Uncertainty over the intensity, geographic reach and duration of the coronavirus (COVID-19) outbreak is negatively impacting primary market activity and significantly increasing volatility, making it likely that capital markets revenue at the global trading and universal banks (GTUBs) will be adversely affected, Fitch Ratings says. We do not expect this hit on earnings to affect GTUB ratings if the outbreak is quickly contained, but prolonged revenue weakness and deterioration in asset quality if a weaker economic outlook becomes more deep rooted could pressure capital levels and ultimately ratings over the longer term.

Following strong market activity during the first two months of the year in Europe and the U.S., increased market volatility will likely reduce issuance activity, which will dent revenue in the normally seasonally strong first quarter. Policymakers have highlighted a determination to use fiscal and monetary tools to lessen the economic and financial market impact of COVID-19, financial market volatility will likely persist while uncertainty remains. The Federal Reserve lowered its target fed funds rate by 50 bps in response to slowing growth from the COVID-19 outbreak. While the Fed response may spur issuance activity, it will also negatively affect asset yields, resulting in lower margins and reducing bank profitability.

While increases in volatility can aid trading revenue, we believe the recent sharp rise in volatility and trading volumes reflects high levels of uncertainty. Transaction volumes in many trading businesses could taper off once investors and corporates have readjusted their portfolios. This environment resembles fourth-quarter 2018 and first-quarter 2016, which saw days with elevated VIX but notable year-over-year declines in markets businesses.

All GTUBs have material capital markets businesses, but their contribution to overall profit varies. In the U.S., FICC and equity trading revenue accounts for around a third of total revenue at Morgan Stanley and around 40% of total revenue at Goldman Sachs in any given quarter. For JPMorgan, Citigroup and Bank of America, the level is lower, with less of a negative impact on overall profitability. At the European GTUBs, trading businesses account for about 25% of total quarterly revenues on average for Barclays, Credit Suisse and Deutsche Bank, with a lower contribution at BNP Paribas, Societe Generale and UBS.

Market exposure from trading is a material risk for the banks. However, we believe risk appetite has remained conservative as the groups primarily concentrate on client-driven transactions. We do not expect material trading losses resulting from volatility spikes or credit spread widening given this conservative approach. However, any sign of outsized hits on trading revenue could indicate control weaknesses or heightened risk appetite, which would be viewed negatively from a credit perspective. Trading activities could also come under pressure if banks have to enact operational changes to ensure business continuity, or if material portion of the banks’ staff have to work from home or from off-site locations.

Given their global presence, several GTUBs also have material businesses in Asia, which include sizable wealth management and lending operations, where asset quality deterioration would likely emerge first. Current asset quality ratios are sound, but a severe hit to GDP growth in the region would test the banks’ underwriting quality after a prolonged period of sustained business growth and a benign credit environment.