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The City of London is dead. Long live the City…

November 27, 2012 by William

If the City of London is doomed, then why are investment banks increasing the number of their most senior staff and management positions in the UK? My latest column for Financial News…

It’s a wonder that there is anyone left in the City of London to bemoan its diminishing prospects as an international financial centre. With all the negative headlines over the past few months; the made-in-London scandals – such as Libor manipulation, rogue trading at UBS and beached whales at JP Morgan – along with oppressive regulation and punitive taxation, you’d have thought everyone would have hightailed it already.

But squeezed out by all the forecasts of doom and gloom, is an indicator that doesn’t fit this narrative. Even as the big investment banks fire thousands of staff, they are locating more of their most senior executives in the UK. And while the financial industry in London is almost certain to shrink in absolute terms over the coming decade, the city’s relative influence looks set to increase.

Let’s pause and consider the recent barrage of pessimistic forecasts. A few weeks ago, the Centre for Economics and Business Research warned that London had already surrendered its position as the world’s top international financial centre to New York. Not only that, it would continue to shrink and, by 2015, would be overtaken by the UK’s former colony Hong Kong. The inevitable eastwards shift in the global economy and in financial markets had been accelerated by “short-sighted overregulation, penal taxation and banker-bashing”, said the report.

Then TheCityUK, a body that promotes the City of London and financial services in the UK, said “an amber warning light” was flashing on the UK’s competitiveness as a financial centre, having found that more than half of the decisions taken since 2007 by banks and other financial services firms as to where they should locate business or invest had gone against the UK.

…

Not all doom

Such doom-mongering makes for great headlines. But many investment banks seem not to be reading them. On my count, seven out of the 10 largest banks in the world have chosen to locate the head (or co-head) of their investment bank in London, even though only two of these banks are headquartered here (Barclays and RBS). That seven compares with five for New York and zero for Asia.

This year alone, three big foreign investment banks have promoted senior staff in London to be head (or co-head) of the division worldwide…

Read more…

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Has fixed income turned a corner?

November 15, 2012 by William

For the first time in three years the engine room for investment banks has stopped shrinking. But for how long?

Investment banks haven’t had a lot to smile about this year, so here’s an unusual piece of good news: for the first time in three years, revenues from fixed income, currencies and commodities have stopped getting worse. The bad news is that this inflexion point could turn out to be miserably brief.

This chart is effectively an index of FICC revenues. It shows the combined underlying revenues in FICC from 14 large investment banks on a trailing 12 month (or four quarter basis), with everything rebased to 100 in 2009.

As you can see, industry revenues from FICC fell every quarter from the end of 2009 all the way through to the second quarter of this year, when they reached a low nearly 40% their levels in 2009.

But in the third quarter this year this longterm trend reversed and things stopped getting worse – an important step towards them getting better. This inflexion was caused by a surge in FICC this year on the back of central bank intervention and continued low interest rates. (FICC revenues in the third quarter increased by 11% compared with the second quarter and by 65% compared with summer 2011).

Hold the champagne

Before you get too excited, however, there are several big caveats to go with this glimmer of good news.

First, there is a still a huge gap between where the industry is today and where it was just a few years back. Revenues would have to jump by 30% to get back up to the levels seen in 2010 and by nearly half to get back to the happier days of 2009.

Second,  while FICC revenues are a much bigger part of investment banks’ top line than equities or investment banking (accounting for 63% of revenues over the past 12 months), FICC has underperformed other business lines over the past few years, as this chart shows:

(This shows that while the declines in equities and investment banking have been steeper over the past 18 months or so, the absolute fall is deeper in FICC).

And third, it is unclear whether this inflexion is just a relief rally based on one good quarter (particularly when compared with the crisis-hit quarter last year), or whether it might be the start of a trend.

For that to be the case, the fourth quarter this year would have to be an improvement on the same period in 2011 – which is probable – and the first quarter of 2013 would have to be up on the first three months of this year – which is an altogether more challenging assumption.

Category: DCM, Sales & Trading, Uncategorized |
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Welcome to the partnership: the (small) Goldman Sachs class of 2012

November 14, 2012 by William

Here is the complete list of the 70 new partners at Goldman Sachs:

Not in alphabetical order (sorry):

Vivek Bantwal

Pat Fels

John Mallory

Michael Ronen

Heather Bellini

Pete Finn

Joseph S. Mauro

Jami Rubin

Brian Bolster

David Fishman

Charles M.McGarraugh

Yann Samuelides

Jill Borst

Sheara Fredman

Xavier C. Menguy

Joshua S. Schiffrin

Michael Brandmeyer

Jacques Gabillon

Amol Naik

David Schwimmer

Jason H. Brauth

Francesco Garzarelli

Jo Natauri

Gaurav Seth

Stuart Cash

Nick Giovanni

Una Neary

Michael Siegel

Alex Chi

Brad Gross

Gregory G. Olafson

Michael Smith (Singapore)

Kent Clark

Anthony Gutman

Lisa Opoku

Josh Struzziery III

Richard Cormack

Leland Hensch

Gerald Ouderkirk III

Damian Sutcliffe

Jack Daly

Russell W. Horwitz

Francesco Pascuzzi

Michael Swell

Anne Marie B.Darling

Roy Joseph

Anthony W. Pasquariello

Ryan Thall

David Dase

John Kim (Seoul)

Huw Pill

Bobby Vedral

Olaf Diaz-Pintado

Marie Louise Kirk

Dmitri Potishko

Simon Watson

Robert Drake-Brockman

Hugh Lawson

Sean Rice

Toby C. Watson

Alessandro Dusi

Scott Lebovitz

Francois J. Rigou

Yoshihiko Yano

Edward A. Emerson

Ericka Leslie

Scott M. Rofey

Antonio F. Esteves

Luca M. Lombardi

Jeroen Rombouts

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A rough guide to Wall St this year

October 24, 2012 by William

After an even more confusing round of quarterly results from investment banks than usual, here is a rough guide to who’s up and who’s down so far this year on Wall St

In an excellent recent article on how investment banks are letting a good crisis go to waste, Ben Wright of Financial News noted how a glimmer of hope in the banks’ third quarter numbers might be encouraging them to postpone difficult decisions. He quoted the memorable line from John Cleese in the movie Clockwise: ‘I can take the despair. It’s the hope I can’t stand’…

The results of the big five Wall Street investment banks may have boosted the hope that the industry was recovering from an atrocious year. After all, when you strip out accounting distortions and stand back from the volatility of quarterly results, you see that over the first nine months of this year underlying pretax profits are up by an average of 40% compared with 2011.

But this is deceptive for at least two reasons: first last year was so bad that if there had not been a wholesale recovery it would have been time for lots of banks to pack up and go home. And second, there was wide variation in the performance of individual banks.

Everyone’s a winner…

As a quick guide, Goldman Sachs (remember them?) had the best nine months relative to last year with an above average performance on every metric except cost control. And Morgan Stanley, which attracted a curious amount of positive coverage around its third quarter results, had the worst year in terms of its performance relative to 2011.

JP Morgan lost a little of its magic dust as it gave up some of its dominant market share, while Bank of America Merrill Lynch bounced back strongly (it could hardly have got much worse).

Citi, as I wrote in my column for Financial News this week, continued its slow if unspectacular turnaround, and while it may be some time before JP Morgan or Goldman Sachs are running scared, it appears to be at least heading in the right direction.

Here is a line by line summary of how each investment bank performed on a range of measures in the first nine months of this year compared with last. Note that all of the numbers exclude own credit / DVA, the source is the banks and my analysis, and the sample is: Bank of America Merrill Lynch markets division; Citigroup securities and banking division, Goldman Sachs group, JP Morgan investment bank, and Morgan Stanley institutional securities division.

Markets revenues (FICC, equities and investment banking):

Pretax profits:

Pretax return-on-equity:

Note that as a rule of thumb, 17% pretax ROE translates into a net ROE of 12%, or roughly the cost of capital for the banks.

The number for BAML is flattering as it doesn’t include its banking division (which is perhaps deliberately bundled up with commercial and corporate banking). The figures for Citi are an estimate (because its doesn’t disclose ROE by division) and assumes it has the same leverage in its investment bank as JP Morgan.

FICC:

Equities

Investment banking:

Category: DCM, ECM, Investment banking, Reporting & Disclosure, Sales & Trading, Uncategorized |
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Is Wall St bouncing back – or bouncing downhill?

October 23, 2012 by William

After what looked like a strong set of third quarter results by the big five US investment banks, has Wall Street recovered from the financial crisis – or merely brushed it under the carpet?

It would be easy to think from a quick glance at Wall Street’s third quarter results that the investment banking industry had put the worst of its troubles behind it.

After all, this chart showing the performance of the big five US investment banks in the third quarter and over the first nine months of this year hardly suggests an industry in the throes of a crisis:

Or does it? On closer inspection the third quarter flattered to deceive. What looked like a recovery was in fact more of rebound that disguised the precociously bad performance of the industry last summer. Yes, the big five investment banks made nearly $9bn in pretax profits between them in the third quarter. But don’t forget that in the same period last year they posted a collective loss of $1bn.

Step back from the rollercoaster ride of quarterly results, and the industry is at best treading water – and most likely still going backwards.

Halting the slide

On a positive note, at least revenues have stopped going backwards: in the first nine months of this year revenues from markets (that is, FICC, equities and investment banking) were up by 2% on last year (although they slipped at JP Morgan and Morgan Stanley):

But revenues are still down by nearly one third from as recently as 2009, which hardly suggests an industry that is thriving or that has turned the corner.

Fixed income, currencies and commodities – the engine room at investment banks that ultimately defines whether they have a good, bad or atrocious quarter – rebounded by 70% in the third quarter compared with last year. This meant that FICC revenues are up by around 13% this year.

That’s great, but they’re still down by more than a third compared with 2009. (Note that industry leader JP Morgan flatlined this year and, for all of the talk of a recovery, Morgan Stanley actually slipped backwards).

Equities continued their gradual spiral downwards, with a flat third quarter and a drop of 9% over the course of the year:

…and this decline was echoed in investment banking, where a one third increase in revenues in the third quarter couldn’t prevent a gentle slide backwards over the course of the year.

Of course, a collapse in revenues over the past few years wouldn’t be a problem if costs had come down roughly in line. But they haven’t. This chart shows what’s happened to costs this year and over the past four years.

This year, costs have fallen by just over 4%, and they have scarcely dropped since 2009, despite a collapse in revenues of around one third.

On the short-term, this translates into a welcome rebound in profits this year: pretax tax profits jumped 40% on Wall St in the first nine months of this year. But when you compare this to 2009, you are still left with an inescapable sense that the Wall St is bouncing downhill with some way to go yet before it reaches the bottom.

Category: Investment banking, Sales & Trading, Uncategorized |
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Full steam ahead at Goldman Sachs?

October 17, 2012 by William

Is the decision by Goldman Sachs to increase compensation this year a) stupid b) stubbornly short-sighted or c) eminently sensible?

Welcome back, Goldman Sachs. It may be too early to call a recovery just yet, but Goldman Sachs had plenty to smile about in its third quarter results (for a full summary of its performance see the table at the bottom of this article).

But perhaps the best indication that Goldman Sachs thinks it is on the road to recovery is that it chose to increase the amount its set aside to pay its staff in the first nine months of the year: compensation increased by $1bn (or 10%), even though the average number of staff at the firm fell by around 7% over the same period.

Averages are fairly useless when it comes to pay, but this means that the annualised average compensation cost per employee at Goldman Sachs has increased this year by some 18% to around $451,000.

While its headline compensation ratio (compensation as a proportion of net revenues) stayed the same, Goldman Sachs passed on the opportunity to reduce pay in absolute terms. In other words, Goldman Sachs stuck two fingers up at critics who argue that it should pay its staff less and give a higher proportion of the rewards to its shareholders.

Dividing the spoils?

It’s very easy to get worked up about this. On paper, you can make a strong case that Goldman Sachs should have paid its staff less. Let’s assume that over the first nine months of the year Goldman Sachs showed more restraint and set aside the same as it did last year to pay its staff. This would have saved $1bn, and the bank’s comp ratio would have fallen from 44% to 39% (compared to 34% at JP Morgan this year).

In theory, pretax profits would have increased by 13%, and the bank’s pretax margin would have jumped to just over 33%. Pretax ROE would have been a couple of percentage points higher than the reported 14.7%, taking the bank dangerously close to generating a return above its cost of capital.

In terms of valuation, this shift in reward from staff to shareholders may even have pushed the bank to trade above book value for the first time in years (it currently trades at 0.9 times book value on a multiple of just over 10 times its annualised net profits). Run a billion dollars less cost through the business over the first nine months of the year and you might just end up with a market cap north of the bank’s book value.

Long-term-greedy?

But then again, you might not. While all of this makes a lot of sense on paper,  in the real world shareholders should perhaps be even more concerned if Goldman Sachs suddenly decided to slash a billion dollars from its wage bill just to keep them happy.

Goldman Sachs would argue that in order to be successful over the long term, any company needs to stick to its strategy. And an essential part of strategy is ‘fit’ – that slightly indefinable notion that everything a company does should ‘fit’ with everything else that it does. Once you start tinkering at the edges, and doing things on an ad hoc basis for short-term gain that don’t ‘fit’ with the rest of your strategy, then things start to unravel.

An excellent article on Harvard Business Review this week argued that one reason Goldman Sachs survived the financial crisis was by not putting the short-term interests of its shareholders first.

Over the past few years, even as its returns to shareholders have collapsed and its business model has looked increasingly broken, Goldman Sachs has resolutely stuck to its strategy. Part of this is trying to hire and retain the best people in the industry and pay them very large amounts of money in exchange for working unfeasibly hard.

If it suddenly starts paying less, then it suddenly stops being Goldman Sachs, and becomes something closer to JP Morgan or UBS or Morgan Stanley. In the short-term, this approach may be hitting profits and dragging on the share price, but the bank would argue that this course is in shareholders’ longer terms interests.

This is a polite way of saying that if shareholders want to own shares in a bank that pays its staff less, they have a wide selection of banks from which to choose. Nobody is forcing them to own shares in Goldman Sachs, but if they want to do so (and its shares are up more than 30% this year), they should accept that high pay is part of the deal.

This line of argument may seem counter-intuitive (and even offensive). But at a time when the entire industry is reinventing itself, it makes sense. The issue for Goldman Sachs is that this line of argument has a short half-life: if the bank is not making proper money for its shareholders within the next few quarters, then it will merely look like its staff were being short-sighted and greedy, and it may well have to think again.

This chart summarises how Goldman Sachs’ performance in the third quarter and over the first nine months of this year, and looks ahead to its full year results. At this rate, pretax profits at the firm will be nearly 90% higher than last year:

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A steep hill to climb for investment banks

October 11, 2012 by William

With the third quarter reporting season about to get under way for investment banks, it is worth remembering how far away most of them are from consistent profitability.

On Friday, JP Morgan will set the tone for what we can expect from the the rest of Wall Street when it unveils its results for the third quarter. Over the past few weeks, Jamie Dimon and other senior bankers across the industry have been talking up activity over the summer, suggesting that business might not have been as bad as most people have been expecting.

But one summer does not a recovery make. Here’s a quick reminder of quite how challenged the investment banking industry has been over the past four quarters (that is, the 12 months to the end of June).

This chart shows the underlying pretax return on equity at investment banks or corporate and investment banking divisions of large banks:

Let’s assume for the sake of simplicity that investment banks have a cost of capital of 12%, and assume a tax rate of 30%. On that basis you need a pretax ROE of roughly 17% to deliver a return in excess of your cost of capital. As you can see from the above chart, the investment bank at JP Morgan is the only bank to have hit this target over the past 12 months. Over the 12m to June 2011, nine out of the 12 banks in the sample managed to beat their cost of capital (with the investment banks at Morgan Stanley, Credit Suisse and UBS falling short).

The road ahead

As any investment banker will tell you, if you generate returns below your cost of capital you are destroying value, and there is a fairly linear relationship between your price / book valuation and your ROE / cost of capital ratio.

One way of looking at the scale of the challenge for investment banks to bridge this gap is to look at what would need to have happened to costs over the past 12 months for each bank to hit a 12% return on equity. This chart shows how much lower costs would have needed to be (assuming the same revenues) for banks to hit a 12% ROE:

JP Morgan investment bank is the only bank at which costs could actually have been higher over the past year for it still to beat 12%. At many of the biggest banks, costs would need to have been 20% to 30% lower than they actually were to make a net economic return for their shareholders.

Bringing up the rear is UBS investment bank, at which costs would have needed to be 77% lower than they actually were. To be fair, if you add back in the losses on rogue trading from a year ago, the bank would only have had to cut its costs by a little more than half to hit its cost of capital.

On average, costs across the industry would need to have been one quarter lower than they were. Another way of putting this is to say that investment banks would need to be roughly one quarter more productive than they were over the past year, which implies that there is both the scope and the need for much deeper cuts than have so far taken place.

Alternatively, you can look at how much higher revenues would have needed to be (assuming that costs had stayed the same) to hit a 12% return:

JP Morgan could afford for its revenues to have been a few percent lower and it would still have made a decent return, but many banks would need to magic an extra 20% to 30% in revenues out of thin air to make up this gap.

We know that investment banks have performed many a magic trick over the past few years, but short of a miraculous recovery it looks increasingly unlikely that they will be able to pull a rabbit out of the hat this time round.

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A crisis in European investment banking?

September 28, 2012 by William

A decent recovery in activity in the third quarter cannot disguise what is turning out to be a miserable year in investment banking – with Europe bringing up the rear.

Any bankers who had hoped that the recent flurry of activity in the capital markets could be a portent for a longer term recovery might at first glance have drawn some solace from the third quarter league tables.

Volumes in debt capital markets increased by 12% in the third quarter compared with last year, equity capital markets bounced back strongly with growth of 48%, while M&A was only down by 18%, according to Dealogic. Overall fees for investment banks were down by just 7%.

But take a step back and look at the first nine months of the year and a more sober picture emerges. In particular, it seems that investment banking in Europe is still in crisis with few signs of recovery anytime soon.

This chart compares the change in activity in the first nine months of this year compared with the same period last year for global and European investment banking, based on numbers from Dealogic:

In every case, Europe has performed worse than the rest of the world, with volumes down more sharply than in other markets over the first nine months of this year.

In M&A, for example, while global activity has fallen by 17%, the value of European deals has dropped by more than a quarter. In the first nine months of the year European deals accounted for their lowest share of global activity since 1998, and third quarter volumes of $121bn were the lowest since 1997, when many investment bankers were still optimistic graduate trainees or MBA students about to enjoy a decade-long surge in activity.

It is the same picture across the board: while global volumes of debt issuance increased by 1% – driven by record volumes from corporate investment grade issuers – in Europe, business fell off by 8% compared with the first nine months of last year. Most notably, the 15% fall in global ECM activity was trumped by a 35% collapse in Europe, taking volumes in the first nine months of the year to their lowest levels since 2003.

This translates into 19% drop in overall investment banking fees globally, but with fees in Europe dropping by 28%. Indeed, if you strip out Europe, the rest of the world has held up reasonably well, with a decrease of just 15% this year – roughly half the rate of decline in Europe. So far this year, Europe accounts for a mere 24% of the global fee pool, its lowest level since the 1990s.

Of course, it is hardly surprising that Europe is bring up the rear, given the impressive inability of policymakers, central bankers or governments to come up with anything resembling a sustainable and sensible solution to the eurozone crisis.

But the poor performance of European capital markets this year will hit European investment banks where it hurts at a time when many of them are already struggling. Almost by definition, investment banks banks such as BNP Paribas, Credit Suisse, Deutsche Bank, and UBS are more heavily exposed to European markets than their US rivals, and have a less developed US business to lean on when business is thin on this side of the Atlantic. (Barclays is an exception in investment banking on account of its acquisition of Lehman Brothers’ US business in 2008, although low volumes in its nascent European investment banking business must be punishing its bottom line).

While investment banking is only a small (and declining) proportion of overall revenues at investments, accounting for around one fifth of all income, low levels of activity are both a function of and indicator for lower volumes in both equities and fixed income trading.

Until Europe can get its act together, European investment banks look set to continue to underperform their US rivals, which could tip some of them into a vicious circle of lower profitably, deeper cost cuts, and lower revenues.

Category: DCM, ECM, Investment banking, M&A, Uncategorized |
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History is not on Nomura’s side in Asia

September 21, 2012 by William

For all the focus on Nomura’s cutbacks in Europe, the Asian market on its doorstep poses bigger problems for ‘Asia’s global investment bank’

At first glance, the recent outbreak of anti-Japanese demonstrations in China has little to do with investment banking. The apparently co-ordinated protests around the 81st anniversary of the Japanese invasion of Manchuria in 1931 and the bubbling tensions over the sovereignty of the Senkaku Islands (or Diaoyu islands if you are Chinese), led to calls for a mass boycott of Japanese goods and the temporary closure of many Japanese factories and businesses in China.

That the protests appeared to have at least some official sanction by the Chinese authorities makes the growing geopolitical tensions between the two biggest economic powers in Asia all the more worrying. According to the FT, this was what helpful Beijing police were telling demonstrators this week:

‘Japan has violated China’s rights and it is only natural to express your views…However, we ask that you please express your patriotism in an orderly, lawful, rational fashion.’

This simmering resentment of Japan in China – and indeed across much of south east Asia – does however have important ramifications for Japan’s biggest investment bank, Nomura, as it struggles to define its future.

Sayonara…

While much of the focus on Nomura over the past few months has been on its struggling European business – which this week has cut as many as 30% of its staff in investment banking – in many ways Nomura faces bigger challenges on its doorstep in Asia.

Ever since Nomura acquired the rump of Lehman Brothers’ activities in Europe and Asia back in October 2008, there have been big question marks over whether the deal was a golden bullet for the bank to export its dominance of the Japanese markets overseas, or a lead balloon. Back in November last year I warned that the business in Europe simply wasn’t working, and that it could be time for Nomura to sound the retreat.

This chart shows the progress that Nomura has made in building up its investment banking business in EMEA, compared with its dominant position in Japan:

According to Dealogic, Nomura trounces the competition in Japanese investment banking, even if its market share has slipped to mere 18% in the first half of this year. Meanwhile, in Europe it has made some progress from its low point of 28th in 2009 to 18th in EMEA investment banking today. This is still some way short of the lower reaches of the top 10 that the bank needs to become sustainably profitable.

But when you look at the Asian market – the only region expected to offer any significant growth over the next few years for the investment banking industry – you see that Nomura has even bigger problems:

Over the past five years, Nomura has slipped consistently down the Asian investment banking league tables, from 13th in 2007 to a shocking 73rd in the first half of this year, according to Dealogic. This is even worse than its ranking of 49th in US investment banking.

Setting aside the fact that there are at least 73 investment banks operating across Asia – which both heightens the competition and impairs the economics of the business for Nomura and others – this sits uncomfortably with Nomura’s stated aim to expand its franchise as ‘Asia’s global investment bank’.

In the last quarter, Nomura made less than $200m in revenues in Asia outside of Japan, down by a quarter on the previous year and representing less than 13% of its global revenues. Dealogic reckons that the bank has made nearly 10 times as much in fees in Japan since the beginning of 2007 ($4.0bn) as it has in the rest of Asia ($432m).

Harakiri?

The problem is that Nomura’s geographic good fortune of being based in Asia does not automatically translate into being able to build a strong Asian business. The uncomfortable reality, as the demonstrations showed, is that being Japanese in large parts of Asia is instead a positive disadvantage.

The brutal Japanese invasion and occupation of large parts of south east Asia during the Second World War – including China, Korea, Indonesia, Malaysia, the Philippines and Singapore – runs deep in the local psyche. As one Nomura banker noted wryly, the problem when you are at a meeting in China or Korea is that you don’t know whether your client’s grandparents were bayonetted by the grandfathers of your Japanese colleagues.

With the European market set to stagnate for the next few years – consulting firm Mercer Oliver Wyman reckons that revenues in the region for investment banks will grow at 0% a year between now and 2015 – and with Nomura having a minimal presence in the US and having reached saturation point in Japan, Asia offers Nomura’s only real growth market.

Unfortunately for Nomura and its shareholders, while this looks attractive on paper, history is not on its side.

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Investment banks: cheer up, it might never happen

September 20, 2012 by William

The third quarter could ride to the rescue of investment banks this year – but don’t get too excited

The relentless headlines about job cuts and scandals at investment banks, depressed markets and economic uncertainty over the past few months are enough to make any banker want to pack it all in and head for the hills. So at first glance, it doesn’t help matters when banks analysts forecast that the third quarter is going to look significantly worse than the previous three months.

With just weeks to go to the end of the quarter, the banks team at JP Morgan put out a cheerful note which predicted more of the same. Revenues from investment banking will be down by around 8% compared with the second quarter, with a strong revival in debt capital markets – particularly corporate bonds which have gone through the roof in the past few weeks – potentially offsetting a steep fall in advisory and equity capital markets.

Fixed income, currencies and commodities will fall by around 10% on the back of stronger rates and credit volumes than initially expected, while equities will bring up the rear with a decline of around 15%.

If you assume that investment banks can continue to cut their costs at the same rate as they have managed so far this year – a big if – all of this translates into a fall in pretax profits across the industry of 8% in the third quarter compared with the last, according to my analysis. Average pretax return on equity would fall to a shade under 10% (note that to cover their cost of capital, banks need to earn a pretax ROE of around 17%). In short, it doesn’t look pretty:

But amid the gloom of the past few months it’s easy to forget how much worse things were as recently as a year ago. This is what the third quarter would look like compared with the same period last year using the same assumptions as above:

While the M&A and equities business still look what an investment banker might call ‘challenged’ (trading volumes in European equities in July and August were down more than 30% on the volatile summer of 2011), the overall picture is much rosier. FICC revenues would surge by a third, and overall revenues would be up by nearly a quarter. Assume that banks can keep a handle on their costs and pretax profits of around $10.4bn across a sample of 15 large investment banks compares very favourably with a collective pretax loss of $3.6bn in the same period last year.

So, while the third quarter will be a marked slowdown compared with a less-than-vintage second quarter, it is likely to be a huge improvement on the carnage of last summer. This all translates into a more positive picture than banks are used to when you consider what the first nine months of this year might look like:

Overall revenues will be down by just a few percent, as growth in FICC offsets the 15% fall in investment banking revenues over nine months and the 21% drop in equities revenues. Again, assume that banks can keep cutting costs at the same rate as they managed in the first half of the year (of 9%), and pretax profits are likely to be up by between 15% to 20%. Pretax ROE would come in somewhere around 15% over nine months, up slightly on 2011 but still a few percentage point short of where it needs to be.

There are several lessons you can take from this: banks cannot afford to relax their cost-cutting, which means thousands more jobs cuts to come; if you work in equities or investment banking you’re probably first in line for the chop; and for the industry to salvage itself in 2012, the fourth quarter will have to be a significant improvement on last year. Bankers will have to hope that the sugar rush provided by Mario ‘whatever it takes’ Draghi and Ben ‘bid ‘em up’ Bernanke proves more durable than many fear it will be.

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