Sector: Wholesale Banking Review 1Q20

Capital Markets: Overview

In an extraordinary quarter, the 15 banks’ capital markets revenue surged 20% y/y, to $54bn. Operating costs grew at just 4%, however, reflecting an uncertain outlook. In the meantime, the aggregate pre-tax profit from FICC more than doubled, led by EMEA banks; in Equities, US banks led the way, as European leaders sustained severe hits in structured equities.

Front Office staff levels declined c.5% y/y, with Equities being (slightly) harder hit than FICC, and Banking essentially unchanged. Headline numbers, however, do not tell the full story, as there are important differences between banks’ internal definitions of front/mid/back office roles.

Several banks paused redundancy programs during Covid-19 crisis, but this won’t last: trading trends seen in April and May suggest 2Q20 will not be as lucrative as 1Q20 – especially in M&A and ECM – and there isn’t enough data yet to forecast 2H20 with confidence. Banks will therefore likely take a cautious attitude to new hiring – and bonuses.

Private equity firms are expanding their reach, with big players lining up significant funds for new investment: a unit of GSAM is raising $5-10bn for a new fund for corporate financing; PIMCO is  seeking ‘at least $3bn’, respectively, for new distressed funds; Apollo recently announced $1bn+ investment in just ten companies; the list goes on.

Commercial Banking & Treasury Services

In corporate/commercial banking, a rapid fall in LIBOR in March hit loan yields. Most banks reported a surge in loans in the same month – partly due to clients’ drawdowns – and credit costs rose, with significant reserve build-up being especially evident in commercial loans. Also, 1Q20 results highlighted a huge divergence in the level of provisioning taken by different banks: this is reminiscent of the initial stages of 2008 Crisis.

In the US, rumours emerged that major US banks are setting up subsidiaries to manage assets seized from bankrupt energy operators. Banks have not confirmed such plans, but the rumour makes sense: the alternative is fire-sale of assets into a weak (or falling) market.

The Covid-19 crisis exposed a key risk for trade finance: market participants reported a severe in private credit insurance (PCI), and that could herald problems: WTO estimates that 80-90% of world trade is reliant on trade finance, and EMEA banks are particularly heavy users of PCI.

Contour, the blockchain trade finance platform, has completed the trials in Hong Kong and is ready to launch in 2H20. The platform is backed by eight banks, including HSBC, Standard Chartered, Citi, CTBC, and BNP Paribas. This follows CIMB and iTrust’s launch of blockchain trade financing platform in Singapore, in Oct-19 (Also, according to People’s Bank of China, 170 banks have joined the blockchain platform spearheaded by China’s State Administration of Foreign Exchange).

Wealth Management

Wealth management revenue declined 5% y/y but careful cost control lifted profits by 8%. Structured notes were in high demand.

Banks have not suffered significant losses on their loan portfolios, but they may change. After years of boosting lending – both Lombard and ‘hard-to-value’/tailored – to their wealthy clients, private banks are now asking for additional collateral. This is a prudent course of action: setting aside the upheaval in the markets, it’s important to note that Lombards have floor RWA of just 12% (reflecting the usually liquid collateral, deposited with the bank), a fraction of other retail loans. Tailored loans, however, are often backed by illiquid – or, at the very least, unusual – collateral.

So far, there is little indication of losses/writedowns in these books; but if the present state of markets persists – a real possibility – it is hard to see how the industry could escape losses. Even without losses/writedowns, the outlook for lending revenue – 30% of total revenue for the banks in this report – is not good. The remainder of 2020 looks … challenging.

For robo-platforms, this is the first major downturn. It is too early to predict how these young firms/teams will fare, but it’ll be interesting to see who emerges stronger – or at least bigger. Whatever the outcome, there is little doubt that recent months have demonstrated that much of the service can be delivered remotely, via digital channels. With revenue and margins under pressure, we expect banks will promote digital delivery to wider range of clients; outsource (and/or centralise) investment functions and back-end functions; and boost ‘client acquisition’ teams.