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December 16, 2011

Bulge Weathers Rough Year

Top Stories in 2011

By Peter Chapman

With one exception, the year 2011 is proving a tough one for the nine bulge bracket equities shops.

In the first nine months, only Morgan Stanley managed to excel. The other eight either saw their revenues decline from last year or grow only modestly.

Conditions looked promising at the top of the year. In the first quarter, Goldman Sachs, Citigroup, UBS, Deutsche Bank and Morgan Stanley all reported higher levels of orders and commissions. That didn't prevent most of them from posting lower revenues overall, however.

Citi reported a healthy cash equities business, but still recorded a 9 percent drop in total revenues due to problems with "principal positions." Goldman cited lower market making revenues for a 7 percent decline. (All figures are net of accounting gains and losses attributable to debt revaluations.)

Morgan Stanley was one of the few to post a gain over the first quarter of 2010, firing on all cylinders. Cash equities, derivatives, and prime brokerage all did well, chief financial officer Ruth Porat told analysts at the time. Prime brokerage recorded its highest level of client balances since the financial crisis of 2008, she noted.

By the second quarter, business conditions worsened as money mangers reined in their trading. Still, the five U.S. bulge banks managed to post double digit gains while the Europeans recorded declines. In the U.S., share volume was down 30 percent compared to the second quarter of 2010. In Europe, notional value traded (in Euros) was down 14 percent.

Deutsche Bank, Credit Suisse, and UBS all reported deterioration in their cash equities business. Deutsche Bank found conditions worse in Europe than in the U.S., where it found some success in derivatives trading. Still, the big German bank posted a 14 percent drop in the quarter to €555 million.

By contrast, UBS reported a big drop in derivatives revenues due to "more challenging trading conditions."

The U.S. banks did well. Goldman overcame anemic inflows of stock orders with better market making results, especially in derivatives. Morgan Stanley reported a 37 percent jump to $1.7 billion.

Again, the gains were across the board, according to Porat, stemming from "strong client activity." In addition, growth in Morgan Stanley's electronic trading services "continued to outpace the market," she said, "while equity derivatives were up significantly."

If the second quarter was dull, the third quarter was anything but. In both the U.S. and Europe, volume and volatility soared as panic over Europe's debt woes set in. Despite heavy trading by clients, most of the bulge brokers got bruised during the quarter. Some reported a strong commission business, but were done in by their market making.

Much of the pain came in derivatives, a notoriously difficult business to manage during frothy market conditions. The volatility got the best of JP Morgan, according to chief financial officer Doug Braunstein, who reported an 8 percent drop in equities revenues to $1 billion during the quarter.

Others did much worse. UBS reported a 30 percent drop to 630 million Swiss francs because of lower revenues in both cash equities and derivatives. UBS took its derivatives hit in Europe, while reporting better results in the U.S. (The figure does not include the 1.85 billion Swiss franc charge UBS took for the losses of a rogue trader on its Delta One desk.)

Both Citi and BofA Merrill were also whipsawed in equities derivatives. Bruce Thomson, Merrill's chief financial officer, reported that revenues from cash equities were down 7 percent during the quarter, but those from derivatives dropped even further.

Only Morgan Stanley, Goldman and Credit Suisse were able to thrive during the tumultuous quarter. Morgan Stanley's Porat again singled out the firm's electronic trading services and its derivatives franchise for praise. Goldman reported robust commissions and improved market making results. The latter was due to "effective risk management of customer-driven positions" in the volatile environment.

As Traders Magazine was going to press the market conditions of the third quarter were still present. The stock markets in the U.S. and Europe were still chewing over the European debt crisis as concerns moved from Greece to Italy. Volume in October and November was up significantly over last year and volatility, as measured by the VIX index, was at historically high levels. Equities departments are bracing for layoffs and significantly lower bonuses.


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