The COVID-19 pandemic has been an interesting time for investment banks. Heightened volatility in the market has meant higher trading volumes and more deal-making, as well as helping companies raise debt and go public.
Investors expected this level of activity would ease up whenever the world settled into life after the pandemic.
But Russia's invasion of Ukraine, supply chain troubles, high inflation, the Federal Reserve's plans to raise interest rates to tame that inflation (as well as to reduce its massive balance sheet), and rising bond yields have combined to intensify volatility over the last six months. This volatility has been good for some investment banking businesses but a headwind for others. This has created an interesting -- almost contradictory -- situation for investment banks. Nowhere can this be seen better than at Goldman Sachs (GS 2.74%).
More trading volume ...
Goldman's two largest business divisions are investment banking, which deals with mergers and acquisition (M&A) advisory services and equity and fixed-income underwriting, and then global markets, which includes sales and trading. The two businesses both cater to a wide variety of needs for institutional and corporate clients.
In the first quarter, trading revenues in Goldman Sachs' fixed income, currency, and commodities (FICC) business surged 21% from an incredibly strong Q1 2021 and were up roughly 154% from Q4 2021. CFO Denis Coleman attributed those impressive results to strong activity in the bank's products related to interest rates, currencies, and commodities.
"Our diversified and global footprint, combined with our risk intermediation and execution capabilities is a key differentiator," Coleman said.
In equities trading, revenue fell compared to a very strong first quarter of 2021 but was also up significantly from Q4, largely due to clients' need to build their cash positions in the uncertain environment.
... But fewer companies going public
It was a completely different story in Goldman Sachs' investment banking division, with revenue way down in the quarter.
Revenue from M&A advisory was actually solid; the company closed 115 deals in the quarter worth $385 billion in deal volume. But those closed deals were originally announced last year. Very few new deals were announced in the quarter, although according to Coleman, the pipeline for new deals is "robust." Still, many companies are postponing them, waiting for more stability in the economy and the markets.
Debt underwriting activity was also down, both on a quarter-over-quarter and year-over-year basis, mainly due to lower activity in leveraged finance and asset-backed products. But the big reason for the decline in investment banking revenues was a huge drop-off in initial public offerings and special purpose acquisition company mergers, which nearly came to a halt in Q1. Equity underwriting revenue fell 83% year over year.
Things could improve later this year
The contrast of the huge slowdown in investment banking activity this quarter with the surge in trading really created a tale of two investment banks for Goldman Sachs and the rest of the industry. I think there are a lot of companies that still want to do deals or go public. But the combination of market volatility and general investor skepticism about the valuations of growth stocks has created an unappealing environment. If things stabilize, there could be an uptick in activity later this year.
Additionally, as the Fed continues to raise benchmark interest rates, bond yields continue to stay elevated and bounce around, and the Fed starts reducing its balance sheet (which could impact longer-term bond yields), volatility is expected to continue to be prevalent, which could set up a nice backdrop for trading revenue. So, while investment banking and trading revenues are hard to predict, and the lack of deals and IPOs could impact investment banking revenue over the next few quarters, my outlook isn't completely pessimistic right now.