Why J.P. Morgan, BAML and Citi think 2016 will be a GOOD year for surviving fixed income traders
2015 is ending badly for those who work in banks' fixed income, currencies and commodities (FICC) businesses. Morgan Stanley is making 1,200 fixed income people redundant, 400 of whom are in the front office - many of them only recently hired. Bank of America and Citi both say the fourth quarter has been weak in fixed income trading. And Deutsche Bank and Credit Suisse are promising big reductions to their fixed income headcount.
And yet, you'd be wrong if you thought 2016 will involve more of the same. Believe it or not, the big US banks are actually pretty upbeat about the prospects for their fixed income trading businesses next year.
Fixed income survivors will start seeing the benefits in 2016
The Goldman Sachs Financial Services Conference has been taking place this week. There, big U.S. banks have repeatedly been asked the same question: why haven't they benefited from European banks' withdrawal from the fixed income business?
Their answer? Because that withdrawal hasn't actually taken place.
"There's a lag between people making announcements about strategic restructuring..and that ultimately manifesting in a material change," said Marianne Lake, CFO of J.P. Morgan, during her presentation on Tuesday. "Not very much has happened [yet]," she added.
Brian Moynihan, CEO of Bank of America, said much the same during his presentation yesterday. Banks that have declared their intention to slim down in fixed income (Credit Suisse, Deutsche Bank, Morgan Stanley, and Barclays Capital) haven't done so "dramatically" until "relatively recently," said Moynihan. "Before, there was a lot of talking but not much they were actually doing," he added.
In 2016, Moynihan predicted this will all change and that these banks will "take more action" in culling fixed income businesses. One reason is the coming Total Loss Absorbing Capacity Standard (TLAC) for systemically important banks, which comes into force in 2019 and requires banks to cut risk weighted assets fast, or raise more capital.
"2019 isn’t that far away and you really have to be adjusting fast," said Moynihan. Once wavering banks pull out, survivors should benefit. "There has been a lot of talk about re-positioning but there hasn’t been that much re-positioning in the overall set of firms," Moynihan added. "For those of us who have the capacity and talent, we should increase market share."
US banks have already made cuts to fixed income and are happy with the size of their operations
Goldman Sachs' CFO Harvey Schwartz has repeatedly proclaimed Goldman's commitment to its fixed income sales and trading business, even when revenues there have disappointed. Goldman cut 10% of its fixed income staff between 2010 and 2014, said Schwartz in October: there's no need for more cuts now.
With the clear exception of Morgan Stanley, rival US banks are saying much the same thing.
Moynihan said Bank of America has already right-sized its fixed income business to fit the available balance sheet. A few years ago, chief operating officer Tom Montag was told he had $600bn of balance sheet, $30bn of capital and some VAR limits and that he had to, "go figure out the best way to deploy that," said Moynihan. As a result, Montag cut $1bn of operating expenses per quarter.
"We reduced breakeven point from maybe $3.5bn to $2.5bn or even $2bn a quarter," said Moynihan. As a result, Bank of America's sales and trading business is now well-positioned: "It's never going to make a huge return on equity...but it's a nice business, it covers its cost of capital," Moynihan added.
John Gerspach, CFO of Citigroup, said something similar during his presentation. When asked why Citi isn't cutting 25% of its fixed income staff like Morgan Stanley, Gerspach said Citi has been, "resizing the business actively for the last three years" and that the future is about "adjustments" rather than dramatic changes. Citi is taking a $300m 'repositioning charge' in the fourth quarter, said Gerspach, but this is going to be spread across businesses rather than in fixed income particularly and is the result of, "resizing infrastructure."
Market conditions to improve
Finally, while the expected US rate rise might be filling markets with trepidation, it could nonetheless be good news for banks' fixed income businesses.
"A rising U.S. interest rate environment with divergent monetary policy should be constructive for [the] rates [business]," said Lake during her presentation. At the same time, Lake said banks' credit sales and trading businesses could benefit as credit spreads come out of their "cyclical trough" of 2016.
It's not all good news though. Following this week's presentations, banks were repeatedly quizzed about their exposures to energy companies. And Lake noted that other banks' withdrawals from fixed income trading won't necessarily make much difference: the banks that are pulling out, "didn’t have material market share," and, "weren’t particularly profitable," anyway.