Written by: Callum Magee
Investment banks may have been at the heart of the 2008 Financial Crisis, but the same can’t be said for the effects Covid-19 has had on the world economy. Much regulation has been implemented since 2008, but how has this fared on banks during the 2020 economic downturn?
This article will analyse the effects Covid-19 has had on investment banks and whether the pandemic will have lasting effects on their operations.
Unsurprisingly, investment banks have seen a fall in IPO activity in Q1 2020 due to market volatility and future economic uncertainty. In the US alone, IPO’s in Q1 2020 were down 35% from Q4 2019. This inactivity wasn’t due to a lack of willing firms floating to public markets pre-Covid-19. Airbnb was in the pipeline to go public this year, but lockdown measures have reduced their bookings by 40% (March), thus hitting revenues significantly and causing them to possibly delay their much-anticipated IPO until 2021.
Lockdown measures, travel restrictions and volatile public markets may be a bad omen for IPO’s. In theory, all three factors should hit roadshows negatively. But this hasn’t been the case. Bankers, CEO’s, and executives have been conducting their roadshows and pitching their company to investors virtually. Bank of America, Citi, Morgan Stanley, Goldman Sachs, JPMorgan and Credit Suisse were all underwriters for Warner Music’s $1.9bn IPO on June 3rd 2020, who used a virtual roadshow. Virtual Roadshows allow banks and CEO’s to see more potential investors in a shorter period of time while saving significant travel costs.
Covid-19 may have halted IPO activity in Q1 2020, but the adaptability of banks may see a change in how future IPO’s are conducted.
As with IPO’s, M&A activity was also down in Q1 2020. Q1 2020 M&A activity in the US was down 35.5% YOY, with very few megadeals announced in the first quarter. The number of announced global deals fell from 2,349 in February, to 1,984 in March, a 15.54% decrease. Cineworld for example, called off their $2.1bn takeover of Cineplex over an alleged breach of terms concerning ‘the outbreaks of illness or other acts of God’.
However, banks may start seeing a pickup in M&A activity in the near future, as firms such as Virgin Australia have entered into voluntary administration. Goldman Sachs successfully advised Bain Capital to acquire Virgin Australia (advised by Houlihan Lokey and Morgan Stanley), after their collapse stemmed from Covid-19 travel restrictions.
Undervalued stocks, risky start-ups and collapsing mega-firms are likely to cause a pickup in takeover activity in the near term, as powerful tech and consumer staple companies look to take advantage of depressed markets to accelerate their inorganic growth and diverse subsidiary portfolios. Banks may see a pickup in client firms seeking restructuring, coupled with an increase in defence strategy advice due to hostile takeover attempts. This combination may offset the sluggish activity seen at the start of the pandemic, but with more scepticism about the future, this remains to be seen.
IPO and M&A deals may have been lacklustre in Q1 2020, but the same can’t be said for trading divisions. For example, Goldman Sachs saw a 46% drop in net earnings in Q1 2020 YOY, which is lower than what analysts were expecting. Revenues from fixed income trading soared in the midst of the pandemic, as investors switched from equities to safer forms of investment. Barclays made $250m in one day of trading alone in March. JPMorgan also saw a 34% rise in fixed income trading revenues.
Fixed income wasn’t the only driver for trading income in Q1. Large market swings with a mixture of bullish and bearish activity have led client investors to chop and change their portfolio positions, reining in commission and transaction fees.
Although countries such as France, Belgium, Spain, and Italy temporarily banned short-selling to avoid deepening an economies recession into a depression, this is unlikely to offset the trading revenues gained from the pandemic.
Reflecting equity market volatility, commodities, specifically oil, have seen major swings in their prices, as WTI futures went negative for the first time at -$37.63 a barrel in April. Traders positions on oil will heavily impact revenues, all depending on their timing of execution.
How banks have survived this crisis
Since 2008, heavy regulation has been placed on banks to avoid risky investments, future bailouts and accelerating economic recessions. Measures include tighter capital requirements (how much liquid capital banks keep on hand, based on the weighted risk of the bank’s assets) and annual stress tests. In the US, the Fed has capped dividends and share buybacks to help keep banks’ balance sheets resilient after a stress test revealed banks are at risk of larger loan losses, along with lost revenues from lower central bank rates. JPMorgan already suspended their buyback scheme this year, whereas UK banks such as HSBC, Barclays, Lloyds, and RBS cancelled their 2019 dividends pay-outs and 2020 interim dividends after bowing to pressure from the Bank of England.
Banks have also been putting money aside to deal with potential loan collapses, with JPMorgan putting aside $8.3bn, Goldman Sachs $937m, Bank of America $5bn and Deutsche Bank €506m.
Banks are not only putting in place measures to protect themselves. They are also funnelling government loans to struggling firms. For example, Goldman Sachs made a $500m capital commitment to the Paycheck Protection Programme to help small businesses survive the pandemic.
Long-term implications of Covid-19
The pandemic will have long-lasting effects on the working style conducted by most banks. The majority of bankers have been working from home since the start of lockdown to maintain social distancing guidelines and reduce unnecessary travel. Roughly 10% of workers are back at Canary Wharf, which has put in place one-way routes, a limit of four within elevators, hand-sanitising stations, and separated trading desks.
Working from home may have many upsides, such as reduced office rent (if work was fully remote) and increased productivity due to reduced travel times. However, traders have complained about the lack of synergy working from home, lacking rapid communication from their peers, while client-facing bankers fear of reduced face-to-face interaction which is used to build long-lasting relationships. Training of new analysts and interns is also difficult, with a lack of physical networking and work-shadowing. This has caused some banks to delay, shorten, or even cancel their 2020 internships.
Covid-19 has had an unprecedented toll on deal flows and working styles within banks. The pandemic has been damaging, but as bankers adapt to the new lifestyle, contingency plans and safety nets, the long-term implications for banks may be more beneficial than expected.