If all the talk of layoffs last year wasn’t enough proof, the financial results from the five biggest U.S. equities houses confirm it: Last year was worse than the year before.
Collectively, the equities departments of Goldman Sachs, Morgan Stanley, J.P. Morgan, Merrill Lynch and Citigroup took in $1 billion less last year than they did in 2011.
The five firms grossed $23 billion in 2012, down from $24 billion the previous year, or a decline of about 4 percent. The data excludes adjustments for credit and debit valuations. It also excludes the approximately $1 billion and $800 million in revenues from Goldman Sachs’ reinsurance activities during 2012 and 2011, respectively.
There was no single explanation for the drop, as the giant banks operate in markets across the globe in both cash equities and equities derivatives. Less customer activity in both cash equities and derivatives got the blame, as well as shortfalls in interest from prime brokerage businesses.
It could have been worse. Goldman actually reported higher revenues last year, but that was due to a onetime sale of its hedge fund administration business to State Street. Goldman booked a $500 million gain on that trade.
The banks do not break out the components of their equities revenues, but an analyst at J.P. Morgan Cazenove in London made an attempt to do so in 2011. Excluding his own firm, Kian Abouhossein figured the other four take in between 24 and 40 percent of their revenues from cash equities, and between 27 and 37 percent from equity-linked derivatives.
These numbers may have changed as some of the firms have shut down their prop trading desks. That business represented between 9 and 15 percent of revenues in 2011, Abouhossein estimated.
Prime brokerage is a significant endeavor at the firms, representing between 18 and 34 percent of revenues, the analyst estimated.
According to Howard Tai, a senior analyst with Aite Group, last year’s decline was the result of lower volumes in both equities and derivatives trading. That is clear from data supplied by the World Federation of Exchanges. The organization found that worldwide share volume dropped 22.5 percent last year, while volume of exchange-traded equity derivatives contracts fell 20 percent.
(Full-year data covering over-the-counter equities derivatives contract volume is not yet available from the Bank of International Settlements.)
Tai explained that the drop in trading volumes of U.S. shares is due to the shift of institutional and investor money from equities to fixed income. Also, retail investors continue to suspect that the market infrastructure is stacked against them in favor of high-frequency traders, at least from an intraday trading standpoint, he said.
At the same time, lower market volatility reduced the need to hedge with derivatives, he said. The CBOE Volatility Index, or VIX, has fallen from a peak of 79 in October 2008 to 12.6 recently. That is the lowest level since the credit crisis erupted in September 2008.
Still, data from another source suggests the large U.S. banks made a killing in equity derivatives last year. The Office of the Comptroller of the Currency reported that, for the first nine months of 2012, the nation’s bank holding companies doubled their revenues from trading equity derivatives to $11.3 billion. In the first nine months of 2011, the banks grossed $5.6 billion, the OCC reported.
Another challenge for banks’ institutional equity trading businesses is that equities are primarily traded electronically, with minimal commissions, Tai said. The margins for IPOs and secondaries are a lot higher, “so you need for companies to come to the stock market to raise money.” But with interest rates so low, they are going to the debt market instead, he said.
Volumes are also low because equities tend to move up or down together so there is less incentive to trade, said Larry Tabb. “Coke and Pepsi are moving in the same direction instead of in relationship to what their real business model is showing,” he said. “A lot of what’s driving the market is macro shocks. Is Washington going to default on their debts? Will the euro break up? If the euro breaks up, it doesn’t make a difference whether I own France Telecom or Fiat. All European stocks are going to go to hell in a handbasket.”
Still, there is a silver lining for the bigger firms. They are faring “much better than the smaller folks,” Tabb said. That’s because the larger firms are attracting more business and pick up a greater slice of the available volume.
With fewer commission dollars, buyside firms are concentrating flow with larger firms that can provide more services such as research, corporate access, IPOs and capital, Tabb explained. And “the dealers have been doing a better job of rationing these services to buyside firms that don’t meet volume and revenue projections,” he said. Dealers are also ticking rates up and not being “as aggressive in pushing everything through low-cost low-touch channels,” Tabb said.
Traders Magazine offers brief synopses of the firms’ results below.
Goldman Sachs
The firm reported a modest 3 percent increase in revenues from its global equities business to $7.4 billion last year, excluding the results of its reinsurance business and any effects of credit or debit value adjustments. The rise was entirely due to a $500 million gain on the sale of its hedge fund administration business to State Street in the fourth quarter. Goldman’s market-making business did well last year, but its commission-generating activities did not, according to company data. Goldman reported a drop of about $600 million, or 16 percent, in commissions and fees. That reflected lower market volumes, management said. Excluding the gain from the sale of the hedge fund business, revenues from Goldman’s securities services business, which includes prime brokerage, fell. That was due largely to a decline in customer balances, according to company management. (In 2011, prime brokerage accounted for about 18 percent of Goldman’s equities revenues, according to estimates by J.P. Morgan Cazenove. Cash equities represented 30 percent, while derivatives represented 37 percent. Prop trading accounted for the rest.)
Morgan Stanley
The firm reported an 11 percent decline in its equities business to $5.5 billion last year, excluding the effects of any credit or debit value adjustments. Much of the decline occurred in the April-to-June period. That drop cut across both cash equities and equity derivatives and was due to “market uncertainty and lower client volumes,” according to the company’s 10-Q. Results reflected “challenging markets and lower industrywide liquidity and volume,” chief financial officer Ruth Porat told analysts at the time. In the third quarter, the firm’s revenues from cash equities remained level with that of the second quarter, Porat told analysts, despite “significantly reduced levels of market activity globally.” Business picked up in the fourth quarter as revenues in cash equities benefitted from rising volume in the Americas and Asia, Porat said. Notably, Morgan Stanley’s equity derivatives group had its strongest fourth quarter since 2008, the CFO added. (In 2011, Morgan Stanley got about 24 percent of its equities revenues from the cash business and 27 percent from derivatives, according to estimates by J.P. Morgan Cazenove. The rest came from prop trading and prime brokerage.)
Merrill Lynch
The firm reported a 13 percent decline in its equities business to $3.3 billion last year, excluding the effects of any credit or debit value adjustments. Most of the decline resulted from a drop in revenues from commissions and brokerage fees of about $400 million. Trading profits and interest from margin and stock loans declined only slightly. Merrill management attributed the decline to lower market volumes with the brunt of the decline occurring in the first half of the year. In the final quarter, Merrill saw a pickup. The uptick was due to higher balances in its prime brokerage business and “improved trading performance in derivatives,” according to a press release. (In 2011, Merrill got about 40 percent of its equities revenues from the cash business and 31 percent from derivatives, according to estimates by J.P. Morgan Cazenove. The rest came from prop trading and prime brokerage.)
Citigroup Global Markets
Equities revenues were essentially flat for Citigroup last year, at about $2.4 billion, excluding the effects of any credit or debit value adjustments. The firm saw a drop of about $430 million in revenues during the first half of the year, compared with the same period in 2011. But that position reversed itself in the second half by roughly the same amount. The rebound stemmed from two factors. First, Citi’s derivatives group performed better, because of “changes we made to that business, including new leadership,” chief financial officer John Gerspach told analysts. Second, during the second half of 2011, Citi recorded large losses from proprietary trading. That group has since been disbanded. Still, lower industry volumes, particularly in cash equities, plagued Citigroup for most of the year, the firm reported. “Low levels of client activity remain a substantial challenge,” Gerspach told analysts in July. (In 2011, Citi got about 29 percent of its equities revenues from the cash business and 35 percent from derivatives, according to estimates by J.P. Morgan Cazenove. The rest came from prop trading and prime brokerage.)
J.P. Morgan
The firm reported a slight decline in equities revenues to $4.4 billion last year, excluding the effects of any credit or debit value adjustments. Outgoing Chief financial officer Doug Braunstein reported “improved results” in both cash equities and derivatives in the first quarter, but changed his tune later on. In the second and third quarters, Braunstein reported a weak cash equities business that was offset by relatively strong derivatives and prime brokerage businesses. “Cash volumes continue to remain a challenge,” he told analysts in October.
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