BAC Bank of America Corporation

Global institutions are gaining in size while more modest firms are running to keep up

By Telis Demos 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (May 8, 2018).

It's a good time to be a megabank.

In many businesses, the largest global banks such as JPMorgan Chase & Co. and Bank of America Corp. are getting bigger, while others are struggling to keep pace. The latest example: the volatility-induced surge in first-quarter stock-trading revenue that smaller U.S. investment banks almost universally missed out on.

Stifel Financial Corp., Raymond James Financial Inc., Evercore Inc., and Piper Jaffray Cos. all reported drops of 10% or more in stock-trading revenue for the first three months of 2018 compared with a year ago, according to company filings, resulting in the lowest market share in years for midtier trading firms.

By contrast, trading arms of the biggest U.S. banks -- at JPMorgan and Bank of America, as well as at Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley -- posted gains in equities sales and trading revenue ranging from 26% to 38% for the quarter versus a year ago.

That suggests one widely held prediction coming out of the financial crisis -- that regulation would crimp giant Wall Street trading desks and open opportunities for nimbler, less-regulated trading shops -- isn't holding up.

Instead, the broad shift toward complex electronic trading and a decline in the number of hedge funds and active asset managers, especially smaller ones, have put pressure on the trading desks of small and midtier firms.

Of course, smaller firms have notched some wins, and some are reporting record revenue, due in part to strong showings in businesses like wealth management and merger advice.

In equities trading, the overall revenue pie has shrunk from about $90 billion in 2007 to about $40 billion last year, according to research provider Coalition. Pricing pressure has been relentless due to factors including lightning-fast algorithmic traders.

The rise of passive index funds and exchange-traded portfolios, plus a new trend of investing directly in volatility, has put active fund managers, who are the core clients of smaller securities firms, on the defensive. The first-quarter equity revenue surge at big banks was driven primarily by derivatives activity around volatility, not traditional "cash" stock trades.

"We would have expected to attract more activity given the bouts of volatility we experienced in the quarter," Deb Schoneman, Piper Jaffray's president, told analysts in April. "However, active asset managers -- our client base -- did not participate as much."

At the end of 2013, six publicly-reporting midtier investment banks including Jefferies Group and Cowen Inc. generated about 8% of U.S. banks' reported equities-trading revenue, according to company reports compiled by analysts at Nomura Instinet. At the beginning of this year, that share dropped to around 4%.

"In the first quarter, the volume that was occurring was from passive strategies, and those ... tend to be more low-touch trading that the big banks have always dominated," said Ronald Kruszewski, Stifel's chief executive, in an interview.

New regulations are playing a role. European authorities this year began a ban on the practice of using trading commissions to pay for stock research, part of a set of rules known as Mifid II.

Now, funds investing money for European clients, even if they are trading in the U.S., may need to pay for research directly.

The upshot of the change is that some fund managers are now more attuned to the cost and value of research and are paring back relationships. Greenwich Associates, an industry research firm, estimated that budgets for research have dropped by $300 million.

"The model for research is challenged across the industry right now, and has been for about a decade," said Paul Reilly, chief executive of Raymond James, on a call with analysts in April. He estimated that the new rules have reduced some of his firm's commission revenue.

While Raymond James had "no plans" to exit trading, Mr. Reilly said, the firm's focus has been to grow its M&A and private-markets businesses. Raymond James's net revenue reached a record level, $1.8 billion, for the first three months of the year.

Meanwhile, JPMorgan's chief financial officer, Marianne Lake, told analysts in April that the new European rules and other changes in the markets may be helping the country's largest bank by assets. "We're gaining some share and we're benefiting from some of that concentration, " she noted.

Some smaller brokerage firms like Stifel say they're less concerned about their own financial health -- the company reported its best first quarter ever this year -- than they are about their clients, many of them small public companies that depend on midsize firms for research and promoting the ease of trading in their shares.

Current regulations "are advantaging highly liquid stocks," says Stifel's Mr. Kruszewski. "Smaller companies can be harmed."

Write to Telis Demos at telis.demos@wsj.com

(END) Dow Jones Newswires

May 08, 2018 02:47 ET (06:47 GMT)

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