Investment Banking Outlook Summer 2012 (PDF ... - Roland Berger

Markus Böhme, Kiarash Fatehi, Pierre Reboul
Competence Center Financial Services 1
Investment Banking Outlook Summer 2012 –
At a turning point?
Competence Center Financial Services

Our theses in a nutshell
> Global investment banking revenues continue their roller coaster ride. After a soft second
half of 2011, they strongly rebounded in the first quarter of 2012. We project a weaker
Q2 with full year revenues in the EUR 200-260 bn range, depending on how the sovereign
debt crisis in Europe unfolds.
> Performance strongly differed both within and among peer groups: Global universal
players with a higher focus on the fixed income business on average outperformed
investment banks with a lower focus on fixed income. Many midsized and smaller players
in developed markets came under pressure. At the same time many peers in emerging
markets roared full steam ahead.
> Even though these trends reflect structural changes such as revenue shifting to emerging
markets and new regulations such as Basel 2.5/3, they are also harbingers of the squeeze
that investment banks are going to face. Unless banks make major changes to their
business models, their Return on Equity is likely to remain in single digits and many
peers underperforming today may see their economic model even more challenged
over the next 3 to 5 years.
> Fixing individual and industry economics will not come easy. Even with rounds of
productivity measures, structural overcapacity still largely exists. We believe that around
75,000 jobs and one third of industry risk taking capability are still on the line. Value
chains, therefore, will undergo transformation and true exits – which we have hardly
seen so far – will be inevitable over the next 3 to 5 years.
> We think that now is the time for banks to step decisively up to this challenge to reap
early mover benefits by a bespoke mix of swiftly implementing sustainable models,
capturing growth opportunities mainly in emerging markets, and in some cases position
themselves as a solution provider for those players who need to consequently refocus
their value chains to survive.

Looking Back
August 2007 marked a watershed event in global investment banking 1) . Liquidity began drying
up in asset backed securities markets and events eventually unfolded into the subprime
crisis that claimed banks throughout the US and Europe. Almost five years later we are looking
at an industry that has gone through a roller coaster ride as global revenue pools tanked
in 2008, rose out of the ashes in 2009 and subsequently hovered back to approximately
pre crisis levels before further decreasing by more than 10% from 2010 to 2011 (exhibit 1).
Exhibit 1: To hell and back – After their post crisis peak global investment banking
revenues are coming in around 2006 levels
Investment banking revenues 1) , 2011
[EUR bn]
~ 75
WE
~ 70
North America
~ 10
Latin America
~5
EE
~5
MEA
~10
A/NZ
~ 10
Japan
~45
Emerging Asia
Revenue trend, 2006-2012e
[EUR bn]
Emerging
Markets
270 265
260
18%
240
23%
230
200
28%
Developed
82%
Markets 77%
72%
2006 2011 Bear Base Opti-
Developed Emerging 2010 case case mistic
2012
1) Adjusted IBD, Equities, and FICC revenues (before loan loss provisions) calculated
at constant 2011 exchange rates
Source: Roland Berger; company disclosure and presentations
scenarios
On the heels of this roller coaster ride Basel 2.5 and other new regulatory requirements are
starting to kick in and despite myriad rescue attempts, the European sovereign debt crisis
has heightened in intensity. With dark clouds continuing to cast a shadow over financial
markets and economic activity, where does investment banking go next?
1) We define global investment banking as the collective IBD (M&A, ECM, DCM, structured origination), Equities, and
FICC (Fixed Income, Currencies and Commodities) businesses and revenue streams generated by global, regional,
and local players active in these lines of business.
Competence Center Financial Services 3

4 Investment Banking Outlook Summer 2012 – At a turning point?
We believe that the answer lies in first understanding the underlying structural changes
that the industry has experienced and thinking of scenarios in how the market will develop.
We see three main shifts that are transforming the industry:
> Continued shifts of revenue pools to emerging markets, first and foremost to Asia with
Brazil being a second hotspot.
> While the FICC roller coaster ride and DVA/CVA effects 2) have been the key drivers behind
ups and downs, they have also somewhat masked that Equities and IBD businesses are
stagnating and contracting in developed markets.
> Many players will continue to see their economic models challenged. The top 16 global
investment banks and universal players took a double hit when markets softened in
2011, just as new regulation such as Basel 2.5 kicked in boosting capital consumption
especially for European based players. In 2011 the game changed and many local players
in developed markets lost their edge as shrinking market shares and revenues propelled
cost-income-ratios into unsustainable territory. In addition regulatory headwind puts
further pressure on capital efficiency.
Exhibit 2: Despite a strong Q1 the full year 2012 revenue pool might only yield
a small uptick and substantial downside risk persists
Quarterly IB revenues, Q1 2010 – Q1 2012 1)
[EUR bn]
88
Q1
2010
60
Q2
2010
59
Q3
2010
57
Q4
2010
85
Q1
2011
62
Q2
2011
43
Q3
2011
39
Q4
2011
80
Q1
2012
?
Q2
2012
JUNE 2012 PROJECTION
IB revenues by product groups, 2006-2012e
[EUR bn]
270 265
230
240
260
FICC – roller coaster ride
> Normalization vs. extra-
FICC
200
ordinary Q1 2009/10 levels
> Weak flow and position losses
in Q3/4 2011
> Once again subdued activity
after Q1 2012 rebound
Equities
1) Adjusted IBD, Equities, and FICC revenues (before loan loss provisions) calculated at constant 2011 exchange rates
Source: Roland Berger; company disclosure and presentations
IBD
2006 2010 2011 Bear Base Opti-
case case mistic
2012 scenarios
Equities – softening
> Heavy dip in Q4 2011
> Softer activity with limited
Q1 pickup
IBD – softening
> Downhill from strong Q2 2011
> Limited pipeline
2) Debt Value Adjustments and Credit Value Adjustments: Mark-to-market changes in the value of own debt issued
and counterparty exposure as mandated by IAS but often recorded in banks' IB and especially FICC divisions.

The picture is not homogenous – for example, many German small- and midsized players
were among those hit hardest. In sharp contrast many – especially Asian and Latin American
– emerging market local players continued to grow profitably.
Exhibit 3: Not all players are born equal – At least five peer groups compete
with distinct business and economic models
Peer group IB economics (Basel 2.5) 1) , 2011 [%]
Note: Bubble size indicates peer group IB revenues 2)
Cost efficiiency
(CIR)
110
100
90
80
70
60
50
40
30
Developed
Markets Locals
Global
Universals
Emerging Markets Locals
(Banks + Brokers)
What Lies Ahead
Advanced
Internationals
Global IBs
20
0 1 2 3 4 5 6 7 8 9 10
Capital efficiency (Rev/RWA)
Global IBs
8 players
Global
Universals
8 players
Advanced
Internationals
15 players
Developed
Markets Locals
> 50 players
Emerging
Market Locals
> 50 players
Examples
of players
Business
model
> IBD, FICC, Equity
> Global
> IBD, FICC,
Equity
> Relatively
global
> Emerging focus
> Mixed player
> Developed focus
> FICC focus
> Limited
IBD/Equity
> Country focus
> Country focus
> Mostly bifurcated:
Banks vs. brokers
Ø EM rev.
share 3)
1) Estimate, assuming 70% on disclosed B2.5/3 impact on CT1 ratio will come through CIB Markets' RWA uplift
2) Revenues calculated at constant 2011 exchange rates
3) Emerging market revenue share of total peer group revenue 4) Investment Banking revenue share of total CIB peer group revenues
Source: Roland Berger; company disclosure and presentations
So far in 2012, these trends are continuing to affect the industry. First quarter results
strongly rebounded from the second half of 2011, which was characterized by higher risk,
drying up of client flows and position markdowns as the sovereign debt crisis unfolded
(exhibit 2).
However, not all ships were lifted equally by the tide. Once again emerging markets players
roared full steam ahead. Small and midsized locals in developed countries, meanwhile,
saw a mixed picture with many of them registering only a moderate recovery or even further
revenue contraction against the global trend. Among global players the field was split but
on average universal players, who enjoyed broader sources of flow such as FX and rates
businesses driven by transaction banking, seemed to fare better (exhibit 3 and 4).
~20%
~30%
>90%
Ø IB/CIB
share 4)
~100%
~60%
~35%
~35% ~45%
minimal ~30%
0-5% ~10%
95-100%
~10%
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6 Investment Banking Outlook Summer 2012 – At a turning point?
Exhibit 4: Recent performance diverges both between as well as
within each peer group
Globals
Developed
Markets
Emerging
Markets
Global
Universals
Global IBs
Locals
Advanced
Advanced
Locals
Contracting Moderate recovery Rebounding Continued growth
Q1
Q1
Q1
Q1
2010 2011 2012e 2010 2011 2012e 2010 2011 2012e 2010 2011 2012e
Source: Roland Berger; company disclosure and presentations
Global Universals
rebound stronger
than IBs
Developed market
players increasingly
under pressure
EM franchises as
growth driver?
Continued growth?
However as banks close the books on the second quarter and will begin reporting results
in a few weeks, we expect to see a sharp drop off from the first quarter. Although this sort of
Q1 to Q2 drop has been more the rule than the exception over the last few years (exhibit 2),
the questions that persist are just how bad will the drop off be and where do we go from here?
Even assuming that the sovereign crisis slowly abates, we would expect the full year outlook to
be just around 2011 levels – a year that was rough, but not nearly as negative as 2008. Nobody
can and wants to project the impact of a euro meltdown. In this case all bets would be off. But
even if the sovereign debt crisis is still as intense by the end of the year as today, the downside
for investment banks for the rest of the year will be substantial. In this case the revenue pool
may shrink by another 15% to about EUR 200bn. Even under rosier scenarios, with a fairly
quick recovery and a much more favorable trading environment and deal pipeline, revenues
seem unlikely to revert to 2010 levels (exhibit 2).
As a result of this challenging environment one European and North American player after
another has already lowered their RoE targets: 12 to15% became the new standard down
from the earlier 25% targets. We believe however, that the industry's economic model is more
challenged than those lowered targets suggest. Even when factoring in the stream of restructurings
and lay offs already announced, the industry will only return to single digit post tax RoEs
on average. Our base case scenario envisions a 9% RoE and in our bear case, a mere 5% RoE
(exhibit 5).

Exhibit 5: Unless markets revert to a bull trajectory it is bye-bye to double digit RoEs
for 2012 except for high growth pockets in emerging markets
Industry RoE 1) – 2012 Base case scenario [%]
Ø 2010 RoE: 15%
Ø 2011 RoE: 7%
5
Bear
Scenario
9
Base
Case
11
Optimistic
Scenario
Cost-income
ratio [%] 80 70 65
1) After-tax, assuming an effective tax rate of 30% for all peer groups
Source: Roland Berger; company disclosure and presentations
Peer groups
Global IBs
Global Universals
Developed
Markets Players
Emerging Markets
Players
RoE range [%]
0% 20%
Once again emerging markets focused players are poised to deliver higher returns – provided
there will not be a sharp reversal of fortunes, and confidence falters tanking emerging markets
growth.
However, for an average developed market focused player or even global players driven by their
European and US businesses, these single digit RoE's lead to an unsustainable trajectory. On
the other side IB players face even more headwind since they are less focused on FICC and
hence benefitted less from the Q1 revenue uptick. In addition they lack regular FICC flows from
transaction banking.
Over the next 3 to 5 years, European players will face further headwind as the full effect of
proposed regulations such as Basel 3 kick in, squeezing capital and economics. We do not
know when exactly this will happen and how long local regulators will allow for transition.
Despite that uncertainty we are sure that post tax industry RoEs might remain in single digits
therefore falling some 7% to 8% short of targets unless more drastic action is taken (exhibit 6).
Competence Center Financial Services 7

8 Investment Banking Outlook Summer 2012 – At a turning point?
Exhibit 6: What would it take to continue to sustainably earn positive
economic profits in the IB industry?
Mid-term perspective RoE [%]
12-15
Target
RoE
9-11
Baseline
2012
Source: Roland Berger
Restoring growth
4
Basel 3
effect
Baseline 2012 given by base
case and optimistic scenario
7-8
How could the profit gap be closed?
Capital reduction of ~30% of industry RWAs in
order to overcompensate Basel III uplift
> Larger, consolidated books
> Risk management activity transferred to
institutional investors ('shadowbanking 2.0'?)
Cost reduction of industry cost base by around
one-third
5-7 > ~15% headcount reduction
> Reduced compensation benefits of around 10%
> 15-20% decrease of non-compensation budget
Mid-term Profita-
baseline bility gap
~10% Repricing
> Limited roll over increased capital requirements
> Capacity and demand gap starts to close
Capacity
reduction
and d exit it
pressure
Such gloomy scenarios make it impossible for most European and US players to retain their
capital allocations. To close this RoE gap the industry would truly need to reduce capacity
to sustainable levels. Evidence suggests that this reduction has yet to occur:
> Few players have truly exited full lines of business. For example RBS and UniCredit have
exited from parts of Cash Equities and Credit Agricole, Santander and BBVA have left
commodities, but none of them was a major player in these business lines anyway.
> Mostly, headcount reductions have increased individual players' productivity but did not reduce
capacity in the overall industry. Furthermore, announced reductions take longer to work
their way through the system – of about 25,000 job cuts announced by the top 16 players
in mid 2011 only 15,000 were realized by year end because attrition came down sharply.
> Some (especially large) players successfully mitigated large parts of the Basel 2.5 driven
RWA (Risk Weighted Assets) uplift through RWA reduction programs. These programs however,
largely pertained to legacy asset sell offs and transfer of certain securitization tranches
and other assets whose capital consumption would have skyrocketed under Basel 2.5 to
hedge funds and other institutional investors – a space often coined as 'shadow banking'.
The industry's client focused trading and risk management capacity itself has hardly been
reduced.

We feel that real capacity reduction is the only way to restore economics in the mid-term. A
shake out with real product line exits, capacity reducing and efficiency boosting mergers and
joint ventures as well as a fundamental reduction in vertical integration in particular for local
players will be required to achieve 12 to 15% RoE assuming a flat to moderate revenue pool
trajectory (exhibit 6).
One scenario to close the collective RoE gap would mean:
> Reducing industry RWAs by about 30% or close to 2 trillion euros – this would mean we
are heading towards 'shadow banking 2.0' as hedge funds would have to pick up half of
this amount – with the other half requiring a real consolidation into fewer, more capital
efficient books.
> Repricing (and hence increasing the revenue pool at flatter volumes) by about 10%, which
would not seem realistic without reduction of overcapacity.
> Reducing the industry cost base by around one third – even with sizable cuts on the non
compensation related cost, further structural compensation adjustments, including the effects
of guarantees and the effect of large albeit deferred bonuses, as well as sizable headcount
reductions would be required. We would estimate that about 15% of the 500,000 jobs
in the industry would have to be cut. Unprecedented rounds of layoffs – well beyond the
10,000 already announced but not executed – would become inevitable.
How can the industry and individual banks mend their economics – especially when the weight
of their portfolio is not geared towards emerging growth markets? We predict four key developments
(exhibit 7):
Exhibit 7: Eventually, industry players will need to take radical action –
Four major areas for profitable change
> Next wave of headcount reduction and
productivity based compensation
> Complexity reduction
> Process re-engineering and automation
Stepped-up efficiency
programs
Refocused + industrialized
value chains
> Challenged local players truly refocus on
unique client value proposition and scale
back trading platforms
> Large platforms leveraged into true bank
for bank offerings
> Industry utilities emerging
Source: Roland Berger
> Universals withdrawing capital
> Lower risk taking capacity for some players
> A real wave of (product line) exits
Reduced over-capacity
Battle for (emerging) ( g g)
growth markets
> Global leaders 'localizing'
> Local leaders professionalizing
Competence Center Financial Services 9

10 Investment Banking Outlook Summer 2012 – At a turning point?
> A refocusing and industrialization of value chains is necessary. Winners will evade the
looming shake out by refocusing on their true edge and value proposition. For smaller players
this might mean concentrating on sales, basic structuring and counterparty risk absorption
with strict focus on their privileged corporate banking and other quasi-captive franchises.
Likewise industry utilities and true "bank for bank" leaders will emerge to fill this void while
other large players might choose to focus on certain products, client segments and regional
niches, in which critical mass can be reached independent of a full scale offering.
> Moving fast will be essential and earning the right to grow and consolidate will mean
stepping -up efficiency programs.
> Sooner or later the industry will tackle its over-capacity as mid-sized players that neither
managed to focus nor to catch up with volume leaders will need to exit some product lines.
> Some capacity will continue to shift into emerging markets and more and more bankers
will head from London and New York to Sao Paulo, Singapore, and Hong Kong as well as
places like Jakarta. However, there will be more aspirants than opportunities as the battle
for emerging growth markets heats up: Global firms build their presence on the ground
(especially beyond hubs such as Hong Kong and Singapore). Regional champions such
as Standard Chartered in Asia or Itau in Latin America invest into their IB capabilities and
local players get serious on various forms of IB, CIB or merchant banking growth.
Moving decisively and robustly executing this transformation while maintaining day to day
focus on capturing business and managing risk in volatile and adverse market conditions will
be paramount. Perhaps another five years down the road we will look back on 2012 as the
year that decided the fate of banks that survived and those banks that did not.

Contact
Markus Böhme
Partner
50 Collyer Quay, #10-02 OUE Bayfront
Singapore, 049321 Singapore
Phone: +65 65 97-4577
E-mail: markus.boehme@rolandberger.com
Kiarash Fatehi
Partner
OpernTurm, Bockenheimer Landstraße 2-8
60306 Frankfurt, Germany
Phone: +49 69 29924-60
E-mail: kiarash.fatehi@rolandberger.com
Pierre Reboul
Partner
11, rue de Prony
75017 Paris, France
Phone: +33 1 53670-325
E-mail: pierre.reboul@rolandberger.com
Competence Center Financial Services 11

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12 Investment Banking Outlook Summer 2012 – At a turning point?
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