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Fixed income slump leaves banks exposed
Topic Started: 30 Sep 2013, 10:23 PM (476 Views)
peter fraser
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Fixed income slump leaves banks exposed
Gareth Gore
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Banks most heavily reliant on fixed income trading are scrambling for ways to offset substantial declines in revenue and new regulations, with bankers predicting deeper cost cuts and job losses, and some pushing a new industry-wide platform to ease the burden on individual firms.

Prices of many fixed income securities have dropped since May, as the market began to price in an early end to the US Federal Reserve’s quantitative easing programme. The declines have led to a drop in trading and reduced the value of securities that banks hold on their books.

At the same time, banks are under pressure to reduce their balance sheets to meet new leverage rules, with the asset-heavy fixed income trading business likely to be worst affected. With fixed income hit on two fronts, bankers are warning of some difficult months ahead.

“You can’t just rebuild your investment bank overnight, so this is going to be painful,” said one global head of fixed income at a European bank. “Everything in fixed income has been impacted by regulation – bonds, derivatives, repos. At the same time, trading revenues are well down.”

Under the proposed new leverage regime, banks will need to hold Core Tier 1 equity equivalent to 3% of total assets. Some, including Barclays and Deutsche Bank, have already announced plans to cut their balance sheets to get there, with the two planning about €400bn of cuts between them.

The costs of such moves are already beginning to show. Barclays said fixed income revenue was down £500m from a year earlier in July and August alone – equivalent to 30% of what it made in last year’s third quarter – while Deutsche has said debt trading income will “decline significantly” from a year earlier.

Lower trading volumes will have affected revenues, but rivals say that shedding assets during the recent market volatility will have also taken its toll. “Banks with the biggest balance sheets have to shrink, and cutting your balance sheet always costs you money,” said a second fixed income head.

Exposed

Both banks are heavily reliant on fixed income. Barclays’ fixed income, currency and commodities unit generated 62% of revenues at its investment bank in 2012, while Deutsche’s debt trading unit generated 59% of its investment banking revenues.

Other firms are even more exposed to the decline, although they are under less pressure to cut their balance sheets. RBS, which has shuttered many of its other businesses in recent years, is the most dependent of the big banks on fixed income, while Citigroup and Nomura are not far behind.

While marginal players in the business are expected to exit, those most reliant on fixed income are unlikely to take such a drastic route. Instead, they are expected to specialise in certain products, and ditch debt securities they hold on their balance sheets in areas they don’t see as core.

“A lot of people will struggle to meet the leverage ratio without completely altering their business models,” said one fixed income head based in London. “Most banks will have to become clinical about what they do, especially in products like repo, structured credit and even CDS trading.”

Indeed, banks have been frantically recalibrating their fixed income business models in recent months, after the Basel Committee surprised the industry in June with plans for a more onerous measure of leverage that will punish those banks that have tended to run bigger, more leveraged businesses.

“There’s no doubt that the fixed income division is being run through a set of metrics now that are different from the metrics we had 12 months ago or 24 months ago,” Deutsche co-chief executive Anshu Jain told a banking conference in London, adding that the bank was “de-risking” its “debt sales and trading franchise”.

Cost-cutting

Cost-cutting is likely to rear its head again as banks seek to offset lost revenues in fixed income. One proposal doing the rounds in the industry is for an intra-bank global bond platform, which would allow banks to offer access to a wide range of securities at lower cost – and without having to hold bonds on their books, which would also improve leverage ratios.

That would require the collaboration of firms across the industry, however, and may be thwarted by firms that have no need to cut balance sheets and are more balanced in terms of business mix. Such banks may prefer to take a hit to revenues in the short term and then attempt to grab market share.

JP Morgan and Morgan Stanley have both said revenues were steady in the third quarter, which might worry those banks such as Barclays and Deutsche that have been forced into cuts.

Even some European firms are having a relatively good time: “We continue to gain market share and in fact, with rate expectations rising, we have seen increased activity from corporates in the last few months,” said the second fixed income head.
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