capital against their balance sheets ... it’s difficult for our customers to make money,” said the head of FICC trading at a top-tier bank.

“Macro hedge funds are really struggling, and when our customers don’t make money, we struggle,” he added.

UNPRECEDENTED HEADWINDS

Several banks have already warned that first quarter revenues will be down sharply from a year ago.

Sergio Ermotti, CEO of Swiss bank UBS (UBSG.S) said on Wednesday that challenging conditions had persisted into 2016.

“We and the industry are facing unprecedented headwinds, for example from interest rates, which have pressured net interest margins in all of our businesses and from macroeconomic and political uncertainties that have contributed to huge risk aversion among our clients,” Ermotti said.

“Industry activity levels in investment banking advisory have slowed markedly year on year, and, while equity volumes in the US are buoyant, flat volumes in Europe and sharp declines in Asia do not favor our geographic mix.”

Tricumen forecasts that Morgan Stanley (MS.N) could be the weakest performer, largely due to its business mix in spread products and parts of equity trading.

Bank of America Merrill Lynch, Goldman Sachs and UBS were likely to suffer the smallest declines, due to their solid performance in credit trading and parts of rates and equity trading, it said.

Investment banks, especially those in Europe, will fail to meet their cost of capital over the next two years, prompting further restructuring that could put up to 5 percent of market share up for grabs, similar in size to the wave of restructuring in 2012, according to Morgan Stanley analysts.

Morgan Stanley analysts forecast revenues down 10 percent in 2016, putting even greater pressure on management teams to act.

Editing by Keith Weir

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