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Thursday,
March 05, 2020 /04:24 PM / By Fitch Ratings / Header Image Credit: Washington Post
Uncertainty over the intensity, geographic reach and
duration of the coronavirus (COVID-19) outbreak is negatively impacting primary
market activity and significantly increasing volatility, making it likely that
capital markets revenue at the global trading and universal banks (GTUBs) will
be adversely affected, Fitch Ratings says. We do not expect this hit on
earnings to affect GTUB ratings if the outbreak is quickly contained, but
prolonged revenue weakness and deterioration in asset quality if a weaker economic
outlook becomes more deep rooted could pressure capital levels and ultimately
ratings over the longer term.
Following strong market activity during the first two
months of the year in Europe and the U.S., increased market volatility will
likely reduce issuance activity, which will dent revenue in the normally
seasonally strong first quarter. Policymakers have highlighted a determination
to use fiscal and monetary tools to lessen the economic and financial market
impact of COVID-19, financial market volatility will likely persist while
uncertainty remains. The Federal Reserve lowered its target fed funds rate by 50
bps in response to slowing growth from the COVID-19 outbreak. While the Fed
response may spur issuance activity, it will also negatively affect asset
yields, resulting in lower margins and reducing bank profitability.
While increases in volatility can aid trading revenue,
we believe the recent sharp rise in volatility and trading volumes reflects
high levels of uncertainty. Transaction volumes in many trading businesses
could taper off once investors and corporates have readjusted their portfolios.
This environment resembles fourth-quarter 2018 and first-quarter 2016, which
saw days with elevated VIX but notable year-over-year declines in markets
businesses.
All GTUBs have material capital markets businesses,
but their contribution to overall profit varies. In the U.S., FICC and equity
trading revenue accounts for around a third of total revenue at Morgan Stanley
and around 40% of total revenue at Goldman Sachs in any given quarter. For
JPMorgan, Citigroup and Bank of America, the level is lower, with less of a
negative impact on overall profitability. At the European GTUBs, trading
businesses account for about 25% of total quarterly revenues on average for
Barclays, Credit Suisse and Deutsche Bank, with a lower contribution at BNP
Paribas, Societe Generale and UBS.
Market exposure from trading is a material risk for
the banks. However, we believe risk appetite has remained conservative as the
groups primarily concentrate on client-driven transactions. We do not expect
material trading losses resulting from volatility spikes or credit spread
widening given this conservative approach. However, any sign of outsized hits
on trading revenue could indicate control weaknesses or heightened risk
appetite, which would be viewed negatively from a credit perspective. Trading activities
could also come under pressure if banks have to enact operational changes to
ensure business continuity, or if material portion of the banks' staff have to
work from home or from off-site locations.
Given their global presence, several GTUBs also have
material businesses in Asia, which include sizable wealth management and
lending operations, where asset quality deterioration would likely emerge
first. Current asset quality ratios are sound, but a severe hit to GDP growth
in the region would test the banks' underwriting quality after a prolonged
period of sustained business growth and a benign credit environment.
Fitch's Negative 2020 sector outlook for Western
European banks reflects pressure on banks' earnings, with reduced capital
markets activity making it more difficult for banks to reach lowered
profitability targets. The sector outlook for U.S. banks remains stable, with a
more challenging operating environment expected in the face of slower economic
growth, with monetary policy loosening to offset the impacts of COVID-19
expected to dampen profitability for U.S. banks.
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