For the past two years or so, Credit Suisse and Deutsche Bank have carried on winning business and making markets, but in private they have been a punchbag for their rivals, as they have ploughed through punishing restructurings that have sapped morale.
Chief executives of major US banks have talked about gaining market share thanks to the weakness of their competitors, while headhunters, scenting a flood of business, joked about the CVs flooding out of Deutsche when chief executive John Cryan announced in January 2017 that he was axing bonuses for 2016.
The absolute size of the European firms in capital markets and investment banking has also taken a long march downwards. In the third quarter of 2017, Deutsche — the firm that recently regarded itself as “last man standing” among European investment banks — made €1.17bn of revenue in fixed income, currencies and commodities. JP Morgan and Citi made $3.16bn and $2.87bn respectively. But these figures do include the vast US market, where few foreign firms have ever cracked the top four.
Alasdair Warren, head of CIB for EMEA at Deutsche Bank, says: “We are naturally a scale player — we are big and we are globally relevant. There’s a certain scale that you have to be in most businesses to be competitive and deliver efficiencies. But do we define success as being the number one everywhere? No we don’t. We do define it as leading the market in Europe, being the clear number one in Germany and being relevant and able to serve our clients in the markets that matter globally.”
Some of this is down to US strength, and some of it down to European weakness. Deutsche Bank’s tangle with the US Department of Justice over residential mortgage-backed securities in 2016 was an ugly moment in the bank’s history.
When reports broke in September 2016 that the bank’s settlement for RMBS mis-selling could be up to $14bn, some corporate deposits fled the bank, and prime brokerage clients left as well.
That blew a hole in the revenues in Deutsche’s markets division, and contributed to the bank’s decision to raise €8bn in capital in 2017.
Warren says: “There was never a moment, notwithstanding the capital that we raised, when we weren’t able to deploy capital into attractive client-driven situations.”
But nonetheless, this balance sheet infusion vaulted Deutsche from among the least capitalised major investment banks to close to the top of the table, and took all questions of capital constraint off the table. It may have had capacity before the rights issue, but there can be no question afterwards.
Credit Suisse had a different set of issues to deal with during 2017. It was never clear that a credit-focused US investment bank, a sleek wealth manager and universal banks in Switzerland and Asia belonged under the same roof. But Credit Suisse cancelled plans for a partial IPO of the Swiss unit, and went to shareholders for Sfr4bn instead, fending off calls to break up the group along the way.
Barclays did not raise capital in 2017, but it did cut its dividend at the beginning of the year, despite years of restructuring efforts.
Under previous chief executive Antony Jenkins, the firm had plunged deep into the now-standard prescriptions for reviving a weakened bank — set up an internal bad bank (Barclays Non-Core), large scale layoffs, the unwinding or novation of expensive structured positions, and the sale or wind-down of the accumulated fruits of decades of empire building.
Watershed year
But 2017 may have been a watershed year. With the biggest fines and most of the restructuring behind Europe’s biggest banks, 2018 ought to be time for the fightback.
Perhaps that is optimistic. Morgan Stanley’s banks analyst team says: “European banks lost market share in Q3 of 2017. This was surprising, especially on the investment banking division side, given that the macro backdrop of stronger equity issuance in Europe could have read positively for European banks.”
But at least, following the capital raisings of 2017, European firms ought to have the resources to get back on the attack. Deutsche has raised €8bn of new equity — enough to support €160bn of assets at a 5% leverage ratio. Barclays has said it will extend £50bn of extra balance sheet to support fixed income financing business.
That won’t be easy. Cryan has said that Deutsche has not yet deployed “a cent” of the €8bn rights issue — perhaps hampered by a lousy third quarter for fixed income and record low volatility.
“Volatility is at the lowest level I have seen in my 30 year career,” says Michael Reuther, head of corporate clients and group treasury at Commerzbank. “We haven’t seen this combination of low volatility in fixed income, equities, and foreign exchange.”
The hurt from Frankfurt
As Reuther points out, “the ECB is not going to raise rates any time soon”. But when it does, perhaps by the end of 2018, that will bring a swathe of banking business back online. Commercial and retail banks will make money from the yield curve, but investment banking, too, can expect revenues to bounce back, particularly in fixed income.
“The biggest factor affecting fixed income financing has been the central bank liquidity,” says Miguel Otamendi, co-head of FIG EMEA at Nomura. “It has taken so much financing business out of the market through QE and compressed margins. Take away the ECB and flows of capital rationalise, the credit market starts discriminating on prices, and that’s the whole business — that’s why you hire an investment bank.”
Less ECB support for the market will come only after a broad-based recovery in Europe, of which some are already seeing signs.
“Eurozone macro remains a more compelling theme for us than global investment banking, where Q3 once again demonstrated the strength of the competitive challenge from better-capitalised US peers,” wrote Macquarie’s banks analyst team in a client note.
But a broader increase in European confidence ought to boost other areas of investment banking, to the benefit of all wholesale firms — and particularly those with deep presences in European markets.
“As the economy in Europe looks up and pools of capital here become a little more confident, that fuels the equity market and a growth in M&A, so there’s quite a bit of room for catching up,” says Otamendi.
For the quintessentially ‘European’ bank — and the year’s biggest turnaround story — it’s the improved prospects across the wider economy that matter most.
“Rather than look at what the banks have done for themselves, look at what European clients are doing,” says Jean Pierre Mustier, chief executive of UniCredit. “For the first time since the crisis, we have a very supportive economic environment, growth in Europe is outstripping the US, and we have a broad-based sectoral recovery.”
Mustier unveiled UniCredit’s turnaround plan in December 2016. At the centre of it was a €13bn rights issue, which Mustier marketed in person, major sales of non-performing assets, and a refocusing of the firm on being a pan-European commercial bank. This was in sharp contrast to the bigger investment banking operations at Deutsche and Credit Suisse, which needed extra capital in part to double down on their CIB strategies.
“US banks are not competition against European banks for most of their business,” says Mustier.
“Some of the US firms are active in very large M&A and ECM, but they are not very present in banking the small and medium sized companies that account for 80% of the jobs in Europe.”
Regulation ruling the nation
European firms must face up to another risk, though — the tilting of the playing field against them.
Global regulators have finally finished the Basel III package of rules and early signs are European banks have further to go to meet them than US rivals. Meanwhile, US firms can hope that deregulation is just around the corner for them. Citi’s shares are up nearly 50% since Donald Trump was elected president in November 2016, and the risk that the US imposes regulation on the world which it declines to apply at home has never been higher.
European politicians have tried to protect the banks they host from the worst effects, promising that Basel IV will not add to overall capital demands.
“The firms that look to come out worst from the RWA output floors are very strong politically, and in very influential countries,” says Otamendi. “One way or another, though, we will end up with some way to compare apples with apples in terms of capital.”
But whatever happens with US regulation, the regulatory treadmill does appear to be coming to an end.
“[At the 2016 investor day] we said that Basel IV will happen, and it will,” says Mustier. “Regulators want it, and we can have a fairly clear understanding of what it will look like.”
He continues: “Contrary to some of my peers in other banks, I think a bit more regulation is good for banks. More regulation means banks will be safer for investors, and if the top line goes up at the speed of the economy, the lower cost of capital should help the share price.”
That is the right way to look at it. Though comparisons across the Atlantic can provoke jealousies, what matters is the certainty, safety and strength of the banking systems and capital markets on both continents.
By this measure, at least, 2017 delivered. Europe has come out of the other side with more certain regulation, stronger banks, a stronger economy, and a renewed swagger, from trading floors to retail lenders. Here’s to 2018!