JP’s recent research report into investment banking has generated a lot of comment (see for instance here for a nice piece from Matt Levine); Citi came out with their version the day before.
Let’s take (some of) JP’s handy cut-out-and-keep classification, add them into the mix (as they don’t appear on their own chart), and use some of Citi’s insights:
The tier 1 banks have a clear franchise. They have profitable IB businesses, global reach, and, – while challenged by regulatory change, – they clearly will stick around in this space. If you want to own an IB, you have to buy one or more of them*.
The tier 2 agency banks similarly have a clear role in life. They make money from flow, don’t have as high a compensation cost, or as volatile earnings. They are investable from an IB perspective.
The tier 2 institutional banks are where the problems are. They don’t have a strategy that makes sense, and likely won’t make enough money to pay for the costs of competing directly with Tier 1. UBS and RBS have already announced that they are exiting this space, presumably keeping a limited agency franchise. Jefferies could certainly follow the agency model, too. For the rest, there is a stark challenge. It isn’t clear that being an asset class champion (e.g. the French banks in equity derivatives or CS in credit) is viable. There isn’t clearly room for all of these banks to move to the agency box: in particular France doesn’t need all of BNP, Soc Gen and CASA in this space. MS, too, doesn’t have a strategic option that looks very attractive, and no tier 1 player needs what it does have enough to buy it. The political support for IB in Switzerland has waned, so CS might have a hard job pretending to be American in IB but Swiss in private client, especially with a niche IB model.
The play of the day is therefore long Barc, BofA, Citi, JPM, GS; short CS, BNP, Soc Gen, MS, RBC‡. This isn’t JP’s argument: they suggest that the tier 1 players can’t afford to exit a business with regulatory uncertainty and volatile ROEs, while the tier 2 players can. I agree with that, but critically that argument depends on the tier 2 players actually seizing the moment rather than wasting two years pretending to be top tier IBs when they are not, and wasting a lot of money in the process. I don’t believe that all of the players in red will have the guts to cut aggressively, hence the call.
*DB is perhaps the exception due to their need for capital to support the US businesss. Note while we are here that 4 out of 6 of these tier 1 firms are American.
‡Any banking trade that doesn’t have a UCG short in it does feel a little incomplete, though.