Europe’s investment banks fell further behind their bigger US rivals in key growth areas of equities and advisory as they faced a “perfect storm” from regulation, market conditions and increased competition. Recent results showed Europe’s investment banks, which have already lost vast ground to US rivals, underperformed in the third quarter, with some delivering stark warnings about regulatory pressures that would depress future returns to shareholders.
“The outlook is uncertain for our industry,” Andrea Orcel, UBS investment banking boss, told the Financial Times in the week his bank reported a return on equity of about 30 per cent. “We’re facing somewhat of a perfect storm, from market, regulation and competitor headwinds.”
The competitor headwinds are the moves by Deutsche Bank, Credit Suisse and Barclays to reinvent their investment banks under new chief executives John Cryan, Tidjane Thiam and John McFarlane.
“A lot of banks want to expand in the same sort of activities, it’s generally the balance sheet light ones . . . like M&A and equity capital markets,” said Jon Peace, an analyst at Nomura. “You could imagine that more competition would not be conducive to better pricing.”
UBS reshaped itself around those kind of capital light activities in 2012.
The challenges facing European investment banks were made clear in the latest set of results. As well as having higher unit costs, estimates from Morgan Stanley showed European banks continued to lose revenue to US banks on an underlying US dollar basis.
Equities revenues at the seven biggest European investment banks fell 4 per cent in the third quarter. The four big US banks - excluding Morgan Stanley - enjoyed a 16 per cent rise in equities revenue. Advisory revenues fell 9 per cent at European banks and 4 per cent at US rivals.
Some European banks, like Deutsche Bank and UBS, outperformed US peers in fixed income, but overall European banks’ fixed income revenues were down 23 per cent year-on-year, worse than the 20 per cent fall at US banks, according to Morgan Stanley’s analysis.
“The US banks are gaining share in the faster growing higher returning businesses,” said Huw van Steenis, head of banks’ research at Morgan Stanley, who expected industry-wide revenues from equities to grow by 10 per cent next year and fixed income to grow at 5 per cent.
US banks have been helped by their dominance of M&A league tables in the last few years. Samir Assaf, head of HSBC’s investment bank, questioned whether this was a permanent phenomenon. “The main business (in M&A) was domestic US and US versus the rest of the world,” Mr Assaf said of recent industry trends. “Does it mean that would remain in the future? Or that others have no chance of remaining in this business? I would not go to this conclusion yet.”
The other big headwind facing European banks is a regulatory-driven surge in risk weighted assets (RWAs), a key metric used to calculate the capital ratios that banks are bound by. As RWAs rise, capital ratios fall, since capital ratios are RWAs divided by capital. Banks face a stark choice - reduce RWAs by selling assets, or increase capital.
Over the summer Deutsche Bank said its RWAs could rise by as much as a third due to regulatory ‘inflation’, in the past few weeks Credit Suisse and UBS have both warned of increases of about 20 per cent even if they do not take on new assets.
The RWA rules are global, but European banks are predicting far bigger jumps than their US peers. “The structure of the (Europeans’) balance sheet is different from the structure of the American banks,” said Mr Assaf, pointing out that US banks tend to get risk off their balance sheets with securitisations, while European banks hold it.
Mr Peace said the RWA situation would “absolutely” impact dividends among the Europeans. “Deleveraging leads to lower revenues, [which] leads to lower earnings,” he said. “Even if you’re keeping your payout policy constant . . . if earnings per share is down, dividends per share is down and dividend yield will go down.”