From the monthly archives:

May 2013

The troubling news continues for the United Kingdom investment banking community this week as Dealogic released its latest industry statistics. Within their own market, UK institutions have rapidly fallen in terms of market share over the past few years, accounting for only 27 percent of the all British investment banking fee revenue in 2013 up to May 22. This is down from 35 percent in the previous year.

In terms of total revenue, the smaller share accounts for only $372 million in fees from debt and equity capital markets as well as mergers and acquisitions advisory services. As regulatory and compliance costs begin to mount for the industry, this is far from welcome news. In the same period last year, this revenue came in much higher, at $413 million.

Some British Institutions Exiting Investment Banking Entirely

Industry insiders are pointing to the exit of some of Britain’s biggest investment banking players as the root cause of the collapse in fee revenue. The Royal Bank of Scotland, a storied institution that prior to the financial crisis was an investment banking leader in the region, is one bank that is exiting the market entirely. Vivek Raja, an analyst at Oriel Securities, told Financial News the decline “could almost entirely be explained by RBS pulling out of the market. It’s a virtual closure of their investment banking business.”

International Banks Swoop in to Capture Market Share

While the exit of some of local players may be a leading factor in declining revenues for British banks, it may not tell the whole story. Increasing competition is also contributing to the trend with American, German and Swiss banks eagerly snapping up whatever market share they can from departing institutions. American institutions accounted for 38.2 percent of British investment banking revenue up to May 22nd, while JP Morgan alone accounted for 9.6 percent of total fees. The German and Swiss banks have captured 7 percent and 12 percent respectively in the same period, led by the likes of Deutsche Bank, UBS and Credit Suisse.

Investment Banks Using Less London Office Space

One indicator of the decline of domestic institutions in the United Kingdom is their usage of high end London office space. And this indicator isn’t looking good for the industry. According to a CBRE industry survey reported by the Financial Times, three quarters of banks in London were looking to cut the amount of office space they use today. This likely represents a twofold trend, the decline in British bank dominance previously discussed as well as a move to reduce costs ahead of regulatory reforms.

“The pressure on the banks in recent years has undoubtedly had an impact on their real estate requirements and recovery in the sector is likely to be slow in an environment of tighter regulation,” Frances Warner-Lacey, Senior Director at CBRE advisory, told the Financial Times.

Regardless of the specific cause of the reduction in office space, this news along with the declining revenues, won’t be welcome to those seeking investment banking opportunities in London.

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Ever since the financial crisis in 2008, analysts have pondered whether investment banks would return to their days of glory or languish in decline for the foreseeable future. In a recent Economist piece on the issue, the author suggests that the worst is yet to come for the big institutions, as global economic trends and regulation continue to work against the industry.

Primarily, it comes down to return versus risk. While investment banks regularly posted returns on equity in the low to mid-twenties up until the crisis, these returns are now half of their peak levels. Worst of all, this decline in return comes at a time when risk within the financial industry has grown substantially. For diversified banks, it’s becoming harder and harder to justify setting aside funds for investment banking activities when their other division can post equal returns, though at substantially less risk. Accordingly, the industry has seen a number of institutions dramatically shrink their investment banking operations since 2008, with some banks exiting the business altogether.

This comes as financial regulators weigh more heavily on the industry. Higher capital standards will force banks to further reconsider investments in riskier business lines, as these activities quickly eat up available capital under new guidelines. Risk taking as a result will be substantially scaled back, with real consequences for some firms. In some countries, regulators are considering a full scale split of investment banking divisions from traditional commercial and retail activities, further endangering some of the industry’s biggest players. These regulatory changes are being driven by politicians that are simply unwilling to accept the public backlash that would come along if another round of taxpayer funded bank bailouts was needed.

In the midst of all this doom and gloom, it is important to note that the Economist admits that it has made negative claims regarding the industry before, and ended up being dead wrong. Fifty years ago, it described British banks as the “world’s most respectable declining industry.” However, these same institutions rallied with decades of consecutive growth, at least up until the financial crisis. While the outlook today may be fairly bleak, the industry has proven itself resilient and innovative in overcoming hurdles in the past. It is always difficult to permanently count out teams of the best and the brightest, even when they’ve been beaten down.

Jamie Dimon, Chariman of JPMorgan Chase, is one of the industry insiders that remains bullish on the future of investment banking. With staggering growth seen in emerging economies and the increases in international trade to go along with it, Dimon believes the “underlying trend [for investment banking] is up… Over time it will grow.” And there may be some history worth paying attention to when it comes to Dimon’s statement. In the past, financial-services revenue has increased with high correlation to global GDP. If this correlation was to return to past form, investment banking would certainly have a very optimistic future.

With strongly contrasting views from those on both sides of the argument, it remains unclear just what the future has in store. However, one thing can be certain. The landscape will radically change for investment banking over the months and years to come. What the industry looks like coming out the other side of this evolution remains anyone’s guess.

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As economies around the world, especially in Europe, continue to struggle in their return to robust growth, American investment banks are quickly establishing themselves as the global leaders in financial deal making once again. While in the darkest days of the financial crisis European politicians were quick to point to the flailing industry as an example of insufficient regulation, today, American investment banks are having the last laugh. American giants JP Morgan, Goldman Sachs and Citigroup alone account for one third of industry revenues. This while their European peers are struggling to keep their heads above water as a crisis of confidence sweeps over the struggling Eurozone.

In the United States, the financial crisis was dealt with swiftly. Financial institutions were forced to take substantial write downs and aggressively raise capital, sometimes directly from the taxpayer. Clearing their balance sheets of toxic assets and taking the bitter pill up front has allowed them to return to strength more quickly. On the other hand, European institutions are being forced to reduce their balance sheets – and reduced assets means reduced revenues.

Flexible Compensation Rules Allow American Institutions to Retain Top Talent

Another factor playing into the disparity between American and European investment banks are regulatory changes relating to bonus pay. In Europe, regulators have capped the amount that can be paid out as bonuses. Even worse, these same regulators require more compensation to be paid out as base salaries, which reduces flexibility in dealing with the regular cyclical nature of the industry. This has caused a migration of talented professionals westward to the United States, where the promise of higher bonuses has attracted top performers.

European Regulators Also Attempt to Address “Too Big to Fail” Moral Hazard

Despite clamoring by taxpayers and some politicians, the United States has been slow to address the risk that their financial industry may require future government bailouts. While this has allowed their investment banks to access cheaper capital through diversified financial operations, it may make the industry more vulnerable in the future. On the other hand, Europe is aggressively splitting riskier investment banking operations from traditional banking activities, effectively raising the cost of capital for investment banks but reducing the chance that the public would be left on the hook for excessive risk taking. While in the short run the American investment banks certainly benefit from the difference in policy, the longer term implications are unclear and may eventually favor European institutions.

While it seems as though the American financial titans are returning to form, questions linger about how risk is being allocated and whether the financial system is any more secure today than it was five years ago amidst the financial panic. While the Europeans can point to concrete measures to reduce the risk to taxpayers, Americans instead have adopted a path of enjoying near term success, with a more uncertain future. As a result, investment bankers likely are seeing more opportunities available in the United States, though competition for these positions may be heating up as their European peers seek out new opportunities in markets that are, currently at least, more robust.

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First Quarter Results Mixed for Investment Banks

May 6, 2013

Last week, we discussed the strong results of investment banks in the first quarter, with many institutions posting substantial gains in revenue. However, as results continued through last week, it became evident that the gains of some were in fact the losses of others. This confirms the long discussed idea that investment banking is becoming […]

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