Trading results surged globally in the first quarter, boosting the performance of both banks that stayed with a universal approach and those that took a hatchet to trading operations.
While JP Morgan, Goldman Sachs and Deutsche Bank were up 5%, 10% and 9% in fixed-income trading respectively, others that assiduously cut trade in risk-weighted assets – and left some businesses altogether – also turned in a strong quarter.
UBS, for example, sharply trimmed its trading unit but saw revenue from sales and trading surge 71%.
Which raises the question: if banks can achieve outsized results with less risk – holding fewer assets and taking smaller capital surcharges – will the big universal institutions feel pressure to pare back trading?
Not likely, argues Dick Bove, a bank analyst at Rafferty Capital, who believes the strong first quarter could mark the beginning of a five-year cycle for trading.
“We are not going back to 2006-2007 levels of activity,” Bove told IFR. “But we are coming off the bottom, because there’s a reason to do more trading in nearly every product.”
He says that, rather than cut, banks will come up with the level of risk-weighted assets they need to stay in the game – because when cycles are strong, the game is very profitable.
For the biggest players, that will mean shifting balance sheet risk in a way that allows more money to be diverted into trading without necessarily driving up RWAs.
That shouldn’t be a problem for US outfits like Morgan Stanley, which has made a real show of cutting RWAs.
But European banks could be facing real constraints that may limit their ability to accelerate into a new trading cycle at full throttle, even if they were so inclined.
“Banks are getting better at making money from lower VaR levels,” said Seb Walker, managing director at analysis firm Tricumen.
He said data showed that, after discounting for execution methods and volume changes, banks improved revenue/VaR ratios by two to three times in key fixed-income products last year compared to 2011.
But there is still considerable “regulatory change risk” for European banks, Walker said.
Europe has yet to implement its swap execution facility rules, for example. How these are implemented could cause further ruptures to the fixed-income market, Walker said.
Beyond that, he said, individual banks have their own pressure points.
For some that’s RWAs, for others it’s leverage – and for still others it’s the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) stress test that drives their view of trading.
How the banks approach each individual trading product matters more than overall RWAs, Walker said.
“It is not as simple as saying (that) a bank cut RWAs and still performed well,” he said.
In fact, rather than broadening out, most banks will stay on their current course – in spite of how the market turns.
Fitch Ratings says that, although the banks with a narrower focus did well in the first quarter, it believes the banks with the universal model took overall market share.
Fitch calculates that volatility in currencies, commodities and equities drove a 48% quarter-over-quarter increase in capital markets revenue for the five largest US banks.
And firms with larger macro platforms benefited most.
That trend could continue as volatility boosts trading and margins this year.
Overall trading revenue is less than in 2011 and probably will not expand that much, according to Walker.
But the banks with universal platforms are still well-positioned to increase market share at the expense of those that have exited product lines.
A new cycle could however bring new entrants, Walker said.
“Wells Fargo is very well capitalized and is growing its capital markets business,” Walker said. The Canadians are also well capitalized and Basel III compliant.