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

March 16, 2010BanksThe key point we want to underscore is that the more we havedug into the proposed funding rules, the more we areconcerned by the implications. We believe a measuredresponse needs to be taken, in the context of restarting loangrowth in Europe. We also think a reopening of thesecuritization market as one of the best ways to fundmortgages is key for banking. It strikes us that the currentproposals – on leverage, stable funding ratios andsecuritization rules – make this quite unlikely in Europewithout major reform. Also, in the UK, a market that for thelast 2.5 years we have argued has a massive mismatch, anational mortgage corporation (like that in Hong Kong) is onepossible solution.Non-banks should prosperWe think the odds are that asset managers and boutiques willblossom as the financial world is reshaped. Although there issill much flux and uncertainty ahead – and in Europeprotectionist measures such as the alternatives directivethreaten this – we think more talent and business will flow tospecialists. In the listed space, players such as Blackstoneand Partners Group strike us as good ways to play thischange.Top-line pressure will mean that progress towardsexchanges and derivative clearing will take time inEuropeWe remain Underweight BME and LSE and Equal-weightDeutsche Boerse. We think brokers’ desire to use MTFs willremain high – the key risk in our view for BME – and equityvolumes are lackluster. On derivatives, we argued previouslythat clearing could be a $0.3-1.0bn opportunity for clearinghouses. At a stock level though, we see this playing out farmore intensely in the US than in Europe (note recentcomments by Fannie Mae and Freddie Mac that they intend tostart using central clearing for their interest rate swapsportfolios within months). As we argued with Oliver Wymanearlier in this report, there are many obstacles to clear inEurope, not least of which are the natural reservations on thepart of central banks to agglomeration risk. Until this isresolved, we think players such as Eurex will struggle to getthe turbo charge seen by players such as ICE, which hasbeen particularly successful in CDS business. It is alsopossible there may be more capital needed, depending onhow regulations settle.Constructive rate and FX volumes should support IDBtop line, though regulatory and competitive uncertaintyremain issuesAlthough we believe that FICC I-bank revenues may be down~26% in 2010, this chiefly speaks to the tightening in bid-askspread. We believe that volume dynamics will be reasonablyconstructive in rates and FX (given macro volatility, debtissuance etc), which offers support for the IDBs’ top line,despite weaker tailwinds from currency versus the prior year.Recently reported bid interest (FT, 10th March) in Tullett,although unconfirmed, also speaks to the potential forvaluation support from private equity interest and/orconsolidation within the exchange/IDB space. That said, wesee some challenges to exchange/IDB deals, including risksof top-line attrition, execution risk (especially wherebusinesses are predominantly voice broking), and potentiallylimited cost synergies, unless IT represents a significantportion of the overall cost base.We have favoured TLPR (Overweight rated) on valuation (itwas trading at ~7x 2010e P/E prior to recently reported bidinterest) and as the vanilla skew in its business to governmentbonds, rates and FX played well to areas where we feltvolume dynamics were supportive. We recognise the longertermrisks, assuming electronic migration accelerates on theback of increased centralised clearing and straight throughprocessing of OTC derivatives, but view ICAP as betterpositioned than peers, given its stronger electronic capability.Our base case has been for regulators to mandate clearingbut not exchange trading (see Identifying winners from marketstructure change, 15th July, 2009), but we nonetheless seewild card risks that more hawkish views within the regulatorycommunity could represent risk on this front to businesscurrently intermediated by the IDBs. Meanwhile, an uncertainregulatory environment places risks to volume recovery, in ourview, given the risk that bank trading activities could becurtailed at the margin. We view the recent profit warning byICAP as chiefly due to execution challenges on new businessinitiatives (e.g. Brazil, cash equity) which we expect renewedfocus to resolve. However, we also see pressures on corebusiness from staff retention, from a shift to lower-marginvanilla business and from intense pressure from user bankson broker commissions in a more challenged environment. Assuch, we are Equal-weight on ICAP (see also Execution andregulatory risks keep us on the sidelines, 10th Feb, 2010),and more broadly see better risk/reward among a number ofthe asset managers (SDR, HGG)35