Bloomberg First Word by Matt Scully (June 27, 2016)
New layers of regulatory capital expected to be imposed on Wall Street are likely to further pressure banks to exit trading of securitized-debt, JPMorgan analysts John Sim, Kaustub Samant, Carol Zhang wrote in client note Friday.
- There’s “no path to profitability” under current and recently released capital rules
- JPM analysts calculated ROE for hypothetical RMBS portfolio based on impact from Basel’s Fundamental Review of the Trading Book
- Concluded ROE of ~4%, “clearly not attractive enough to entice dealers to enter the space and make markets”
- Adjusted model to various hypotheticals, such as reallocation, bid-ask, turnover rates
- Concluded the “cumulative effect of all of these realistic and unrealistic changes would only increase the return to 7%, which is far short of our 10% to 15% ROE threshold”
- “Running ROEs for hypothetical ABS and CMBS businesses would not result in markedly different results”
- Primary market and business of underwriting new-issue securitizations can still be attractive, however, contingent underwriting volumes
- Revenue derived from underwriting fees without consuming much capital; when balanced with secondary trading, ROEs for the business can become attractive, depending on volumes
- Liquidity will continue to be constrained for non-agency RMBS, particularly in legacy space where dealers have no commensurate underwriting
- CRT deals will also suffer from limited trading activity relative to market size; expect limited liquidity for Jumbo RMBS and SFR deals
- NOTE: Reports of dealers paring or shutting down trading units have grown; banks include Barclays, DB, MS, SocGen, Jefferies, RBS, Nomura, CS
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