Outlook for Global Wholesale and Investment Banking - BlackRock ...

March 16, 2010Banks2) Margins – Tighter margins mean scale in core flow products is criticalMargins in fixed income trading were ~3x wider in Q109 thanin Q108, we estimate, but are now much closer to pre-crisislevels in core flow products (although still far wider in non-flowand some parts of credit). As banks have delevered andaddressed bad assets, margins have compressed materially,and our base case is that they end 2010 pretty much flat. It isplausible margins widen from here, depending on regulation.The race for scale to cover fixed costs and trading efficiencyto extract bid-ask spreads is likely to become ever moreimportant. For the top 15 investment banks, we think being a‘flow monster’ – with scale, leading edge technology andoutstanding risk management in key categories – is a winningstrategy. More regionally focused players can look for scale intheir own markets.Key to success in 2009 was trading well and extractingbid/ask spread. In the client franchise, the main developmentswere a rebound in hedge fund assets and spend, limitedgrowth in long only, and a boom in FIG capital raising. Retail,insurance, public sector and pensions were relatively benign.Overall “pure” client value growth (as measured by salescredits) was limited by muted volume growth and only partialcapture of wider bid-asks, with a higher proportion of valueattributed to market-making and related principal activities.Revenues earned in ring-fenced prop trading groups fell to10% in 2009 from 15% in 2006, as many banks disbandedring-fenced prop groups after poor 2008 results and/or movedthem closer to the client-facing desks. The dramatic marginexpansion in Q408 was driven by three factors: 1) inefficientprice discovery; 2) retraction of supply; and 3) increased costof risk.1. Price discovery was linked to volatility anddiscontinuity, and is likely to have normalized.2. The retraction of supply drove a significant shift inmarket share at the product level, as the few firmswith balance sheet to be price takers took anoutsized share of activity. We believe the marketshare of the leading three to five firms in eachbusiness typically increased by 5-10%.3. The increased cost of risk has, in our view, likelyrepriced to current risk conditions for the time being.Exhibit 9Example: European credit bid-offer spreads (*) inQ110 are ~75% lower than in Q109, although ~200%above the 2006 level16001400120010008006004002000Jun-06Sep-06-7%Dec-06+2%0%Mar-07Jun-07+98%Sep-07+14%+36%+39%Dec-07Mar-08Jun-08+83%Sep-08+39%Dec-08+31%Mar-09-25%Jun-09-43%Sep-09-36%-17%Source: Bloomberg, Markit, Oliver Wyman, Morgan Stanley Research. (*)Grey area: dailyevolution of bid/ask spread on Iboxx EUR corporate incl. financials and non-financials; Blueline: average bid/ask spread on EUR corp. Iboxx per quarterDec-09Exhibit 10Bid-ask spreads have tightened a lot alreadyBid-ask spread - indexed Pre - crisis Crisis 2010 CommentUnderwriting (DCM, ECM) 100 150-200 100-150Balance sheet commitment still at a meaningfulpremium to risk pre-crisisCommodities 100 125-150 75-125 In some cases margins below pre-crisisFX 100 150-225 100-125 For major currencies, liquidity very goodRates 100 200-250 100-125Credit 100 400-600 150-225Source: Bloomberg, Markit, Oliver Wyman, Morgan Stanley ResearchFor large orders, liquidity still constrained leading towider spreads especially in single name10