Grim first half looms for investment banks

By Chris Hughes, Investment Banking Correspondent

Credit Suisse has removed any doubt that the investment banking industry will post anaemic revenues in the first half of this year.

Only four weeks ago, the outlook did not seem so barren.

Back then, the Swiss bank had said it made a profit in the first seven weeks of the year – even after taking an estimated $2.85bn mark-down on its trading book. But on Thursday, it revealed that it would probably post a loss for the first quarter of the year for the first time since 2003.

This marks a tremendous reversal of fortune. Credit Suisse’s performance must have deteriorated substantially in recent weeks. After all, the earlier trading mark-down turns out to have been smaller than first thought, and much of it has been backed into 2007.

Small wonder Credit Suisse has damped the mood of optimism that followed first-quarter results from some of Wall Street’s top investment banks earlier this week. Goldman Sachs, Lehman Brothers and Morgan Stanley all reported much less dramatic falls in earnings than forecast.

Moreover, there were tentative signs that the investment banking industry might at last be getting on top of its exposure to the subprime mortgage crisis. Mark-downs on mortgage-backed assets were lower than expected, largely thanks to successful hedging. Lehman had even bought up some so-called Alt-A mortgage securities, which are more creditworthy than sub-prime, and said that it did not believe the market value of many such assets reflected their true worth.

The snag is that these banks were reporting on the three months to the end of February. That may have been a period of extreme gyration in the markets. But the turmoil worsened in March, which marks the quarter-end for the rest of the investment banking industry.

Credit Suisse gave little detail on Thursday about where the pressure points were. The problems appear to be a mixture of further trading losses caused by the market volatility, fresh write-downs on credit securities and leveraged loans, and weaker revenues in corporate finance and mergers and acquisitions. That pattern likely to be repeated elsewhere, with Goldman saying this week that its backlog of deals had thinned for the second consecutive quarter.

Some parts of the investment banking business are humming along nicely. Areas such as rates, foreign exchange, commodities and equity trading are booming. But this will not be enough to fully offset slower activities elsewhere.

Huw van Steenis, analyst at Morgan Stanley, says the industry is likely to post revenues down 40 per cent in the first quarter, including fresh write-downs on its credit portfolios. For the full year, he expects a fall of 15 per cent. The less severe drop is because the industry started started to mark down its credit portfolios from October last year.

This is putting pressure on investment banks to re-evaluate their commitment to the business. Bank of America said late last year that it had had all the fun in investment banking that it could take, and Germany’s Dresdner Bank is carving out its investment banking unit in a move that could make it easier to bring in an outside partner.

“Revenues are essentially back to 2005 levels,” says Mr van Steenis. “What’s really fascinating about this downturn is the number of first- and second-tier players considering whether they can stay in the game.”