investment banking and capital markets - bcg · investment banks faced difficult conditions but...

Investment Banking and Capital MarketsMarket Report — First Quarter 2008

May 28, 2008

1

Contents

Overview of first quarter 2008 results 1

Market review• Fixed-income and equity trading 6• Corporate finance and advisory 10

Focus: Asia-Pacific 15

BCG project example 19

BCG investment banking contacts 23

2

Investment banks faced difficult conditions but managed to improve performance during the first quarterInvestment banks had a difficult start to the year but showed signs of improvement

• The aggregate revenues of ten leading investment banks remained negative, at -$3.9 billion, driven by additional write-offs, but they were well above fourth-quarter revenues of -$19.6 billion

• As a result, the BCG performance index improved from -559.2 to -376.5 in the first quarter

Difficult market conditions prevailed in the first quarter• The period was defined by the collapse of Bear Stearns and its subsequent takeover by JPMorgan Chase• Markets were affected by the global liquidity crisis and further repricing of credit risk• The structured-credit market was dampened by depressed client activity in CDOs and related products• The disruption in credit and fixed-income markets reverberated across virtually every asset class

regardless of fundamentals or underlying quality• Activity in high-margin institutional businesses, such as advisory and underwriting, slowed

Revenues were heavily affected by the downturnFixed-income and equity trading• Sales and trading revenues of ten leading investment banks totaled -$5.1 billion, well above fourth-quarter

revenues of -$32.0 billion• Fixed-income revenues were again adversely affected by write-downs. Revenue from equity-trading

activities was similar to the previous quarter but 16.0 percent lower than the same period last year

Corporate finance and advisory• Corporate finance and advisory revenues fell by 74.9 percent over the previous quarter and were 74.4

percent lower than the same quarter last year. M&A advisory and equity and debt underwriting activities all experienced declining revenue

Source: BCG analysis

3

Industry performance improved in the first quarter

BCG Investment Banking Performance Index

133.983.5

133.5 119.2172.4 165.1

135.9

193.3218.3

-9.8

-559.2

-376.5

242.5

-650

-550

-450

-350

-250

-150

-50

50

150

250

Q2/05 Q4/05 Q2/06 Q4/06 Q2/07 Q4/07

Index(Q1/01= 100)

2005 2006 2007 2008

Note: The BCG Investment Banking Performance Index is calculated based on aggregate profits of ten leading banksSource: Company reports; BCG analysis

4

Revenues improved but were more than 100 percent lower than the same quarter last year

Pre-tax profit margins and revenues:Q1 2008 versus Q4 2007




0%

10%

20%

30%

40%

50%

60%

0 2 4 6 8 10 12

Pre-tax profit margin (%)

Revenues ($B)

GS

LEHBSC JPM

Q1/08 Q4/07

0%

10%

20%

30%

40%

50%

60%

0 2 4 6 8 10 12

Pre-tax profit margin (%)

Revenues ($B)

GSLEH

BSC JPM

Q1/08 Q1/07

MS MS

Change in revenues including write-offs: n/m1

Change in revenues excluding write-offs: +18 percentChange in revenues including write-offs: -107% Change in revenues excluding write-offs: -23%

Note: Ø calculated on a revenue-weighted basis; revenue includes investment banking, institutional sales and trading, and principal investments. Citigroup, Credit Suisse, Deutsche Bank, Merrill Lynch, and UBS were omitted from charts but were included in the calculationsSource: Company reports; BCG analysis

5

Write-downs took a heavy toll on trading revenues

Revenues by company: Q1 2008 vs Q1 2007

11.63.0 3.0

47.9

-5.1

45.5

($B)

59.5

-2.1

-18

-15

-12

-9

-6

-3

0

3

6

9

12($B)

Note: Not including principal investments and other revenuesSource: Company reports; BCG analysis

Corporate finance & advisory revenues Trading revenues

07 08MS

07 08GS

07 08JPM

07 08LEH

07 08BSC

07 08Citi

07 08DB

07 08CS

07 08MER

07 08UBS

Total revenues

1Q07Total

1Q08Totalincl

Write-offs

48.5

1Q08Totalexcl

Write-offs

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7

Equity trading fared better than fixed-income trading

Fixed-income trading• Revenues from fixed-income markets were 172 percent lower than the same quarter last

year, as write-downs continued to mount– Fixed-income revenue of ten leading investment banks was hit by write-downs totaling

about $50 billion – UBS, Credit Suisse, Citigroup, and Merrill Lynch recorded negative revenue– Revenues from FX, interest rates, and commodities increased, partially offsetting the

declines in credit products• US bond-trading volumes were 15.1 percent higher than the previous quarter

Equity trading• Revenues from equity trading were marginally lower in the first quarter and were 16.0

percent lower than they were during the same period last year, when they peaked at $18.7 billion

– Trading volumes remained stable during the quarter


8

Subprime write-downs continued to weigh on fixed-income revenues

-20.9

-47.9

1.7

25.629.1

21.820.523.224.1

14.719.4

14.620.9

-60

-40

-20

0

20

40

Q307 Q407 Q108

($B)

Q205 Q305 Q405 Q106 Q206 Q306 Q406 Q107 Q207Q105

Fixed-income trading

U.S. weekly average bond-trading volumesU.S. weekly average bond-trading volumes Fixed-income trading revenues by quarterFixed-income trading revenues by quarter

0

500

1,000

1,500

1,2771,226

1,0651,072 1,092 1,053 1,0631,107

1,070 1,037

Q108

+15%

1,411

1,148

Q105 Q205 Q305 Q405

1,179

Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407

Corp Bonds

MBS/ABS

Treasury/Agencies

($B)

Note: Trading volumes single counted, includes investment funds traded at exchanges; aggregated trading revenues for ten leading investment banks surveyedSource: Federal Reserve Bank of New York; BCG analysis

9

Equity-trading revenues declined marginally

Equity trading

15.715.8

12.6

18.018.7

12.8

10.0

12.1

14.8

9.210.2

7.3

9.0

0

5

10

15

20

Q105 Q205 Q305 Q405 Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407 Q108

-1%

($B)

Global-exchange trading volumesGlobal-exchange trading volumes Equity-trading revenues by quarterEquity-trading revenues by quarter

0

5

10

15

20

25

30

26.2

Q108

12.3 12.1 12.813.8

17.618.7

15.5

18.2

22.1

25.0

27.0 26.3

Q105 Q205 Q305 Q405 Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407

EMEA

Asia

Americas

($T)

Note: Trading volumes single counted, includes investment funds traded at exchanges; aggregated trading revenues for ten leading investment banks surveyedSource: World Federation of Exchanges; BCG analysis

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Contents






11

The financial crisis continued to affect advisory and origination activity

Advisory• M&A activity declined 38.9 percent over the previous quarter and was 18.2 percent lower

than the same period last year– In the Americas, advisory activity was 56.1 percent lower than the previous quarter;

activity in Asia-Pacific was 40.3 percent lower– Goldman Sachs continued to take the highest share of global advisory revenues

Corporate Finance• Equity origination was 59.3 percent lower than the previous quarter

– Underwriting declined in all three regions, with activity in EMEA and Asia-Pacific dropping by 79.7 percent and 61.8 percent respectively. In the Americas, equity underwriting was 29.5 percent lower than the previous quarter

– IPO activity weakened• Debt origination dropped slightly during the quarter, reflecting the continual decline in

leveraged finance and mortgage-related activity since the third quarter of 2007– Bond issuance was 1.9 percent lower than the previous quarter and 47.3 percent

lower than the same period last year


12

Revenues from corporate finance and advisory activities dropped by 74 percent

-5

0

5

10

15

6.8

Q105

7.1

Q205

8.1

Q305

8.7

Q405

9.0

Q106

9.9

Q206

8.9

-74%

11.9

Q406

11.7

Q107

($B)

13.6

Q207

9.6

Q307

11.9

Q407

3.1

Q108

ECM

DCM

M&A

Q306

Global corporate finance and advisory revenues

Note: Aggregated revenues for ten leading investment banks surveyedSource: BCG analysis

13

Advisory and underwriting levels weakened in the first quarter

Effective M&A dealsEffective M&A deals Equity issuanceEquity issuance Bond issuanceBond issuance

53

95

36

79

16

49

66

43

61

43

43

71

70

76

29

0

100

200

300

145

Q107

232

Q207

149

Q307

216

Q407

88

Q108

Asia-Pacific

Americas

EMEA

-59%

($B)

814 771

384 359 406

709609 557

112132

112

0

500

1,000

1,500

2,000

2,500

1,086

2,013

Q107

1,221

2,124

Q207

801,173

Q307

1,081

Q407

971,060

Q108

-2%

($B)

301 356274

473392

498472

470

579

254

87126

126

134

80

0

500

1,000

1,500

886

Q107

954

Q207

870

Q307

1,186

Q407

725

Q108

-39 %

($B)

Source: Thomson SDC; BCG analysis

14

Goldman Sachs remained the market leader in M&A while JPMorgan Chase continued to lead underwriting

Share of global M&A revenuesShare of global M&A revenues Share of global underwriting revenuesShare of global underwriting revenues

0

20

40

60

80

100

0 20 40 60 80 100

Relative market position Q1/07 (%)


Gained share

Lost share

JPM

CS

GS

MS

LEHCiti

MER

UBS

BSC

DB

0

20

40

60

80

100

0 20 40 60 80 100



Gained share

Lost share

GSLEH

UBS

MER

JPM

CS

BSC

MS

Note: Market position expressed relative to market leader; aggregated revenues for ten leading investment banks surveyed. Citigroup and Deutsche Bank were omitted from underwriting chart.Source: Thomson SDC; BCG analysis

15

Contents






16

Several trends are driving strong growth in Asia-Pacific

• Fastest growing region in the world over a sustained period (fee pool in Asia-Pacific ex-Japan is expected to grow at an average annual rate of 11-16% from 2006 to 2012)

• Asia-Pacific economies are becoming increasingly international, offering significant cross-border opportunities (trade and investment)

• Capital markets still largely underdeveloped in Asia-Pacific; bank loans still the primary corporate financing source (e.g., China ~80%); significant potential for long-term growth

• Rapid growth already started; Asia-Pacific home to 8 of top 20 stock markets globally

• Very sizable and fast-growing private wealth in the region due to rapid GDP growth• Shifting of wealth from bank deposits to investment assets• Overall wealth industry growth at ~20-25% per annum, with development of both

onshore and offshore private wealth markets

• Large pool of sovereign wealth funds (SWF), insurance and banking assets seeking higher yield

• Significant flow of investment funds into the region

• Deregulation is opening more opportunities to foreign institutions, e.g., onshore capital-market opportunities in China, outbound investments of banks and insurance companies in Asia-Pacific

Fast accumulation of private wealth

Demand from institutional assets (including SWFs)

Deregulation trends

Rapid economic growth (domestic and cross-border trends)

Fast-developing capital markets


17

Asia-Pacific presents five major growth opportunities for investment banks

Asset liability management (ALM) and yield enhancement

Growing demand for risk management solutions, such as ALM, and yield enhancement solutions due to profitability pressure, regulatory changes, and increasingly complex financial needs

Sovereign wealth funds, central banks, and pension funds

Central banks and SWFs in the region have different levels of sophistication and varying investment appetites; serving them will require both strong local relationships and global network capabilities

China’s capital marketsChina’s equity market more than tripled from 2006-2007, and last year boasted IPOsvalued at €77 billion. Major players are building a strong local presence and forming JVs to tap large and rapidly growing onshore opportunities

Retail structured products / equity derivatives

Asia-Pacific household wealth exceeded €17 trillion in 2006. The region’s largest markets for retail structured products were Japan, Hong Kong, and Taiwan. Many players are actively targeting private and retail clients. Structured-product opportunities, whilst led by equities-based products, span a range of asset classes

Structured finance –acquisition financing

Strong inflow of new buyout funds into Asia-Pacific, with largest opportunities in Australia and Japan; market tends to be more “lumpy”, especially due to US-led credit crunch. Significant continued growth in demand for infrastructure financing as Asian economies develop


18

To develop a strategic growth plan for Asia-Pacific, players must address a range of issues

For market attackersFor market attackers

• Which geographies and products are most attractive/suitable?

• How much/ fast to invest (pioneer vs. fast follower)?

• Build joint ventures or alliances vs. major acquisitions vs. organic business expansion?

• How do local regulations affect existing business models?

• How can local knowledge and client relationships be built?

• Regional vs. global product lead?• Role of the headquarter?

• How should the local platform be integrated with global off-shoring/ outsourcing strategy?

For market incumbentsFor market incumbents

• What share of the business portfolio should/could capital markets be?

• Playing offense vs. defense by product area?

• Alliances with other local players?• Pan-Asian joint ventures/ alliances?• Partnerships with regional players in the

US/ Europe?

• Can state-of-the-art capabilities in technology and risk management be acquired or built?

• In foreign partnerships, how can differences in culture and compensation be managed?

• How can a scalable target operating model be built despite legacy systems?

Strategic priorities

Partnering

Capabilities

Structure/ governance

Ops/IT platform

BCG has advised major attackers and incumbents on their growth strategies for Asia-Pacific and other emerging markets


19

Contents






20

BCG project example: Capital markets portfolio alignment

Context

BCG helped a capital-markets player in North America to review its strategic priorities and adjust its business portfolio to current market conditions

• Focused on separating the effects of short-term market dislocations from longer-term structural trends and growth opportunities

• The effort involved joint client and BCG work streams and project teams

Approach

In-depth business portfolio review across sales & trading and banking• On sub-product level for a number of prioritized business units

Assessment of businesses based on internal and external criteria including• Financial performance, capital efficiency, risk, client portfolio, current capabilities

and gaps, market trends and projections (short term vs. mid/long term)

Formulation of overall business vision and strategy

Portfolio alignment based on business assessment and strategic fit• Identified business areas for future growth, refocusing, and exit

21

Select learnings from recent engagements in aligning capital markets portfolios

Key findingsKey findings ResultsResults

Many capital-markets businesses have been only mildly affected by the credit crunch

• E.g., equity derivatives, FX, prime brokerage

For some businesses that have been more directly affected, long-term fundamentals are still intact

• E.g., securitization, credit derivatives• Portfolio adjustments should focus on balance-sheet exposure while maintaining or

strengthening the talent base

Other businesses, especially in fixed income, have become over-reliant on balance-sheet and short-term funding

• These economics are not sustainable in the current capital and liquidity environment

Buoyant market conditions made it easy to replace shrinking client margins with proprietary trading, which is not always linked to specific capabilities

• To focus on client-driven business models, players will need to concentrate risk-taking on client facilitations, rather than universally reducing risk

• A commonly agreed-upon portfolio alignment strategy as a platform for future growth

• Clarity on target clients

• Focus of future investments

• Significant reduction in capital and higher net-income growth driving an uplift in ROE

Continuous progress of technology and electronification requires significant investment and capability build-outs

• Even in areas of strong current performance and position

Many businesses still operate with product-silos• Not fully capturing share-of-wallet opportunities with clients and efficiency

opportunities in the middle and back office

22

Strategic questions going forward

What are the long-term implications of reduced risk appetite, capital, and leverage? • Size and growth of ongoing revenue and profitability• Capital markets revenue models (e.g., reduced “carry” income, enhanced focus on agency

fees)• Operations and IT capacity/productivity alignment with front-office strategy

What counter-cyclical opportunities have been created due to the present dislocation?• Inexpensive franchises, talent, and assets• Materially reduced competition in several capital-markets businesses• Ability to use capital and technology to strategically drive market share gains

What capital-markets businesses will emerge as the industry’s growth engines? • Intermediation in emerging markets?• Private liquidity pools?• Re-distribution of “impaired” tranches of securitized assets?• Strategic mergers and acquisitions by non-sponsor buyers?• Other?

23

Contents






24

BCG investment banking contacts

Achim SchwetlickPartner and Managing DirectorNew York+1 212 446 2800

Robert GrübnerPartner and Managing DirectorHamburg+49 40 30 99 60

[email protected] [email protected]

Ranu DayalPartner and Managing DirectorSingapore+65 6429 2500

Shubh SaumyaPartner and Managing DirectorNew York+1 212 446 2800

[email protected] [email protected]

For questions regarding methodology and analyses, please contact:

Anthony Cheong Josh EllsteinNew York New York+1 212 446 2800 +1 212 446 [email protected] [email protected]

mailto:[email protected]






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