Revenue generation has a greater impact on long-term profitability and share prices than cost cutting alone. While cost cutting can provide short-term gains, investment banks should focus on innovating to create new business lines and revenue sources. An analysis of 12 banks found a strong correlation between operating revenue and pre-tax profit margins but a weak correlation with operating expenses. Revenue generation is thus a better determinant of valuation metrics like price-to-earnings and price-to-book value ratios.

1. Theme
Profit drivers
Cost management, while important, is at best a short-term play. Revenue generation has a far
greater – and more immediate – impact on the underlying profitability and share price.
Investment banks seeking to improve their long-term returns should therefore focus on creating
new business lines and finding new revenue sources. The challenge for investment banks is to
do what they do best - innovate.
One of the more striking features of the 3Q13 reporting season was the unusually strong emphasis on
cost-cutting, with banks and the analyst community commenting that, while revenues were down,
some banks managed to offset this to a large degree with decisive cost-cutting. In principle, that’s
great, but could also be misleading – to state the most obvious example, inter-year comp & benefits
are accrued, not paid out, and 4Q is often the balancing period for the full year.
More importantly, most banks have, over the past year or so, already effected the bulk of their major
cost-cutting and/or wholesale restructurings. The focus has now shifted to underperforming units
(which are usually small in the overall capital markets operations) and to variable cost component of
operating costs in revenue-generating units; both of these are, at best, short-term plays …
… that have no lasting impact on banks’ underlying profitability: ultimately, what matters is the
revenue generation. Below, we plot the quarterly movement in operating revenue and expenses
against the sequential quarterly movement in pre-profit margin for 12 banks1, for 6 periods ranging
from 1Q12 (which is, roughly, the first quarter which reflected the impact of major re-orgs) to 3Q13.
The chart on the left shows a very strong 0.70 R-squared and 0.84 correlation value between revenue
generation and pre-tax profitability; even excluding the two outliers (both of which represent HSBC),
R-squared remains above 0.60, in both total capital markets and sales & trading revenue and profits
(see Appendix). Running the same analysis with operating costs produces a negative 0.13 correlation.
There are several obvious explanations for this counterintuitive finding: a sizeable portion of costs are
variable2 and/or accrued and so the management has great influence on both the size and the timing
of recognition of costs; revenue, by comparison, is booked in ‘real time’. Also, expenses are smaller
than revenue (for most banks and most of the time, anyway) and so have a smaller impact on profits.
Q/Q movement: pre-tax profit margin vs operating revenue and expenses
(12 banks*, US$, 1Q12-3Q13)
120%
Op't expenses
Op't revenue
post-w/down
120%
R-SQ 0.70
CORREL 0.84
100%
80%
100%
80%
60%
60%
40%
40%
20%
20%
0%
-100%
R-SQ 0.02
CORREL -0.13
0%
0%
100%
200%
-50%
300%
0%
-20%
-40%
50%
100%
-20%
-40%
-60%
-60%
Pre-tax profit margin
Pre-tax profit margin
Source: Tricumen.
1
2
The 12 banks are investment banking/capital markets units of: Bank of America Merrill Lynch, Barclays, BNP Paribas,
Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, J.P.Morgan, Morgan Stanley, Societe Generale, and UBS.
Though shrinking, in no small part due to Brussels’ politicians determined effort to regulate bonuses, even if doing so plainly
restricts banks’ ability to adjust their cost base to revenue shifts. Please see our ‘EU bonus cap’ note, published 1-Mar-13.
1/5
DK / Agentha / 27 November 2013

2. Theme
Equity investors heavily favour revenue generators, too. Below, we focus on banks which generated
50%+ of their normalised Group 9m13 pre-tax profit from capital markets activities (MS’ Institutional
Securities contributed 45%, but the bank’s share price is heavily influenced by capital markets
earnings, so we include it in this peer group).
For these banks, we compare capital markets revenues with Group historical book value and earnings
valuations. This is an imperfect comparison, not least because capital markets earnings are but one
of the factors influencing share valuation, especially at global universals (here, mainly Citigroup) and
‘specials’ (e.g. the ‘Swiss finish’ for CS and UBS). And yet, the link between operating revenue and
valuation dynamics is evident, particularly for banks that have avoided ‘transformational’ restructuring
from 1Q12 to date: Bank of America Merrill Lynch, Barclays, Deutsche Bank and J.P.Morgan – all of
which have generated well over half of their 9m13 Group profit from capital markets activities.
Operating revenue vs P/E and P/BV* valuations (US$, 1Q12-3Q13, indexed to 1Q12)
Bank of America Merrill Lynch
Barclays
140%
130%
130%
120%
120%
110%
110%
100%
100%
90%
90%
Composite P/E & P/BV
Op't revenue
Composite P/E & P/BV
Citigroup
end-3Q13
end-2Q13
end-1Q13
end-4Q12
end-3Q12
end-2Q12
end-1Q12
end-3Q13
end-2Q13
end-1Q13
end-4Q12
60%
end-3Q12
70%
60%
end-2Q12
80%
70%
end-1Q12
80%
Op't revenue
Credit Suisse
Composite P/E & P/BV
Composite P/E & P/BV
Deutsche Bank
end-3Q13
end-3Q13
Op't revenue
end-2Q13
40%
end-1Q13
60%
end-4Q12
60%
end-3Q12
80%
end-2Q12
80%
end-1Q12
100%
100%
end-2Q13
120%
end-1Q13
120%
end-4Q12
140%
140%
end-3Q12
160%
end-2Q12
160%
end-1Q12
180%
Op't revenue
Goldman Sachs
130%
120%
110%
100%
90%
80%
70%
60%
50%
40%
120%
110%
100%
90%
80%
70%
60%
50%
Composite P/E & P/BV
Op't revenue
Composite P/E & P/BV
end-3Q13
end-2Q13
end-1Q13
end-4Q12
end-3Q12
end-2Q12
end-1Q12
end-3Q13
end-2Q13
end-1Q13
end-4Q12
end-3Q12
end-2Q12
end-1Q12
40%
Op't revenue
Source: Tricumen analysis; share price sourced from FT.com. Notes: (1) composite price/earnings (P/E) and price/book value
(P/BV) calculations are based on actual period-end values and share prices; (2) P/E outliers falling outside the 3-standard
deviation band for the 12 banks peer group are excluded.
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DK / Agentha / 27 November 2013

3. Theme
Operating revenue vs valuations (US$, 1Q12-3Q13, indexed to 1Q12) (cont.)
J.P.Morgan
Morgan Stanley
Composite P/E & P/BV
Composite P/E & P/BV
end-3Q13
end-2Q13
end-1Q13
end-1Q12
Op't revenue
end-4Q12
60%
end-3Q12
70%
60%
end-2Q12
80%
70%
end-3Q13
90%
80%
end-2Q13
100%
90%
end-1Q13
110%
100%
end-4Q12
110%
end-3Q12
120%
end-2Q12
130%
120%
end-1Q12
130%
Op't revenue
UBS
180%
160%
140%
120%
100%
80%
60%
Composite P/E & P/BV
end-3Q13
end-2Q13
end-1Q13
end-4Q12
end-3Q12
end-2Q12
end-1Q12
40%
Op't revenue
Source: Tricumen analysis; share price sourced from FT.com. Notes: (1) composite price/earnings (P/E) and price/book value
(P/BV) calculations are based on actual period-end values and share prices; (2) P/E outliers falling outside the 3-standard
deviation band for the 12 banks peer group are excluded.
In conclusion, we believe that in the current ROE-constrained environment, the winners will need to
find new revenue sources, or new ways of generating revenue from existing businesses. Most banks
are already exploring more effectively partnering with their commercial, transaction or private banking
divisions.
We also expect more progress in genuine product innovation to create new markets. Arguably, the
last large-scale innovation was the birth of credit derivatives; since then, new markets have emerged
– e.g. longevity derivative, property derivatives and carbon trading - but none has grown enough to
make a meaningful impact on capital markets revenues. The challenge for investment banks is to do
what they do best - innovate.
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DK / Agentha / 27 November 2013

4. Theme
Appendix
Q/Q movement: pre-tax profit margin vs operating revenue (12 banks*, US$, 1Q12-3Q13)
Capital Markets
Primary activities
Op't revenue post-w/down
200%
120%
R-SQ 0.70
CORREL 0.84
100%
100%
0%
-50%
0%
-50%
-100%
60%
R² = 0.206
50%
50%
100%
150%
-100%
Pre-tax profit margin
40%
Sales & Trading
20%
150%
0%
-100%
-50%
0%
50%
100%
150%
200%
250%
-20%
R² = 0.6992
Op't revenue post-w/down
Operating revenue post-w/down
80%
150%
100%
50%
0%
-100%
-40%
0%
100%
200%
300%
-50%
-60%
-100% Pre-tax profit margin
Pre-tax profit margin
Q/Q movement: pre-tax profit margin vs operating expenses (12 banks*, US$, 1Q12-3Q13)
Capital Markets
Primary activities
200%
Op't Expenses
120%
150%
100%
100%
80%
R² = 0.2552
0%
-50%
0%
-50%
60%
Operating Expenses
50%
40%
-100%
20%
R-SQ 0.02
CORREL -0.13
-40%
-20%
100%
150%
200%
Pre-tax profit margin
Sales & Trading
150%
0%
-60%
50%
0%
20%
40%
60%
80%
Operating Expenses
-20%
-40%
-60%
-100%
Pre-tax profit margin
100%
50%
R² = 7E-05
0%
-50%
0%
50%
100%
150%
-50%
-100%
Pre-tax profit margin
Source: Tricumen. Note: The 12 banks are investment banking/capital markets units of: Bank of America Merrill Lynch,
Barclays, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, J.P.Morgan, Morgan Stanley,
Societe Generale, and UBS.
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5. Theme
About Tricumen
Tricumen was founded in 2008. It quickly become a strong provider of diversified market intelligence
across the capital markets and has since expanded into transaction and corporate banking coverage.
Tricumen’s data has been used by many of the world’s leading investment banks as well as strategy
consulting firms, investment managers and ‘blue chip’ corporations.
Situated near Cambridge in the UK, Tricumen is almost exclusively staffed with senior individuals with
an extensive track record of either working for or analysing banks; and boasts what we believe is the
largest capital markets-focused research network of its peer group.
Caveats
This report and the information contained herein may not be reproduced or distributed in the whole or
in part without the prior written consent of Tricumen Limited. Such consent is often given provided
that the information released does not prejudice Tricumen Limited’s business or compromise the
company’s ability to analyse the financial markets.
Tricumen Limited has used all reasonable care in writing, editing and presenting the information found
in this report. All reasonable effort has been made to ensure the information supplied is accurate and
not misleading. For the purposes of cross- market comparison, all numerical data is normalised in
accordance to Tricumen Limited’s proprietary product classification. Fully-researched dataset may
contain margin of error of +/-10%; for modelled datasets, this margin may be wider.
The information and commentary provided in this report has been compiled for informational purposes
only. We recommend that independent advice and enquiries should be sought before acting upon it.
Readers should not rely on this information for legal, accounting, investment, or similar purposes. No
part of this report constitutes investment advice, any form of recommendation, or a solicitation to buy
or sell any instrument or to engage in any trading or investment activity or strategy. Tricumen Limited
does not provide investment advice or personal recommendation nor will it be deemed to have done so.
Tricumen Limited makes no representation, guarantee or warranty as to the suitability, accuracy or
completeness of the report or the information therein. Tricumen Limited assumes no responsibility for
information contained in this report and disclaims all liability arising from negligence or otherwise in
respect of such information.
Tricumen Limited is not liable for any damages arising in contract, tort or otherwise from the use of or
inability to use this report or any material contained in it, or from any action or decision taken as a
result of using the report.
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DK / Agentha / 27 November 2013