Thursday, 26 April 2018

The futility of being second-rate

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IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

Less obvious market distress Wednesday following a better 10-year Bund auction (1.3 bid/cover ratio; €4.06bn filled at 1.93%) and after Portugal got €1bn in three-month bills away at 4.346%, the lowest since last April. The only slightly worrisome (although predictable) news was UniCredit pricing its €7.5bn rights issue at €1.943, a massive discount of 69.3% to Tuesday’s close.

The multi-HQ’d bank did a 10-for-1 reverse stock split a couple of weeks ago that had the effect of making its share price look a bit more respectable. But the only thing that exercise seems to have done is given investors more opportunity to hammer the stock. Against Tuesday’s close of €6.33, the bank’s shares closed almost 15% lower Wednesday. Makes the discount look better but really not good.

Away from today’s news, I spent a fair bit of time diving into some of the detail of the 2011 full-year advisory and capital markets underwriting league tables. I’m going to be focusing a lot this year on investment banking strategy and competitive positioning so I figured a review of last year’s report card might be instructive.

One of my recurring themes is the lack of industry consolidation in terms of the number of market players. A significant number of banks continue to operate optically full-service investment banking and trading operations that are either loss-making, break-even or only marginally profitable but which management insists on maintaining for reasons I can’t fathom beyond bravado and inertia.

The onset of increased operating costs caused by higher capital requirements, more constrained and expensive access to capital, as well as higher regulatory compliance costs are starting to have some sort of impact at the strategic level. But the process is still embryonic and I think some players are delusional about their ability to compete. Others talk the talk of right-sizing but aren’t yet walking the walk.

Focus, focus, focus

UBS’s investment bank offers a great example of a business that is overtly restructuring. Group CFO Tom Naratil acknowledged in a pre-Christmas interview with Reuters that the bank is happy to give up its place in the top 10 in selected businesses as a result of the optimisation process it’s kicked off. “Investment banks will continue to fight it out to top the league tables for total global fee pool. Two will make it; another three will think they can. With our strategy, we can’t be one of them. Rather, we will be a top-tier investment bank in the eyes of our clients by focusing on them and not ourselves.” he told Reuters.

Interesting comment. The bank unveiled to great fanfare at its recent investor day how its investment bank was downsizing to play second fiddle to the wealth management business. But it’s only exiting four of 25 businesses it highlighted in its presentation (equity prop, macro directional trading, securitisation and complex structured products). It’s engineering a ‘large decrease’ in long-end flow rates and correlation trading as well as a ‘small to medium decrease’ in US credit flow and short-end flow trading, synthetic equity and equity-linked. But most of the businesses will remain as they are.

Once you get beyond the top 25, you’re fighting for crumbs. You can’t lay claim to having a credible business; nor can you make any real money

I question the utility of a decrease, particularly a large one. Looks like pointless tinkering to me. I also wonder how maintaining vestigial elements of businesses – where by definition you’ll be second-rate – counts as being top tier in the eyes of clients. I can’t really picture a conversation that’s going anywhere with a client or counterparty around doing business in an area you’ve said you’re downsizing. Seems to me it’s better to direct them to houses that are in the flow and can execute better. It’ll certainly help get those stubbornly high cost/income ratios down.

I suspect firms industry-wide will make similar pronouncements, but I wonder how quickly changes will happen. A glance at the investment banking league tables might help them see how futile their efforts might be,

Fighting for crumbs

Now I can see how firms want to have a piece of the action. Taken as a whole, investment banking (capital markets underwriting and M&A advisory) was a US$11.6trn business in 2011 in terms of gross business volumes and it generated a wallet of US$81bn in fees. Not bad.  But only four firms – Bank of America Merrill Lynch, JP Morgan, Citigroup and Barclays Capital – were top 10 across DCM, ECM, syndicated lending and advisory. If you exclude syndicated lending from the mix (as it’s not a core investment banking product for all firms), you can add another four houses to the top flight: Goldman Sachs, Morgan Stanley, Credit Suisse and Deutsche Bank.

If you widen the net to the top 25 across each product set, you’re still stuck with a pretty rarefied group. Only12 firms are top 25 across DCM, ECM, syn-loans and M&A (BofA Merrill, BarCap, BNPP, Citi, CS, DB, GS, HSBC, JPM, MS, RBC and RBS) and a further eight (CIBC, CAIB, Mizuho, Nomura, SG, TD, UBS and Wells Fargo) feature in three of the four.

In fact, there were only 44 firms in total across the top 25 of the four business lines. And of the larger list, you can discount around a quarter of those on the basis that they have one-dimensional businesses. For example, there were six Chinese securities firms in the ECM table who were only there because they got in on Chinese equity deals; Itau Unibanco was also ECM-only and did all of its business in Latin America (the vast majority in its home country of Brazil). Four advisory firms made the M&A list that don’t have financing businesses. Nothing wrong with any of this, for sure, but these are not global multi-product industry players.

My point is that once you get beyond the top 25, you’re fighting for crumbs. You can’t lay claim to having a credible business; nor can you make any real money. You certainly can’t generate revenue close to your cost of equity. Yet there are literally hundreds of banks in various segments of the overall investment banking business. How many will be left at the end of 2012? Hard to predict, but I have a sneaking suspicion that it’ll still be hundreds too many. Time for some aggressive decision-making.

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