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Markus Böhme, Kiarash Fatehi, Pierre Reboul Investment Banking Outlook Summer 2012 – At a turning point? Competence Center Financial Services
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Roland berger investment_banking_20120710

Sep 11, 2014

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Page 1: Roland berger investment_banking_20120710

Competence Center Financial Services 1

Markus Böhme, Kiarash Fatehi, Pierre Reboul

Investment Banking Outlook Summer 2012 – At a turning point?

Competence Center Financial Services

Page 2: Roland berger investment_banking_20120710

Our theses in a nutshell

> Global investment banking revenues continue their roller coaster ride. After a soft second 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.

> Performance strongly differed both within and among peer groups: Global universal 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.

> Even though these trends reflect structural changes such as revenue shifting to emerging 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.

> Fixing individual and industry economics will not come easy. Even with rounds of 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.

> We think that now is the time for banks to step decisively up to this challenge to reap 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.

Page 3: Roland berger investment_banking_20120710

Competence Center Financial Services 3

Looking Back

August 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 subprime crisis 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 tanked in 2008, rose out of the ashes in 2009 and subsequently hovered back to approximately pre crisis levels before further decreasing by more than 10% from 2010 to 2011 (exhibit 1).

On the heels of this roller coaster ride Basel 2.5 and other new regulatory requirements are starting to kick in and despite myriad rescue attempts, the European sovereign debt crisis has heightened in intensity. With dark clouds continuing to cast a shadow over financial markets and economic activity, where does investment banking go next?

Exhibit 1: To hell and back – After their post crisis peak global investment banking revenues are coming in around 2006 levels

Revenue trend, 2006-2012e[EUR bn]

265

77%

23%

270

82%

18%

Developed Markets

EmergingMarkets 230

28%North America~ 70

~5EE

~5MEA

Emerging Asia~45

~ 10 Japan

WE~ 75

Investment banking revenues1), 2011 [EUR bn]

200

240260

Developed Emerging 2010

77%

2006

Markets

Opti-mistic

Base case

Bear case

2011

72%

1) Adjusted IBD, Equities, and FICC revenues (before loan loss provisions) calculated at constant 2011 exchange rates

Latin America~ 10

~10A/NZ

Source: Roland Berger; company disclosure and presentations

2012 scenarios

1) We define global investment banking as the collective IBD (M&A, ECM, DCM, structured origination), Equities, and FICC (Fixed Income, Currencies and Commodities) businesses and revenue streams generated by global, regional, and local players active in these lines of business.

Page 4: Roland berger investment_banking_20120710

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:

> Continued shifts of revenue pools to emerging markets, first and foremost to Asia with Brazil being a second hotspot.

> While the FICC roller coaster ride and DVA/CVA effects2) have been the key drivers behind ups and downs, they have also somewhat masked that Equities and IBD businesses are stagnating and contracting in developed markets.

> Many players will continue to see their economic models challenged. The top 16 global 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

80

43

62

85

575960

88

IB revenues by product groups, 2006-2012e[EUR bn]

FICC

260

200

230

265270

240 FICC – roller coaster ride> Normalization vs. extra-

ordinary Q1 2009/10 levels> Weak flow and position losses

in Q3/4 2011> Once again subdued activity

after Q1 2012 rebound?

JUNE 2012 PROJECTION

Quarterly IB revenues, Q1 2010 – Q1 20121)

[EUR bn]

Source: Roland Berger; company disclosure and presentations

Q22012

Q12012

Q42011

39

Q32011

Q22011

Q12011

Q42010

Q32010

Q22010

Q12010

IBD

Equities

Equities – softening> Heavy dip in Q4 2011> Softer activity with limited

Q1 pickup

IBD – softening> Downhill from strong Q2 2011> Limited pipeline

1) Adjusted IBD, Equities, and FICC revenues (before loan loss provisions) calculated at constant 2011 exchange rates

20102006 Opti-mistic

Base case

Bear case

2011

2012 scenarios

2) Debt Value Adjustments and Credit Value Adjustments: Mark-to-market changes in the value of own debt issued and counterparty exposure as mandated by IAS but often recorded in banks' IB and especially FICC divisions.

Page 5: Roland berger investment_banking_20120710

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.

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).

Exhibit 3: Not all players are born equal – At least five peer groups compete with distinct business and economic models

70

80

90

100

110

Developed Markets Locals

Global Universals

Global IBs

Peer group IB economics (Basel 2.5)1), 2011 [%]Note: Bubble size indicates peer group IB revenues2)

ienc

y (C

IR)

Global IBs8 players

Global Universals8 players

Advanced

Business model

> IBD, FICC, Equity> Global

> IBD, FICC, Equity

> Relatively global

> Emerging focus

Ø EM rev. share3)

~20%

~30%

>90%

Examples of players

Ø IB/CIBshare4)

~100%

~60%

~35%

Source: Roland Berger; company disclosure and presentations

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 rates3) Emerging market revenue share of total peer group revenue 4) Investment Banking revenue share of total CIB peer group revenues

20

30

40

50

60

0 1 2 3 4 5 6 7 8 9 10

Emerging Markets Locals (Banks + Brokers)

Advanced Internationals

Cost

eff

ici

Capital efficiency (Rev/RWA)

Advanced Internationals15 players

Developed Markets Locals> 50 players

Emerging Market Locals> 50 players

> Emerging focus

> FICC focus> Limited

IBD/Equity> Country focus

> Country focus> Mostly bifurcated:

Banks vs. brokers

>90%

0-5%

95-100%

~35%

~10%

~10%

> Mixed player

> Developed focus

~35% ~45%

minimal ~30%

Page 6: Roland berger investment_banking_20120710

6 Investment Banking Outlook Summer 2012 – At a turning point?

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 industry's 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).

Global IBs

Global Universals

Exhibit 4: Recent performance diverges both between as well as within each peer group

Global Universals rebound stronger than IBs

Contracting Moderate recovery Rebounding Continued growth

2012e

Q1

20112010 2012e

Q1

20112010 2012e

Q1

20112010 2012e

Q1

20112010

Glo

bals

Locals

Advanced

Locals

Advanced

Source: Roland Berger; company disclosure and presentations

Deve

lope

d M

arke

tsEm

ergi

ng

Mar

kets

Developed market players increasingly under pressure

EM franchises as growth driver?

Continued growth?

Page 7: Roland berger investment_banking_20120710

Competence Center Financial Services 7

Once again emerging markets focused players are poised to deliver higher returns – provided there will not be a sharp reversal of fortunes, and confidence falters tanking emerging markets growth.

However, for an average developed market focused player or even global players driven by their European and US businesses, these single digit RoE's lead to an unsustainable trajectory. On the other side IB players face even more headwind since they are less focused on FICC and hence benefitted less from the Q1 revenue uptick. In addition they lack regular FICC flows from transaction banking.

Over the next 3 to 5 years, European players will face further headwind as the full effect of proposed regulations such as Basel 3 kick in, squeezing capital and economics. We do not know 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 digits therefore falling some 7% to 8% short of targets unless more drastic action is taken (exhibit 6).

Exhibit 5: Unless markets revert to a bull trajectory it is bye-bye to double digit RoEsfor 2012 except for high growth pockets in emerging markets

Industry RoE1) – 2012 Base case scenario [%]

Ø 2010 RoE: 15%

Ø 2011 RoE: 7%

RoE range [%]

0% 20%

Global IBs

Global Universals

Peer groups

119

5

Optimistic Scenario

BaseCase

Bear Scenario

Cost-income ratio [%] 80 6570

1) After-tax, assuming an effective tax rate of 30% for all peer groups

Source: Roland Berger; company disclosure and presentations

Developed Markets Players

Emerging Markets Players

Page 8: Roland berger investment_banking_20120710

8 Investment Banking Outlook Summer 2012 – At a turning point?

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:

> Few players have truly exited full lines of business. For example RBS and UniCredit have 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.

> Mostly, headcount reductions have increased individual players' productivity but did not re-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.

> Some (especially large) players successfully mitigated large parts of the Basel 2.5 driven 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 industry's client focused trading and risk management capacity itself has hardly been reduced.

Exhibit 6: What would it take to continue to sustainably earn positive economic profits in the IB industry?

How could the profit gap be closed?

Capital reduction of ~30% of industry RWAs in order to overcompensate Basel III uplift> Larger, consolidated books> Risk management activity transferred to

institutional investors ('shadowbanking 2.0'?)

Mid-term perspective RoE [%]

12-154

9-11

7-8

Cost reduction of industry cost base by around one-third

Capacity reduction

d it

Source: Roland Berger

~10% Repricing> Limited roll over increased capital requirements > Capacity and demand gap starts to close

Target RoE

Basel 3 effect

Baseline 2012

Profita-bility gap

Mid-term baseline

5-7 > ~15% headcount reduction> Reduced compensation benefits of around 10%> 15-20% decrease of non-compensation budget

Baseline 2012 given by base case and optimistic scenario

and exit pressure

Page 9: Roland berger investment_banking_20120710

Competence Center Financial Services 9

We feel that real capacity reduction is the only way to restore economics in the mid-term. A shake out with real product line exits, capacity reducing and efficiency boosting mergers and joint ventures as well as a fundamental reduction in vertical integration in particular for local players will be required to achieve 12 to 15% RoE assuming a flat to moderate revenue pool trajectory (exhibit 6).

One scenario to close the collective RoE gap would mean:

> Reducing industry RWAs by about 30% or close to 2 trillion euros – this would mean we 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.

> Repricing (and hence increasing the revenue pool at flatter volumes) by about 10%, which would not seem realistic without reduction of overcapacity.

> Reducing the industry cost base by around one third – even with sizable cuts on the non 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 weight of 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

> Universals withdrawing capital> Lower risk taking capacity for some players> A real wave of (product line) exits

> Next wave of headcount reduction and productivity based compensation

> Complexity reduction> Process re-engineering and automation

Battle for (emerging)

Reduced over-capacityStepped-up efficiency programs

Refocused + industrialized value chains

> Global leaders 'localizing'> Local leaders professionalizing

( g g)growth markets

> Challenged local players truly refocus on unique client value proposition and scale back trading platforms

> Large platforms leveraged into true bank for bank offerings

> Industry utilities emerging

value chains

Source: Roland Berger

Page 10: Roland berger investment_banking_20120710

10 Investment Banking Outlook Summer 2012 – At a turning point?

> A refocusing and industrialization of value chains is necessary. Winners will evade the 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.

> Moving fast will be essential and earning the right to grow and consolidate will mean stepping -up efficiency programs.

> Sooner or later the industry will tackle its over-capacity as mid-sized players that neither managed to focus nor to catch up with volume leaders will need to exit some product lines.

> Some capacity will continue to shift into emerging markets and more and more bankers 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.

Page 11: Roland berger investment_banking_20120710

Competence Center Financial Services 11

Contact

Markus Böhme Partner 50 Collyer Quay, #10-02 OUE Bayfront Singapore, 049321 Singapore

Phone: +65 65 97-4577 E-mail: [email protected]

Kiarash Fatehi Partner OpernTurm, Bockenheimer Landstraße 2-8 60306 Frankfurt, Germany

Phone: +49 69 29924-60 E-mail: [email protected]

Pierre Reboul Partner 11, rue de Prony 75017 Paris, France

Phone: +33 1 53670-325 E-mail: [email protected]

Page 12: Roland berger investment_banking_20120710

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Roland Berger Strategy Consultants07/2012, all rights reservedwww.rolandberger.com