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Squeeze is on for investment banks
Investment banks are facing a big squeeze. For an industry that was generating record revenues just months after the collapse of Lehman Brothers, this may seem unlikely. But the revival looks set to be short-lived. Increased regulation and greater competition means the super-charged returns the industry generated for most of the past decade are likely to prove elusive.
Analysts at JPMorgan believe 2009 will prove to be the high point in the investment banks’ relentless upward march. They expect revenues in 2011 to be no higher than in 2006. More significantly, the industry’s return on equity will fall to 10.8 percent, far lower than what they have got used to.
What explains this reversal? Regulation plays a big part. Contrary to the received wisdom that investment bankers are being allowed to carry on much as before the crisis, regulators have whacked up capital requirements for complex, illiquid products. These were the source of much of investment banks’ profit during the boom, and most of the trouble since. Higher capital charges will make a lot of what banks’ structured credit desks used to do unviable, and reduce the profitability of what remains. Caps on leverage will also make it harder for banks to juice returns.
Similarly, the drive to ensure more derivatives are traded on an exchange or, at the very least, cleared through a central counterparty will have a big impact. Blowing away the fog that surrounds derivatives will make it harder for banks to hide their true cost from clients and clear the way for new players to enter the market.
Deutsche Bank walks bad loan tightrope
   Deutsche Bank’s Josef Ackermann has bet that income from investment banking will more than cover bad debts buried in his balance sheet.
   Ackermann is as usual putting a brave face on things, but looking at the hefty charges Deutsche is taking to provision against credit losses, it’s going to be a close call.
   At the height of the financial crisis, Deutsche shifted assets from its trading to its banking book, thus avoiding mark-to-market write-downs and the need to raise more capital.
   But dodgy loans catch up with you even if you hold to maturity — the losses just take longer to work their way through the pipe as loans become impaired.
   Like Barclays in the UK, Deutsche’s sleight of hand may have helped it wriggle out of needing government help. But the Q2 charges have understandably rattled investors, with its shares down some 9 percent on Tuesday.
   The big fear is that these charges are only the beginning and there are other skeletons in Deutsche’s cupboard.
   But even if there is more bad news to come — and Ackermann is not overly optimistic in his outlook — the question is whether Deutsche can earn its way out. At first glance, it has successfully done this in the second quarter, beating estimates with a net profit of 1.1 billion euros ($1.57 billion) — helped by a lower tax bill — despite charges of 1.4 billion euros.
   There are a few serious caveats other than the rise in bad debt provisions. Deutsche’s profit before tax was actually lower than some estimates, as were the revenue figures for some businesses including investment banking. Costs rose 9 percent.
   Given that conditions for sales and trading and other investment banking activities could not get much better than they were in Q2, Deutsche is going to be closely watched.
   Deutsche can’t do much more about its previous lending decisions. By focusing on avoiding past mistakes and growing its profits it might still squeeze through with no need to raise new capital, a move Ackermann has staked his reputation on doing without.
   Deutsche has done well to bolster its capital ratios and cut risk weighted assets. But on the basis of these results, it’s going to be tight.
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The Wall
