As investment banks head nervously into 2014, revenues are flatlining with no sign of improvement anytime soon. My column for Financial News (from August)
The thing about growth is that, like liquidity, you only really notice it when it’s gone. For years, the investment banking industry was accustomed to double-digit growth. Now banks are having to grind out every last dollar.
There have been some sporadic signs this year that the industry might be getting back on its feet. But the latest set of quarterly results provided a chastening reality check and a reminder of the challenges of operating in a world without growth.
Revenues across the investment banking industry increased by a mere 2% in the first half of this year – effectively a rounding error – according to my analysis. Just two out of the 14 big banks posted a double-digit increase in revenues (and they were coming off a low base), and revenues dropped at five firms.
There is little evidence that growth will ride to the rescue anytime soon. This realisation is forcing investment banks to be more creative about how they increase their profitability: they are cutting costs, focusing on their core business, trying to improve productivity, and stealing market share from rivals that are in more trouble than they are. While this approach has worked for some banks, there’s only so far it can go.
Goldilocks banking
Once upon a time – and not so long ago – investment banks lived in a fairytale world of perpetual double-digit growth. From the early 1990s until 2007, the global stock of debt, loans and equity (a decent proxy for capital markets), increased at an average annual rate of 8%, according to McKinsey – meaning that it was doubling in size roughly every 10 years.
Investment banks grew even faster, with their revenues increasing at a compound annual rate of just under 12% in the decade up to 2007, according to consultancy Oliver Wyman (doubling roughly every six years). And (of course) Goldman Sachs grew fastest of all, with a blistering annual grow rate in its revenues of 20% between 1997 and 2007 (doubling in size roughly every four years).
Since the crisis, that sort of growth has gone the same way as Lehman Brothers. Global economic uncertainty and tighter financial regulation means the growth rate in financial stock has slowed to less than 2%. And, after a premature relief rally in 2009, the investment banking industry has slammed into reverse.
Over the past four quarters, revenues at the biggest investment banks are down by more than one fifth compared with 2009. Revenues from fixed income – the traditional engine room of investment banks – have slumped by one third over the past few years. In the first half of this year, revenues from fixed income fell by 9%.
In fairness, there were signs of growth in the first half. Revenues from equities and investment banking rose by nearly a fifth, but much of that was a rebound from a low base. The only part of the business that has been growing steadily is debt capital markets.
The outlook doesn’t look too rosy either. JP Morgan estimates that there will be no growth in investment banking industry revenues this year compared with 2012 (which was hardly a great vintage), followed by just 1% growth in 2014 and maybe another 1% the year after. In other words, the industry is flatlining. In comparison, Morgan Stanley seems positively extravagant in predicting that growth might hit 3% to 4% a year over the next three years.
Riding to the rescue?
As recently as 2011, many investment banks believed that they could rely on growth to dig them out of the hole. The securitisation market was going to reopen, deleveraging by European banks would force companies to turn to the capital markets, investment banks would start providing radical new solutions to the pensions crisis, China would have a soft landing, and the eurozone crisis would blow over.
While some of these longer term opportunities have not gone away, “growth is not going to ride to the rescue”, as the chief executive of one European bank recently put it to me.
The prospect of this unfamiliar zero-growth future is forcing banks to take some radical action. First, and most obvious, banks have focused more on the profitability of their business rather than just top-line growth. European banks in particular have been forced to pull back from nice-to-have but unprofitable global outposts to focus on their core business, with banks such as Credit Suisse, RBS and UBS performing radical surgery on their investment banks.
Second, every investment bank has cut costs and fired thousands of staff – and found that these costs are remarkably stubborn. For all the noise about draconian axe-wielding, costs across the industry over the past four quarters are exactly the same as they were in 2009 (while revenues have fallen by one fifth). In fairness, costs have fallen by about 8% from their peak in 2011, mainly because banks have fired an estimated 15% of their front-office staff since then.
Third, after years of not having to worry about efficiency, investment banks are falling over themselves to improve the productivity of their systems and those staff left standing. In other words, they have taken a more disciplined approach to management. This ranges from moving staff to Birmingham (Deutsche Bank), hiring thousands of staff in “high value locations” such as India and Utah (Goldman Sachs), integrating legacy IT platforms (notably HSBC and JP Morgan) and reorganising client coverage (Credit Suisse). In short, they are doing anything and everything to squeeze more out of less.
Zero sum game
Finally, banks are trying to eke out growth by stealing market share from their weaker rivals (although by definition, this is not a game at which everyone can succeed). While revenues from fixed income dropped in the first half, the two largest players in that market (Citigroup and JP Morgan) increased their market share further.
Goldman Sachs has quietly emerged as the third biggest bank by revenues in the debt capital markets business. And Barclays has gained significant market share in equities over the past five years, even if its progress in mergers and acquisitions has been less impressive. Big, well-capitalised, and particularly US, banks are confident that they will continue to take market share off their punier rivals over the next few years.
This all means that, for the foreseeable future, growth will be a function of shuffling revenues from one bank to another while trying to keep a ruthless rein on costs. Eventually, real growth will return, even it is unlikely to be as strong as before. After all, companies and governments need capital. Savers need returns.
But which investment banks will survive until growth returns? And will they be able to retain the discipline they will have learnt in the lean years when it does?
–This article first appeared in the print edition of Financial News dated August 12, 2013