U.S. Banks' Capital Markets Outlook Brighter but Still Tough

The outlook for major U.S. banks' equity trading and investment banking businesses may be brightening somewhat in early 2013, but weak volumes and a still sluggish M&A environment are likely to hold back revenue growth in the near term, according to Fitch Ratings. Until a lasting resolution of U.S. fiscal problems is agreed, moreover, equity volumes and trading bank revenues are still exposed to downside risk.

Fourth-quarter 2012 equity underwriting, trading, and advisory revenues all showed signs of life relative to abysmal levels reported in 4Q11, when market turmoil surrounding troubles in the eurozone was at a peak.

Aggregate capital markets revenues for the top-five U.S. banks (JPM, Citi, BofA, GS, and MS) grew by 39% year over year in the fourth quarter, with fixed income, currencies, and commodities (FICC) revenues driving 47% of the total. Despite the typical seasonal slowdown in the fourth quarter and deep concerns over fiscal issues late in the year, capital markets revenues declined by only 10% sequentially from a generally solid 3Q12.

Equity underwriting and advisory revenues for the top-five banks bucked the broader trends, with both categories showing growth in 4Q12 compared with the prior quarter. Underwriting revenues grew by 16% sequentially and 34% year over year. Advisory revenues rose by 17% sequentially and 13% versus the prior-year period.

Major banks have generally reported a better pipeline of advisory and equity underwriting activity moving into 2013. However, lingering macro risks linked to developments in Washington and the eurozone have not been addressed to the extent necessary to support rapid growth in deal volume.

Relative to debt underwriting, which drove 17% of total capital markets revenues in 4Q12 on the back of robust bond issuance, equity underwriting and advisory accounted for a smaller share of the revenue mix for major U.S. banks (8% and 5%, respectively, of total capital markets revenues in the fourth quarter).

Relief surrounding the tax agreement reached at year end has fuelled a pickup in equity volumes and share prices since the beginning of January (S&P 500 up 4.7% ytd). Still, market activity could again be hit by fiscal uncertainties in March, when debate over sequestration and the expiration of federal spending authority could raise the risk of fiscal drag later in the year.

The first quarter is typically the strongest for U.S. banks' capital markets revenues. A continuation of somewhat better equity market performance witnessed so far in January, coupled with improving deal flow, could set the stage for good capital markets revenue growth in 1Q13. However, the looming fiscal battles that are set to intensify in the spring could undercut any signs of revenue strength evident in the early part of the quarter.

Importantly, a recovery in advisory and underwriting volume, driven principally by cyclical factors and a revival of economic growth prospects, may not be followed by a corresponding bounce back in equity trading volumes, which appear to be weakening on a secular basis.

In response to the shifts in capital markets activity seen since the crisis, many large banks have reduced headcount significantly. In 4Q12, profitability of capital markets segments generally benefited from efficiency initiatives. We believe this pattern will continue, with increasing specialization in capital markets segments, such as equities trading, M&A advisory, and debt capital, as banks focus on their key strengths. In addition, banks are focused on those businesses within capital markets where they can achieve adequate returns on a Basel III risk-weighted basis.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

To subscribe or visit go to:  http://www.riskcenter.com