Traders surpassed in Wall St reshuffle

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It looks like the revenge of the investment bankers. For years, Wall Street’s traditional business of advising companies on acquisitions and helping them sell debt and equity has been subjugated to the traders.

Even after the huge trading losses of the financial crisis, buying and selling stock and bonds and more complicated fixed income products has remained a far more important source of revenue at banks such as Goldman Sachs, where, incidentally, chief executive Lloyd Blankfein comes from the trading side of the business.

Yet at the end of Wall Street’s results season on Friday, there is a sense – supported by a renewed confidence from the bankers themselves and a flurry of January deals – that the pecking order has adjusted.

At Goldman, trading accounted for about 46 per cent of total revenues in 2013, the lowest percentage since 2002, while investment banking had its best year since the crisis. Bank of America reported a record quarter for investment banking fees, with $1.7bn.

Across the sector, more eye-catching initial public offerings – from companies including Twitter, Hilton and SeaWorld – helped drive fees; bumper acquisitions involving Dell and Vodafone helped too.

Now a recent flurry of January deal activity including Suntory’s $16bn takeover of US spirit maker Beam; the announcement by Charter, the US cable operator, of a $61bn bid for rival Time Warner Cable; and smaller acquisitions featuring Google and Chuck E. Cheese, have boosted confidence.

“Our view is that we are finally seeing the pick-up in M&A that we’ve been waiting for for quite some time,” says Ruth Porat, chief financial officer of Morgan Stanley. “That’s attributable to greater CEO confidence on the back of more data globally that suggests we’re finally seeing consistent economic growth.”

But other post-crisis years have seen a handful of big deals only for the overall volumes to disappoint. Bankers have come up with a variety of excuses, including, a particular favourite, political uncertainty ranging from elections to the implementation of the Affordable Health Care Act.

However, Ms Porat believes that this time is different, noting that there are more non-financial companies looking at growth via acquisitions, and it is not only American private equity firms, known as financial sponsors, that are driving the pick-up. “In addition to sponsor activity we’re seeing more corporate engagement and finally Europe is participating in this as well. It does seem as though this one has more legs to it.”

The positive vibe is even tempting Moelis & Co, the boutique investment bank, towards a long-awaited initial public offering, on the expectation that investors might want to own a stock that would benefit from any surge in M&A.

However, the change in revenue mix is at least as much about poor trading as stronger banking. Showing the divide, Morgan Stanley beat expectations for investment banking on Friday but missed analysts’ forecasts for trading as its chronically underperforming fixed income business continued to struggle.

Year-on-year fixed income trading revenues fell 14 to 15 per cent in the fourth quarter at Goldman, Morgan Stanley and Citigroup. JPMorgan did less badly with a 7 per cent decline, while BofA was the only one to announce an improved result.

“Investment banking had a good year and trading didn’t,” said Glenn Schorr, analyst at ISI Group. “If you say what’s working right now, it’s definitely equity underwriting, a little M&A with a lot better outlook than we’ve seen in a while, it’s asset and wealth management for sure. It’s definitely not FICC [fixed income, currencies and commodities]. That’s why people are loving Morgan Stanley.”

The mixed picture, soft returns on equity and political and regulatory pressure adds up to pressure on bankers’ bonuses. Goldman cut its share of pay to revenues by a percentage point to 36.9 per cent. Morgan Stanley’s came down from 45 per cent to 42 per cent in the institutional securities group and said it would “trend down to 40 per cent”. Under pressure from analysts, Citi announced its first ever pay-to-revenues ratio in its investment bank – 29 per cent – and said it was lower than last year.

Different companies are taking different approaches to dealing with trading. Morgan Stanley is looking to reduce risk-weighted assets and ditch capital-intensive businesses, including its physical commodities business.

Goldman, on the other hand, is content to retain underperforming businesses until the final post-crisis rules are in place and it can better judge their normal profitability. “We don’t want to forgo the upside,” said Harvey Schwartz, Goldman’s chief financial officer.