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

March 16, 2010Banks5) Funding – driving a dramatic rethinking of portfolios, with regulationthe swing factorFunding has already driven a major review of the industryportfolio, and we think funding constraints will remain criticalto business choices, particularly as stable funding ratio targetskick in. Against this backdrop, the critical drivers for theinvestment banks and, we think, key issues for policymakersare: 1. whether or not securitisation resumes; and 2. theflexibility given to banks to perform maturity transformation.One of most fundamental shifts resulting from the liquiditycrisis is an ongoing rethinking of the businesses, shapedaround the quality of collateral generated, especially given theongoing cost of wholesale funding. Today, there are threeclusters of funding markets (see Exhibit 20):securities that can be pledged to central banks;other good quality collateral that can be funded(e.g. equities in Europe that are pledgable in the US); andthose that require unsecured funding.The cost and scarcity of unsecured funding has alreadydriven banks to shrink units that are heavy consumers ofunsecured funds – such as warehousing, non-investmentgrade, prop, illiquid fixed income, some prime brokerage. Ithas also significantly amplified the shift to liquid flow markets.On the other hand, businesses such as flow rates, FX, cashequities, and flow derivatives have been re-emphasised in thebusiness portfolio.Impending regulatory change will reinforce these trendsover the coming three years. Morgan Stanley haselsewhere estimated the net stable funding ratio for theEuropean banks sector at large at about 87%, implying afunding gap of approximately €1.5 trillion in Europe, ontoday’s accounts. This is a dramatic gap, and there is a widedispersion in the health of the banks operating in this sectoraround the net stable funding ratio. Given the scarcity andcosts of matched funding for both well funded and less wellfunded banks, there will be tremendous scrutiny applied tohow scarce unsecured term funding is deployed. This is likelyto continue to drive a reshaping of the industry portfolio andthe competitive landscape around four segments ofbusinesses (Exhibit 21).• Low Return on Asset (ROA), high asset intensitybusinesses which are largely self-funded throughaccess to the repo market. This is primarily PrimeBrokerage, but also includes some niche such as FundLinked. Firms without pressure on leverage ratio andbalance sheet size (which may be a null set) could takeoutsized share of the rebound in hedge fund demand;others (most) will be highly selective on fund financing.• Medium ROA business which are net consumers ofunsecured funding, such as fixed income, warehousing,illiquids. Only those with strong access to a diversity offunding sources across the term structure are able tocompete here at the moment, and there are veryattractive opportunities available for these firms.• High ROA, medium ROE, low funding demandbusinesses such as structured rates, structured equity,structured FX. These are attractive from a fundingperspective, but are effectively pushing banks higher upthe risk-return curve in search of funding-free returns.While most firms have run to the flow side of the boat, afew firms will continue to reap an outsized share of theFIG restructuring and long-dated ALM business, inparticular.• High ROA, medium or low funding demand: Flowrates, FX, cash equities, and flow derivatives. These areall highly attractive to all banks, and a key driver of theflow monster strategy. Note, however, that it is difficult todeliver alpha growth in these businesses; as a result,somewhat ironically, risk taking is becoming a biggerfeature in all of these markets.Sovereign risk remains a key risk to funding. Assuming thisstabilizes, over the medium to long term, deposit gatheringand terming out debt may help. Put another way, banks willwant to rethink their funding model so they have the capacityto enjoy higher-margin businesses that need unsecuredfunding. Deposit gathering, expansion of transaction bankingbusinesses, regulatory impact of inclusion or exclusion ofcorporate deposits, re-intermediation of money market fundsin retail deposit gathering strategies will all be key drivers ofsuccess at the industry and firm level.19