Major US and European investment banks expect their advisory and underwriting businesses to recover in 2024 as companies begin to accept higher-for-longer interest rates.
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Global investment banking revenues have collapsed amid a rapid hiking cycle in which US and European interest rates have risen to their highest levels in decades. Central banks have signaled they will keep rates elevated to ensure persistent inflation shrinks to target levels.
Green shoots of M&A and capital markets activity registered in the third quarter of 2023, and signs that clients are gradually adjusting to pricing in a higher-rate environment have sparked optimism about business in the coming year. Many bank bosses projected revenue recovery during recent earnings calls.
"Even if rates stay higher for longer, we expect investment banking activity to revert to normal levels once there is greater clarity around the economic outlook and interest rates. Ultimately, management teams need to make strategic decisions and move forward," said Michael McTamney, senior vice president in the North American financial institutions ratings team at DBRS Morningstar.
Signs of recovery
Advisory revenues have been the primary drag on investment banks in 2023. Rising financing costs have made it hard to fund deals and meet seller pricing expectations, while economic uncertainty and geopolitical tensions have weighed on equity market sentiment, said Lucille Jones, senior manager at London Stock Exchange Group's deals intelligence unit.
Yet, investment bank bosses spoke of a tentative recovery during the third quarter, suggesting companies' appetite for M&A might improve in 2024 with capital markets business also likely to gradually pick up.
Citigroup Inc.'s "healthy sell-side M&A pipeline" should unlock as conditions improve further, CEO Jane Fraser said on an Oct. 13 earnings call. "Companies do accept the new pricing reality, which will be helped by a rebound in equity markets," Fraser said.
As the conversation shifts from how high rates would rise to how long they would stay high, there has been resurgence in activity in debt capital markets too, Fraser said. "We've seen clients get off the sidelines and just bite the bullet," the CEO noted.
Deutsche Bank AG expects advisory and origination revenues to grow in the fourth quarter of 2023 from the third, when activity had already started to pick up, CFO James von Moltke said at a banking conference Nov. 14.
Revenue outlook
Historical trends suggest that investment bank revenues should rebound soon, as the third quarter of 2023 was the seventh consecutive quarter of revenues well below long-term averages and previous downturns have typically lasted no longer than eight quarters, DBRS Morningstar's McTamney said.
Seven quarters have been enough for "pricing expectations to fully adjust to new realities" in the past, Citigroup's Fraser said. Goldman Sachs Group Inc. CEO David Solomon also projected on an Oct. 17 call that advisory revenues should rebound to 10-year historical averages in the next four to eight quarters.
The pricing gap between sellers and buyers is set to narrow in 2024 as key factors affecting deal values such as inflation, financing costs and uncertainty are likely to stabilize next year, Boston Consulting Group said in an M&A outlook report Oct. 26.
The end of central bank hikes bodes well for M&A activity even if rates remain elevated as stability gives buyers a better understanding of deal costs, according to a recent Market Intelligence analysis. If markets expect rates to be stuck at a certain level for longer there would not be a need to delay deals in the hope of a change, said Seb Walker, partner at consultancy firm Tricumen.
While a recovery is on the cards, it is hard to say exactly when that will translate into higher investment banking revenues, executives cautioned.
"Investment banking can come back very, very quickly," Bank of America Corp. CFO Alastair Borthwick said on an earnings call Oct. 17. "It's just that we've grown tired of predicting when that might be."
