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* Dire year for fixed income prompts bank rethink on scale
* FICC 2013 income down 10 pct at top banks after H2 slump
* Central bank policies hurt, but tougher regulation is maindrag
By Steve Slater
LONDON, Feb 13 (Reuters) - Have the mega-buck years of bondand interest rate trading gone for good, or will normal serviceresume after an ugly 2013?
That's the question facing investment bank chiefs as theytry to squeeze costs and improve returns. Some are clinging tothe hope that diving revenue from a "complex, messy business"will be temporary, and they need to keep trading teams togetherfor when the market recovers.
However, many are already changing, and the likes ofDeutsche Bank, Barclays and Morgan Stanley look set to make deeper cuts to their fixed incomedivisions to deal with weak volumes and tough regulation.
Investment banks are reshaping themselves to increase theirprofitability, and the trading desks that buy and sell interestrate and credit products are under most scrutiny.
Revenues from fixed income, currencies and commodities(FICC), particularly in interest rates, suffered badly last yearas the tighter regulations imposed following the financialcrisis started to hurt. Switzerland's largest bank, UBS, is largely pulling out of fixed income and thepressure on its peers could get worse.
"The problem in fixed income is being sold by investmentbanks as cyclical, but it's a structural one," said ChirantanBarua, analyst at Sanford Bernstein. "Everyone is just solvingaround the edges, no-one other than UBS has taken a sword to thebalance sheet, just in case the market turns and they don't wantto be caught without capacity."
FICC trading accounts for about half of investment banks'income but the sums are falling. Across the top 11 banks whichhave reported their 2013 results so far, it fell 10 percent from2012 to $83 billion last year, according to analysis by Reuters.
Most alarming for the banks is that revenue in the secondhalf of the year crashed 40 percent from the first half and wasdown almost a fifth from a year earlier.
That's why the pressure is on FICC. By comparison, equitiesincome rose 17 percent last year and advisory revenues grew byjust over a tenth across the 11 banks.
The slump has been blamed on low volumes after the FederalReserve said it would start putting the brakes on buying bondsunder its programme to stimulate the U.S. economy.
But tougher global rules forcing banks to hold more capitalagainst risky assets also squeezed margins and threatens tocause more long-lasting damage. "Last year was a double whammy,"said Seb Walker, partner at investment banking consultancyTricumen.
Governments across the world are determined avoid a repeatof the crisis which exploded in 2008 when taxpayers had to bailout a series of banks at huge expense.
"Basel III" rules being phased in require banks to squirrelaway more of their profits and hold more reserves so that theycan absorb future losses without seeking public help.
They also apply higher risk weightings to loans, and requirebanks to trade more through exchanges and central counterpartiesrather than directly between each other. These exchanges requirethem to put up more collateral.
Interest rates revenues were particularly hit by theserules, especially for repurchase agreements ("repos"),government bonds and swaps, which are some of the most heavilytraded derivatives contracts.
Activity in 2014 already looks to be down on the strongstart seen last year, unsettling bankers who know that often thefirst quarter is the busiest period. Kian Abouhossein, analystat JPMorgan, estimated this week that FICC revenues will be down16 percent in the first quarter.
"The challenge for a bank is that fixed income is a complex,messy business," Tricumen's Walker said, citing the wide varietyof products and their different risk profiles and capitalrequirements.
"To make the right decisions you have to have a lot of gooddata about your business and predict the actions of others. Sothey need to look at their businesses segment by segment anddecide where to compete and to what extent, and where to leavethe market for others," he said.
Analysts said few fixed income businesses are likely to havedelivered a return on equity (RoE) last year above investmentbanks' cost of equity, estimated at about 12 percent, meaningthey are not putting their share and bond holders' capital togood use.
Walker estimated that fixed income business typically hadpre-tax RoE of between 7 and 12 percent, although individualsegments could range from negative to more than 17 percent.
NO LONGER A REVENUE CHASE
Executives at several banks have recently acknowledged whenannouncing results that the fixed income landscape could be reshaped - but none thought it would be at their expense.
"We expect that fixed income after some adjustment will be agood business," JPMorgan boss Jamie Dimon told analysts."We think a lot of these trends are cyclical, not secular andthat's how we are positioned for it."
Banks such as JPMorgan and Bank of America benefitfrom their large balance sheets, which give them greatercapability to maintain fixed income desks during lean periods.
But European rivals such as Deutsche Bank and Barclays areunder pressure to meet tough capital and leverage rules earlierand appear to be losing share to the big U.S. names.
The rates market malaise has also been deeper in Europe thanin the United States. Positive effects of when the EuropeanCentral Bank pumped more than 1 trillion euros of cheapthree-year loans into the banking system in late 2011 and early2012 are fading, hitting banks based in Europe harder.
Deutsche, Barclays, Credit Suisse, HSBC and BNP Paribas are expected to continue to pull backfrom lines that were unprofitable or where they lack sufficientsize, analysts and bankers said.
Anshu Jain, co-CEO of Deutsche Bank, admitted that afteryears of chasing revenues across all products to win marketshare, there has been a shift in focus.
"We could afford to carry those businesses in the past; weno longer can. We are utterly focused now on bottom-lineperformance of fixed income," he told analysts. "Revenue impact,yes; market share, client impact, no."
Last week's results from UBS - which racked up huge lossesduring the financial crisis that prompted a state bailout - mayhave offered some encouragement to others to take action.
Only 18 percent of revenue at UBS's streamlined investmentbank last year came from FICC, compared with 45 percent in 2010.But equities income has jumped, and operating profit was upslightly from three years ago as expenses tumbled 36 percent ina division that now has 5,200 fewer staff.
Bankers said firms face a delicate balancing act in searchof the "sweet spot" where they have enough scale and resources,but are not too bloated and carrying hefty costs that hurtreturns. As ever, they also have eyes on the competition, andthe likes of JPMorgan and Goldman Sachs appear confident theywill win more business at better margins when rivals retreat.
"A lot of products weren't making money and all banks arecutting back in areas they are not strong. So a lot are thinkingwhether to get out or stick it out," one senior banker said.
FICC PERFORMANCE 2013 (in millions of dollars): BANK FICC INCOME UP/DOWN Q4 INCOME
2013 VS 2012 VS YR AGO JPMorgan $15,468 0 +1% Citi $13,107 -6% -15%pp Deutsche Bank $9,400 -25% -31% Barclays $9,100 -17% -16%
Bank of America $8,882 +1% +22% Goldman $8,651 -13% -15% Credit Suisse $5,400 -11% -16% BNP Paribas $4,900 -21% -13% Morgan Stanley $3,594 +52% -15% SocGen $2,970 -21% -39% UBS $1,800 -11% -2%
