Introduction
Jefferies analysts have reported that there is a continuation of muted trends in investment banking; however, there are some encouraging signs in advising on corporate mergers and acquisitions. Despite recent projections for equity capital markets activity, which is the “one bright spot,” investment banking fees are down by 22% from year-ago levels, with trading proxies for the second quarter pointing to softness in investment banking and sales & trading.
Analysis of Equity Capital Markets and Advisory Revenue
Jefferies analysts suggest that advisory revenue has declined as an offset; however, it is showing green shoots in deal and volumes. Equity capital markets, on the other hand, have shown meaningful improvement over the year-ago quarter. Recent guidance generally implies that sales and trading revenue will drop by 20% to 30% given declining volatility. Fixed income, currency, and commodity trading is holding up better, given the rates debate.
The US Banks Quarterly Earnings Reports
The highly anticipated release on Friday of the big US banks’ earnings reports supported indications of an improbable surge in advisory fees in Q2 of 2021, offsetting weakness in trading. However, these fluctuations have not been sufficient to lift the dark clouds hanging over the sector. The signs of life in corporate deal-making and the healthy spot in equity capital markets do offer some optimism, but the delayed economic recovery, rising inflation, and government bond yields have stoked anxiety in financial markets.
American Banks and the Equity Markets
In the past year, American banks have relied on the surge in American equity markets. The S&P 500, Dow Jones, and Nasdaq were all up approximately 5% in Q2, with listing surges driven by the rebound in economic sentiment, as well as the boom in fintechs and digital payment companies, paving the way for the resilience of the equity capital markets.
Capitalizing on Trends
In particular, some American banks have capitalized on this trend with Jefferies reporting a record revenue (including an estimated $30mn for underwriting activity) for the quarter due to companies going public by way of special purpose acquisition companies (SPACs). Wall Street banks’ mergers and acquisitions activity hit a record high in the first half of the year, driven by low-interest rates and healthy corporate cash reserves. This M&A activity has managed to make up for the expected fall in trading revenue in Q2.
Q3 Market Concerns
However, these positive factors may not last for long in Q3. Equity market declines have been more significant in Q3 due to inflation fears leading to more cautious trading during the summer months. In Q3 of 2020, JP Morgan reported a 32%, Citigroup a 26%, and Bank of America a 15% drop in investment banking fees. This phenomenon was promptly reversed in Q4 due to the US elections, the progress of COVID-19 vaccine developments, and Joe Biden’s promise of fiscal stimulus. Market participants are now wondering whether the delay in the Fed’s tapering could have a similar positive impact on bank earnings.
The Need for Corporations to Raise Capital
There is still a clear need for corporations to raise capital as COVID-19 restrictions are lifted globally, and the global vaccination program improves. Many corporate leaders are still driving towards longer-term strategic objectives, including but not limited to divestment, M&A deals, or divestment. The general trend of optimism regarding M&A deals persists and may help to contain the drastic impact of the drop in investment banking fees.
Positive Sentiment
Despite the slowing activity in the markets, Jefferies analysts expect the positive sentiment to continue as large US banks continue to report impressive earnings. SPAC activity has not yet reached the heights of Q1, with mergers valued at over $780bn announced in Q1, only $160bn in mergers have been announced in Q2. The list of deals remains extremely strong, and IPOs are expected to persist. A clear silver lining, however, is the COVID-19 recovery spurring financial services consolidation, which is likely to increase the deal flow.
Conclusion
Jefferies analysts believe a combination of factors like the slightly increased confidence in M&A activity, healthy American equity markets, strong corporate balance sheets, and lower interest rates will help offset the decreasing trading revenue to the end of this quarter. Whether these factors persist into Q3 remains to be seen.