Competence Center Financial Services 1Markus Böhme, Kiarash Fatehi, Pierre ReboulInvestment Banking Outlook Summer 2012 –At a turning point?Competence Center Financial Services
Our theses in a nutshell> lobal investment banking revenues continue their roller coaster ride. After a soft second G half of 2011, they strongly rebounded in the first quarter of 2012. We project a weaker Q2 with full year revenues in the EUR 200-260 bn range, depending on how the sovereign debt crisis in Europe unfolds. erformance strongly differed both within and among peer groups: Global universal P players with a higher focus on the fixed income business on average outperformed investment banks with a lower focus on fixed income. Many midsized and smaller players in developed markets came under pressure. At the same time many peers in emerging markets roared full steam ahead. ven though these trends reflect structural changes such as revenue shifting to emerging E markets and new regulations such as Basel 2.5/3, they are also harbingers of the squeeze that investment banks are going to face. Unless banks make major changes to their business models, their Return on Equity is likely to remain in single digits and many peers underperforming today may see their economic model even more challenged over the next 3 to 5 years. ixing individual and industry economics will not come easy. Even with rounds of F productivity measures, structural overcapacity still largely exists. We believe that around 75,000 jobs and one third of industry risk taking capability are still on the line. Value chains, therefore, will undergo transformation and true exits – which we have hardly seen so far – will be inevitable over the next 3 to 5 years. e think that now is the time for banks to step decisively up to this challenge to reap W early mover benefits by a bespoke mix of swiftly implementing sustainable models, capturing growth opportunities mainly in emerging markets, and in some cases position themselves as a solution provider for those players who need to consequently refocus their value chains to survive.
Competence Center Financial Services 3Looking BackAugust 2007 marked a watershed event in global investment banking1). Liquidity began dry-ing up in asset backed securities markets and events eventually unfolded into the subprimecrisis that claimed banks throughout the US and Europe. Almost five years later we are look-ing at an industry that has gone through a roller coaster ride as global revenue pools tankedin 2008, rose out of the ashes in 2009 and subsequently hovered back to approximatelypre crisis levels before further decreasing by more than 10% from 2010 to 2011 (exhibit 1).Exhibit 1: To hell and back – After their post crisis peak global investment bankingrevenues are coming in around 2006 levelsInvestment banking revenues1), 2011 Revenue trend, 2006-2012e[EUR bn] [EUR bn] 270 265 260 Emerging 240 ~ 75 ~5 Markets 18% 23% 230 WE EE 200 ~ 70 ~ 10 28% North America Japan ~5 ~45 Emerging Asia Developed MEA 82% Markets 77% 72% ~ 10 Latin America ~10 A/NZ 2006 2011 Bear Base Opti- Developed Emerging 2010 case case mistic 20121) Adjusted IBD, Equities, and FICC revenues (before loan loss provisions) calculated scenarios at constant 2011 exchange ratesSource: Roland Berger; company disclosure and presentationsOn the heels of this roller coaster ride Basel 2.5 and other new regulatory requirements arestarting to kick in and despite myriad rescue attempts, the European sovereign debt crisishas heightened in intensity. With dark clouds continuing to cast a shadow over financialmarkets and economic activity, where does investment banking go next?1) e define global investment banking as the collective IBD (MA, ECM, DCM, structured origination), Equities, and W FICC (Fixed Income, Currencies and Commodities) businesses and revenue streams generated by global, regional, and local players active in these lines of business.
4 Investment Banking Outlook Summer 2012 – At a turning point? We believe that the answer lies in first understanding the underlying structural changes that the industry has experienced and thinking of scenarios in how the market will develop. We see three main shifts that are transforming the industry: ontinued shifts of revenue pools to emerging markets, first and foremost to Asia with C Brazil being a second hotspot. hile the FICC roller coaster ride and DVA/CVA effects2) have been the key drivers behind W ups and downs, they have also somewhat masked that Equities and IBD businesses are stagnating and contracting in developed markets. any players will continue to see their economic models challenged. The top 16 global M investment banks and universal players took a double hit when markets softened in 2011, just as new regulation such as Basel 2.5 kicked in boosting capital consumption especially for European based players. In 2011 the game changed and many local players in developed markets lost their edge as shrinking market shares and revenues propelled cost-income-ratios into unsustainable territory. In addition regulatory headwind puts further pressure on capital efficiency. Exhibit 2: Despite a strong Q1 the full year 2012 revenue pool might only yield a small uptick and substantial downside risk persists JUNE 2012 PROJECTION Quarterly IB revenues, Q1 2010 – Q1 20121) IB revenues by product groups, 2006-2012e [EUR bn] [EUR bn] 88 270 265 85 260 80 FICC – roller coaster ride 240 230 Normalization vs. extra- ordinary Q1 2009/10 levels 200 62 Weak flow and position losses 60 59 FICC 57 in Q3/4 2011 Once again subdued activity ? after Q1 2012 rebound 43 39 Equities – softening Heavy dip in Q4 2011 Equities Softer activity with limited Q1 pickup IBD – softening IBD Downhill from strong Q2 2011 Limited pipeline Q1 Q3 Q1 Q3 Q1 2006 2010 2011 Bear Base Opti- 2010 2010 2011 2011 2012 case case mistic Q2 Q4 Q2 Q4 Q2 2012 scenarios 2010 2010 2011 2011 2012 1) Adjusted IBD, Equities, and FICC revenues (before loan loss provisions) calculated at constant 2011 exchange rates Source: Roland Berger; company disclosure and presentations 2) ebt Value Adjustments and Credit Value Adjustments: Mark-to-market changes in the value of own debt issued D and counterparty exposure as mandated by IAS but often recorded in banks IB and especially FICC divisions.
Competence Center Financial Services 5 The picture is not homogenous – for example, many German small- and midsized players were among those hit hardest. In sharp contrast many – especially Asian and Latin American – emerging market local players continued to grow profitably. Exhibit 3: Not all players are born equal – At least five peer groups compete with distinct business and economic models Peer group IB economics (Basel 2.5)1), 2011 [%] Examples Business Ø EM rev. Ø IB/CIB Note: Bubble size indicates peer group IB revenues2) of players model share3) share4) Global IBs IBD, FICC, Equity ~20% ~100% 8 players Global 110 Global 100 Universals 90 Global IBD, FICC, ~30% ~60% Global IBs Universals Equity iency (CIR) Developed 8 players Relatively 80 Markets Locals global 70 Advanced Emerging focus 90% ~35%Cost effici 60 Advanced Internationals 15 players Mixed player ~35% ~45% Internationals 50 Developed focus minimal ~30% 40 Developed FICC focus 0-5% ~10% Emerging Markets Locals Markets Locals Limited 30 (Banks + Brokers) 50 players IBD/Equity Country focus 20 0 1 2 3 4 5 6 7 8 9 10 Emerging Country focus 95-100% ~10% Market Locals Mostly bifurcated: Capital efficiency (Rev/RWA) 50 players Banks vs. brokers 1) Estimate, assuming 70% on disclosed B2.5/3 impact on CT1 ratio will come through CIB Markets RWA uplift 2) Revenues calculated at constant 2011 exchange rates 3) Emerging market revenue share of total peer group revenue 4) Investment Banking revenue share of total CIB peer group revenues Source: Roland Berger; company disclosure and presentations What Lies Ahead So far in 2012, these trends are continuing to affect the industry. First quarter results strongly rebounded from the second half of 2011, which was characterized by higher risk, drying up of client flows and position markdowns as the sovereign debt crisis unfolded (exhibit 2). However, not all ships were lifted equally by the tide. Once again emerging markets players roared full steam ahead. Small and midsized locals in developed countries, meanwhile, saw a mixed picture with many of them registering only a moderate recovery or even further revenue contraction against the global trend. Among global players the field was split but on average universal players, who enjoyed broader sources of flow such as FX and rates businesses driven by transaction banking, seemed to fare better (exhibit 3 and 4).
6 Investment Banking Outlook Summer 2012 – At a turning point? Exhibit 4: Recent performance diverges both between as well as within each peer group Contracting Moderate recovery Rebounding Continued growth Q1 Q1 Q1 Q1 2010 2011 2012e 2010 2011 2012e 2010 2011 2012e 2010 2011 2012e Global Universals Global Universals Globals rebound stronger Global IBs than IBs Developed market players increasingly Developed Locals Markets under pressure Advanced EM franchises as growth driver? Advanced Emerging Markets Continued growth? Locals Source: Roland Berger; company disclosure and presentations However as banks close the books on the second quarter and will begin reporting results in a few weeks, we expect to see a sharp drop off from the first quarter. Although this sort of Q1 to Q2 drop has been more the rule than the exception over the last few years (exhibit 2), the questions that persist are just how bad will the drop off be and where do we go from here? Even assuming that the sovereign crisis slowly abates, we would expect the full year outlook to be just around 2011 levels – a year that was rough, but not nearly as negative as 2008. Nobody can and wants to project the impact of a euro meltdown. In this case all bets would be off. But even if the sovereign debt crisis is still as intense by the end of the year as today, the downside for investment banks for the rest of the year will be substantial. In this case the revenue pool may shrink by another 15% to about EUR 200bn. Even under rosier scenarios, with a fairly quick recovery and a much more favorable trading environment and deal pipeline, revenues seem unlikely to revert to 2010 levels (exhibit 2). As a result of this challenging environment one European and North American player after another has already lowered their RoE targets: 12 to15% became the new standard down from the earlier 25% targets. We believe however, that the industrys economic model is more challenged than those lowered targets suggest. Even when factoring in the stream of restruc- turings and lay offs already announced, the industry will only return to single digit post tax RoEs on average. Our base case scenario envisions a 9% RoE and in our bear case, a mere 5% RoE (exhibit 5).
Competence Center Financial Services 7Exhibit 5: Unless markets revert to a bull trajectory it is bye-bye to double digit RoEsfor 2012 except for high growth pockets in emerging marketsIndustry RoE1) – 2012 Base case scenario [%] Peer groups RoE range [%] 0% 20%Ø 2010 RoE: 15% 11 9 Global IBsØ 2011 RoE: 7% 5 Global Universals Bear Base Optimistic Developed Scenario Case Scenario Markets PlayersCost-income Emerging Marketsratio [%] 80 70 65 Players1) After-tax, assuming an effective tax rate of 30% for all peer groupsSource: Roland Berger; company disclosure and presentationsOnce again emerging markets focused players are poised to deliver higher returns – providedthere will not be a sharp reversal of fortunes, and confidence falters tanking emerging marketsgrowth.However, for an average developed market focused player or even global players driven by theirEuropean and US businesses, these single digit RoEs lead to an unsustainable trajectory. Onthe other side IB players face even more headwind since they are less focused on FICC andhence benefitted less from the Q1 revenue uptick. In addition they lack regular FICC flows fromtransaction banking.Over the next 3 to 5 years, European players will face further headwind as the full effect ofproposed regulations such as Basel 3 kick in, squeezing capital and economics. We do notknow when exactly this will happen and how long local regulators will allow for transition.Despite that uncertainty we are sure that post tax industry RoEs might remain in single digitstherefore falling some 7% to 8% short of targets unless more drastic action is taken (exhibit 6).
8 Investment Banking Outlook Summer 2012 – At a turning point? Exhibit 6: What would it take to continue to sustainably earn positive economic profits in the IB industry? Mid-term perspective RoE [%] How could the profit gap be closed? Capital reduction of ~30% of industry RWAs in order to overcompensate Basel III uplift Larger, consolidated books 7-8 Risk management activity transferred to institutional investors (shadowbanking 2.0?) 4 12-15 Capacity Cost reduction of industry cost base by around 9-11 one-third reduction 5-7 ~15% headcount reduction and exit d it Reduced compensation benefits of around 10% pressure 15-20% decrease of non-compensation budget Target Baseline Basel 3 Mid-term Profita- RoE 2012 effect baseline bility gap ~10% Repricing Limited roll over increased capital requirements Baseline 2012 given by base case and optimistic scenario Capacity and demand gap starts to close Source: Roland Berger Restoring growth Such gloomy scenarios make it impossible for most European and US players to retain their capital allocations. To close this RoE gap the industry would truly need to reduce capacity to sustainable levels. Evidence suggests that this reduction has yet to occur: ew players have truly exited full lines of business. For example RBS and UniCredit have F exited from parts of Cash Equities and Credit Agricole, Santander and BBVA have left commodities, but none of them was a major player in these business lines anyway. ostly, headcount reductions have increased individual players productivity but did not re- M duce capacity in the overall industry. Furthermore, announced reductions take longer to work their way through the system – of about 25,000 job cuts announced by the top 16 players in mid 2011 only 15,000 were realized by year end because attrition came down sharply. ome (especially large) players successfully mitigated large parts of the Basel 2.5 driven S RWA (Risk Weighted Assets) uplift through RWA reduction programs. These programs how- ever, largely pertained to legacy asset sell offs and transfer of certain securitization tranches and other assets whose capital consumption would have skyrocketed under Basel 2.5 to hedge funds and other institutional investors – a space often coined as shadow banking. The industrys client focused trading and risk management capacity itself has hardly been reduced.
Competence Center Financial Services 9We feel that real capacity reduction is the only way to restore economics in the mid-term. Ashake out with real product line exits, capacity reducing and efficiency boosting mergers andjoint ventures as well as a fundamental reduction in vertical integration in particular for localplayers will be required to achieve 12 to 15% RoE assuming a flat to moderate revenue pooltrajectory (exhibit 6).One scenario to close the collective RoE gap would mean: educing industry RWAs by about 30% or close to 2 trillion euros – this would mean we R are heading towards shadow banking 2.0 as hedge funds would have to pick up half of this amount – with the other half requiring a real consolidation into fewer, more capital efficient books. epricing (and hence increasing the revenue pool at flatter volumes) by about 10%, which R would not seem realistic without reduction of overcapacity. educing the industry cost base by around one third – even with sizable cuts on the non R compensation related cost, further structural compensation adjustments, including the effects of guarantees and the effect of large albeit deferred bonuses, as well as sizable headcount reductions would be required. We would estimate that about 15% of the 500,000 jobs in the industry would have to be cut. Unprecedented rounds of layoffs – well beyond the 10,000 already announced but not executed – would become inevitable.How can the industry and individual banks mend their economics – especially when the weightof their portfolio is not geared towards emerging growth markets? We predict four key develop-ments (exhibit 7):Exhibit 7: Eventually, industry players will need to take radical action –Four major areas for profitable change Next wave of headcount reduction and Universals withdrawing capital productivity based compensation Lower risk taking capacity for some players Complexity reduction A real wave of (product line) exits Process re-engineering and automation Stepped-up efficiency Reduced over-capacity programs Refocused + industrialized Battle for (emerging) ( g g) value chains growth markets Challenged local players truly refocus on unique client value proposition and scale Global leaders localizing back trading platforms Local leaders professionalizing Large platforms leveraged into true bank for bank offerings Industry utilities emergingSource: Roland Berger
10 Investment Banking Outlook Summer 2012 – At a turning point? refocusing and industrialization of value chains is necessary. Winners will evade the A looming shake out by refocusing on their true edge and value proposition. For smaller players this might mean concentrating on sales, basic structuring and counterparty risk absorption with strict focus on their privileged corporate banking and other quasi-captive franchises. Likewise industry utilities and true bank for bank leaders will emerge to fill this void while other large players might choose to focus on certain products, client segments and regional niches, in which critical mass can be reached independent of a full scale offering. oving fast will be essential and earning the right to grow and consolidate will mean M stepping -up efficiency programs. ooner or later the industry will tackle its over-capacity as mid-sized players that neither S managed to focus nor to catch up with volume leaders will need to exit some product lines. ome capacity will continue to shift into emerging markets and more and more bankers S will head from London and New York to Sao Paulo, Singapore, and Hong Kong as well as places like Jakarta. However, there will be more aspirants than opportunities as the battle for emerging growth markets heats up: Global firms build their presence on the ground (especially beyond hubs such as Hong Kong and Singapore). Regional champions such as Standard Chartered in Asia or Itau in Latin America invest into their IB capabilities and local players get serious on various forms of IB, CIB or merchant banking growth. Moving decisively and robustly executing this transformation while maintaining day to day focus on capturing business and managing risk in volatile and adverse market conditions will be paramount. Perhaps another five years down the road we will look back on 2012 as the year that decided the fate of banks that survived and those banks that did not.
Competence Center Financial Services 11Contact Markus Böhme Partner 50 Collyer Quay, #10-02 OUE Bayfront Singapore, 049321 Singapore Phone: +65 65 97-4577 E-mail: firstname.lastname@example.org Kiarash Fatehi Partner OpernTurm, Bockenheimer Landstraße 2-8 60306 Frankfurt, Germany Phone: +49 69 29924-60 E-mail: email@example.com Pierre Reboul Partner 11, rue de Prony 75017 Paris, France Phone: +33 1 53670-325 E-mail: firstname.lastname@example.org
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