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

March 16, 2010Banks7) Sustainable Industry Returns? Regulatory impact meansmanagement will have to act decisively to rebuild returnsDespite heavy marks, industry returns in 2009 were ~14% –below the 18% average of 2002-06, but not far off the 15.5%average in 1987-99. Given the likely tightening of regulation,maintaining 15%+ returns will depend more than ever onstrategic positioning of the business portfolio, consciousadjustment to compensation to offset higher capital andfunding costs, and outstanding management execution toimprove revenue on assets.The range of possible outcomes by 2012 is clearly wide, giventhe flux in regulatory debate and uncertainty on underlyingWestern economic growth as policy response is withdrawn.We have taken a scenario-based approach, and highlight fivepotential outcomes for returns in 2012, of which we see threeas plausible, framing returns in the 12% to 16% range.Our base case assumes industry level returns of ~15%.We estimate that this would require a stabilization of theunderlying compensation as a proportion of revenues at 2009levels (equivalent to absolute compensation levels flat toslightly down), which we see as achievable without undulyforcing material additional talent migration to the lessregulated sector. It would also require a shift in the businessmodel (see below) that improves revenue/assets by ~20%from today. Again, we think this is achievable, although itwould probably require very proactive management, withmargins maintained at (or close to) current levels to offset theregulatory impact.The severity of regulatory response will probably be tiedto macro conditions. In looking at other scenarios, we haveassumed a strong correlation between the severity ofregulatory response and underlying state of the economy. Forthis reason, of the five combinations of these two factorsoutlined in Exhibit 26, we see only two as plausiblealternatives to our base case.caps on industry leverage to reduce gearing to growth tobelow historical levels, effectively bounding returns below17%, on average.‘Regulatory Fragmentation’ scenario. We see the mostlikely ‘Incremental Change’ scenario for the industry asone of G10 stagnation on growth and dissipatingregulatory cohesion and conviction. As this is a low growthenvironment, despite a lesser regulatory drag, we wouldstill expect returns to be around ~14%.Exhibit 23Reported ROE for major investment banks40%30%20%10 %0%'93'94-10%-20%-30%//-40%-100%'95'96'97'98'99'00'01'02'03'04'05'06'07'08'09Cycle ‘93-’99Avg RoE = 15.4%MaximumMedianMinimumCycle ‘00-’06Avg RoE = 17.5%Source: Annual reports, Oliver Wyman, Morgan Stanley Research; Sample includes Citi, CS,DBK (CIB Only, 2006-1998), GS (2008-1999), JPM (I-Bank Only 2008-2003), LEH, ML (CIBOnly), MS(2008-1997), BSC, UBS‘Punish the Banks’ scenario. A draconian regulatoryoutcome would require dramatic industry shrinkage andwould require margins to rise 50-150% from today’s levelsto have any hope of rebuilding returns to north of 11%. Wenote, however, that in this dramatically lower riskenvironment, sub-15% returns may be acceptable toinvestors. In a robust growth outcome combined withstrong regulation (a plausible combination, we believe, aspolicy makers are to some extent setting the parametersfor regulation based on economic health) we would expect23