Brexit is the last thing investment banks needed.
Friday’s currency swoons and stock rout — triggered by U.K. voters’ surprise decision to withdraw from the European Union — herald even harder times for securities firms already struggling to improve earnings. While some desks made money in the initial turmoil, continued market volatility in the months ahead poses a threat to trading profits. And companies that hire banks to advise on takeovers and raise money face years of uncertainty as Britain negotiates new international ties.
Analysts on both sides of the Atlantic cut earnings estimates for the biggest investment banks on the expectation that securities sales and major deals will be thwarted by economic and political uncertainty and currency swings. Fees from that business are likely to “tank,” dropping more than 30 percent this year at European banks, Sanford C. Bernstein analyst Chirantan Barua wrote. Analysts at Citigroup Inc. and JPMorgan Chase & Co. estimated lower underwriting volumes in the U.K. and Europe.
“In light of such uncertainty, a lot of primary deals will be put on hold in equity and debt,” said Joseph Dickerson, an analyst at Jefferies International Ltd. in London. On the bright side, “the next week is going to be OK in terms of trading volumes.”
Bank stocks extended losses Monday in anticipation of weaker profit as the British pound continued its biggest slide on record from Friday, when global equities lost more than $2 trillion of value. Hans Humes, who runs hedge fund firm Greylock Capital, a specialist in distressed bonds, told Bloomberg Television on Sunday he watched fellow investors take a “step back,” leading to wider spreads on relatively muted volume. Such caution threatens to stifle the corporate bond market.
Lower revenue in European markets will probably chop earnings over the coming four quarters by an average of 4 percent at the biggest U.S. firms, Wells Fargo & Co.’s Matt Burnell said Friday. Those banks and their European counterparts may face a risk-off approach from trading clients, may of whom could be dealing with their own issues of losses and redemptions. Trading units already were coming off their worst first quarter since 2009.
“The pound and euro currencies are experiencing extreme movements, which could cause some clients to experience significant trading losses,” wrote Mike Mayo, a bank analyst at CLSA Ltd. “However, given that this was a much more anticipated event, banks should have been better positioned heading into the vote (we’ll see).”
In the short term, currency trading desks may have seen the biggest benefit, as many banks saw very high volume last week even after warning clients they may not be willing to take on principal risk. Jamie Dimon, the chairman and chief executive officer of JPMorgan, said his firm saw record foreign-exchange volume, at one point processing 1,000 trading tickets per second.
“Short-term trading revenues may even go up as volatility increases and volumes increase,” analysts led by Michael Helsby at Bank of America Merrill Lynch wrote in a note to clients on Monday. However, erratic volatility and longer-term uncertainty will probably offset these gains and hurt earnings, analysts at UBS Group AG led by Daniele Brupbacher wrote in a note to clients.
Some analysts caution bad trades may surface.
“Investment bank trading books could see some bombs go off as positions are exposed, albeit we would hope any sensible traders would have already hedged their positions for a Brexit scenario,” Gary Greenwood, an analyst at Shore Capital, wrote in a note to clients.
While banks have been operating with lower levels of trading inventory in the past, leaving them less vulnerable to large writedowns, “gapping” movements in credit spreads could still hurt trading revenues, JPMorgan analyst Kian Abouhossein wrote.
Barclays Plc, whose investment bank has been reshaping for almost a decade under three successive CEOs, fell as much as 11.5 percent in London trading on Monday, extending losses after its biggest drop in more than seven years on Friday. Its shares were cut by at least four brokers, including a sell rating at Citigroup. Deutsche Bank AG, Europe’s largest securities firm, slid as much as 8 percent. Stateside, investment banks didn’t do much better with Morgan Stanley down 10 percent on Friday.
“The future structure, profitability and, indeed, existence of Barclays’s investment bank is called into question,” Jefferies’s Dickerson wrote in a note to clients on Monday. “We expect a costly impact on the investment bank from the referendum result, stemming not just from reduced debt capital markets revenue, but also costs associated with bulking up subsidiaries located in EU jurisdictions such as Frankfurt and Dublin.”
HSBC Holdings Plc, which generates most of its earnings in Asia, can probably weather the turbulence better than other U.K. lenders because it operates across multiple regions around the world, according to Bank of America Merrill Lynch. Still, the bank extended declines in London trading on Monday while Standard Chartered Plc also slipped.
Even before Brexit, the outlook was bad for investment banks.
Banks worldwide have been slashing staff and leaving areas across trading and investment banking as revenue slumped and the businesses required more capital under new global rules. They’re facing issues from difficulty placing leveraged-loan deals in the U.S. to turnover in Asian equities shrinking at the fastest rate in a decade.
Revenue from fixed-income trading at the biggest global firms has fallen by 36 percent over the past five years, according to data from Coalition Development Ltd. While investment banking has been steady in recent years amid record-low interest rates, market turmoil early this year led to a dropoff in mergers and stock sales.
“Uncertainty always slows down M&A activity,” Evercore Partners Inc. CEO Ralph Schlosstein said Sunday in a Bloomberg Television interview with David Westin and Guy Johnson. “The spread between what buyers want to pay and what sellers are willing to accept widens out a lot.”
Volatile markets and lingering uncertainty also make it harder for banks to arrange bond and equity sales such as initial public offerings. The turmoil isn’t limited to Europe, with Line Corp., Japan’s most popular messaging service, delaying its IPO in Toyko and New York till Tuesday after Britain’s vote to exit the EU roiled global markets.
Brexit also raises the specter that England Governor Mark Carney may use negative interest rates to support the economy, a tool that has hurt banks’ lending margins when applied in other countries. And lenders that still need to meet higher capital requirements will find it harder to tap equity markets.
Brexit “will exacerbate the processes of disintermediation and negative rates that are weighing on investment banks,” said Emad Mostaque, a London-based strategist at emerging-markets consultancy Ecstrat Ltd., who said some bank staff could move to Dubai. Volatility should help trading desks, but as more exceptional moves occur “the more pressure will be put on bank balance sheets, and the less stable they become.”
Investment banks operating out of the City of London could be further hurt if Britain fails to retain its so-called “passporting” capabilities, which allow financial companies in the country to operate across the EU without having to set up local subsidiaries. Some global firms, including JPMorgan and Morgan Stanley, indicated they would move thousands of staff to other locations in Europe to sidestep the uncertainty.
That could call into question London’s position as the most important currency trading hub in Europe, according to the UBS analysts. Banks such as Barclays and Deutsche Bank with “outsized operations in London” and significant scale in euro trading may be hurt most.