Investment Banking and Capital Markets Market Report Fourth Quarter 2009

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1 Investment Banking and Capital Markets Market Report Fourth Quarter 29

2 Contents Review of 29 and outlook 2 Overview of fourth quarter 29 results 9 Market review 15 Fixed income and equity trading Underwriting and M&A advisory 1

3 Following a strong recovery last year, investment banking revenues are expected to fall in 21 After a devastating 28, the investment banking industry staged a strong comeback in 29 Net revenues (before write-downs) jumped nearly 5% to $311 billion, up from $213 billion in 28 They remained below the 27 peak of $328 billion The recovery was fueled by trading revenues, in particular fixed income Fixed income accounted for 45% of revenues while equity trading accounted for 21% and proprietary trading for 14% Extraordinary market conditions characterized by above-average volatility and relatively low liquidity generated exceptional spreads in fixed income The growth engines were client-driven business in credit and rates as well as proprietary trading The surge in revenues, coupled with cost controls, resulted in a strong profit margin of 24% (by comparison, the margin in 26 was 22%) Post-tax profits hit $75 billion, up $11 billion from 26 The comeback will falter in 21, however, as markets continue to normalize There were already signs of stalling revenue growth in Q4 29 Under a neutral market scenario, revenues will fall to $277 billion, down 11% The revenue mix will shift notably as markets normalize Fixed income's share is expected to decline from 45% to 39% Proprietary trading from 14% to 7% Whereas equity trading's share will rise from 21% to 26% Underwriting and M&A are expected to continue their recovery, increasing their share of revenue from 2% to 28% Source: BCG analysis. 2

4 Under a neutral market scenario, revenues will fall 11% in 21 Global net revenues (excluding write-downs) Profitability (including write-downs) % 277 Post-tax profits % Post-tax profits Profit margin Historical profit margin range Post-tax profit margin 75 24% 3% 25% 2% % 1% 5% Neutral Scenario 1 \\ ~ < % 1. Assumes no significant market disruptions. Source: Company reports; BCG analysis. 3

5 Revenue mix will shift markedly with equities and underwriting/m&a gaining CAGR vs. 27 peak Equities Fixed Income Proprietary Trading Underwriting and M&A 29 21: Neutral Scenario -2.6% -5.5% % % 1% 8% -5% -15% -32% -22% -7% 1% 3% % 28 Equity derivatives Equity cash Prime Brokerage Structured credit Credit (incl. deriv.) Rates (incl. deriv.) Currencies Commodities Proprietary trading DCM ECM M&A Underlying Drivers Recovery in less complex products Steady growth in trading volumes and performance indices Growth in trading volumes and increase in market concentration Continued weak demand, risk aversion Continued tightening of spreads as volatility declines, liquidity returns, and competition heats up; lower DCM Similar to credit; rise in corporate hedging needs counteracting factor Continued tightening of spreads as volatility and macro-economic uncertainty declines Recovery in client demand, lower risk aversion Market normalization sharply reduces opportunities; regulatory/capital pressure Continued rise in investor demand and confidence; low rate environment Economic recovery and rising performance indices; need to replenish capital Economic recovery, improving corporate earnings, and attendant rise in confidence Neutral Source: BCG analysis. 4

6 The banks in BCG's performance index achieved aboveaverage revenue growth Revenues of the 12 banks in BCG's Investment Banking Performance Index grew significantly They generated $245 billion in net revenues (before write-downs), up 69% from 28 After write-downs, net revenues were $217 billion As markets stabilized, write-downs fell sharply, amounting to $28 billion, or less than a fifth of 28 write-downs The top three banks accounted for 43% of revenues After five quarters of severe losses (Q4 27 to Q4 28), trading revenues rebounded vigorously from Q1 through Q3 29 Trading revenues (before write-downs) nearly doubled to $22 billion in 29 After write-downs, trading still earned an exceptional $174 billion, nearly $1 billion above 27 Underwriting and M&A advisory revenues grew 23% to $43 billion but remained 14% below the 27 peak At the same time, the 12 banks maintained cost discipline Costs were 16% lower than the 27 peak and 2% lower than in 28, partially driven by a reduction in compensation pay-out ratio Quarter over quarter performance was uneven with a peak in Q2 BCG's performance index rebounded to 86 in Q1 from -414 in Q4 28 and continued to rise to 14 in Q2 The rebound stalled in Q3 at 139 and then reversed in Q4 with the index falling to 14 Source: BCG analysis. 5

7 An exceptional trading environment fueled the recovery in 29 Aggregated net revenues of 11 leading banks 1 Net revenues: 28 and 29 (in descending order of 29 net revenues) Excluding net write-downs 69% Including net write-downs , 3, 2, 36,588 3,426 26,257 Underwriting & M&A advisory revenues Trading revenues incl. write-downs 23,11 21,227 2,413 19, ,52 Underwriting & M&A Trading excl. write-downs Trading incl. write-downs 1, -1, 13,194 11,475-3,147 6, ,977 12,519 8,888 6,765 5,465 3,387-2,3 6, , ,157-23,93-3, -12 G GS JPM Citi 2 BoA 3 Ba Bar D DB 2 C CS M MS B BN S SG No No- U UBS S M i A* rc B S S N G m B apcap P PP 4 ur mura S P a Note: Net revenues exclude credit valuation adjustments on banks' own credit. 1. Excludes BNPP for which disaggregated data were not available. 2. For Deutsche Bank and Citigroup, write-downs on leveraged finance were moved from DCM revenues to trading to be comparable with other banks in Underwriting excludes fees on own transactions in Q Total of both. Note: Aggregated net revenues excludes "other" capital markets revenues reported by Deutsche Bank, Credit Suisse, and Citigroup. Source: Company reports; BCG analysis. 6

8 Expense control contributed to the bottom line Aggregated gross operating expenses of 12 leading banks % Gross operating expenses: 28 and 29 (in descending order of 29 net revenues) Includes Bear Stearns for full year Includes Merrill Lynch for full year excludes Lehman Bros. Source: Company reports; BCG analysis. G GS D DB JPM J * C CS Citi M MS Bar B BoAB 2 UBS U N No- BNPP B S SG S B P M S ti S ar Cap 3 C a p o A B S mura o m ur a N P P G 7

10 The industry's recovery slowed during the fourth quarter After three quarters of revenues north of $6 billion, revenues dropped dramatically in Q4 Net revenues totaled $44 billion in Q4 29, down $18 billion from Q3 (-28%) but still robust compared to the year prior when net write-downs pulled revenues down to -$36 billion The fall was driven by a continued decline in volatility, an increase in liquidity, an attendant reduction in bid-ask spreads, and a seasonal decline in trading volume (reported by the majority of banks) Gross operating expenses declined 3%, largely driven by a sharp reduction in bonus pay-out ratios relative to provisions at the majority of banks Several firms saw a decline in compensation of over 5% during Q4 Expenses fell far less than revenues in absolute terms (-$1 billion), however As a result, the BCG Investment Banking Performance Index fell from 139 to 14 Signaling that the strong recovery is not sustainable in normal market conditions The decline in revenues was concentrated in sales & trading, in particular fixed income Fixed income and equity trading After barely missing the precrisis peak of $31. billion in Q3, fixed income revenues fell sharply to $15.7 billion 1, a 49% decline Equity trading revenues also suffered, falling 29% to $9.1 billion 1 despite an increase in trading volumes Underwriting (ECM and DCM) and M&A advisory In contrast, underwriting and advisory revenues surged in Q4, up 27%, hitting $1.7 billion 2 M&A led the charge (74% increase), followed by ECM (27%), and DCM (6%) Note: All financials in this report exclude credit valuation adjustments on banks' own credit. 1. Excludes Barclays Capital, BNPP, and Nomura, for which data were not available. 2. Excludes Barclays Capital, BNPP, Nomura, and Société Générale, for which data were not available. Source: BCG analysis 9

11 Performance declined again during the 4th quarter BCG Investment Banking Performance Index Index Performance Index (Q1/6 = 1) Q16 Q26 Q36 Q46 Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q Note: The index includes Bank of America, Barclays Capital (includes Lehman North America as of Q4 28), Bear Stearns (through Q1 28), BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Lehman (through Q3 28), Merrill Lynch (through Q4 28), Morgan Stanley, Nomura (includes Lehman APAC and select EMEA operations as of Q4 28), Société Générale, and UBS. The index tracks gross operating profit. The index excludes credit valuation adjustments on banks' own credit. Source: Company reports; BCG analysis. 1

12 The rise in underwriting and M&A revenues was eclipsed by the decline in trading revenues Underwriting and M&A Trading Aggregated net revenues 1 Excluding net write-downs % Including net write-downs % , 6, 4, 2, 7, ,598 Net revenues: Q4 28 vs Q4 29 (in descending order of net revenues for Q4 9) 765 5,318 Q4 8 Q4 9 Underwriting & M&A advisory revenues Trading revenues including net write-downs 5,159 3,814 3,865 3,539 3,5 2,321 2,267 1,113 2,145 2, Trading // // Q29 Q39 Q49 Q29 Q39 Q49 Q48-2, -1,545-2,31-1, , -3,41-2,556-3,94-36 Q48-15,758-4,675-4,87 GS 2 JPM Bar Citi BoA 3 MS 2 DB CS No- SG UBS BN- Cap mura PP 4 Note: Net revenues exclude credit valuation adjustments on banks' own credit. 1. Excludes BNPP for which disaggregated data are not available, and "other" capital markets revenues reported by Deutsche Bank, Credit Suisse, and Citigroup. 2. Q4 8 ended in November; Q4 9 ended in December. 3. Includes Merrill Lynch for both quarters; underwriting excludes fees on own transaction. 4. Total of both; disaggregated data were not available. Source: Company reports; BCG analysis. 11

13 The reduction in operating expenses did not make up for the revenue shortfall Op.exp. ($M) 7, Despite reining in operating expenses... (sorted in descending order Q4 9) -3% Q39-Q49...most banks suffered deteriorating operating leverage Op.exp. Q3-Q4 (%) 2% Costs up Revenues down Negative operating leverage Costs up Revenues up 4, 3, Q4 8 Q3 9 Q4 9 % BNPP BoA Citi Nomura Positive operating leverage 2, -2% DB MS SG UBS CS 1, DB Citi Bar MS 1 JPM BoA 2 CS Nomura PP UBS BN Cap 3 3 GS 1 1. For GS and MS, Q4 8 ended in November. 2. For comparability, BoA includes ML in Q Data not available to add Lehman to Q48. Source: Company reports; BCG analysis. SG -4% JPM GS Costs down Revenues down Costs down Revenues up -4% -3% -2% -1% % 1% 2% Net rev Q3-Q4 (%) 12

14 Net revenues and profit margins declined at most banks Pre-tax profit margin 9% 8% Legend Q39 Q49 GS Both margin and revenues declined Both margin and revenues improved One improved while other declined or remained the same 7% 6% JPM 5% SG BoA Avg pre-tax profit margin Q4 4% BNPP Citi 3% CS 2% Nomura UBS MS 1% % DB 2, 4, 6, 8, Note: Net revenues exclude credit valuation adjustments on banks' own credit. Source: Company reports; BCG analysis. 1, 12, Net revenues 13

16 As markets normalized, trading revenues fell precipitously After an extraordinary rebound from Q1 through Q3, fixed income trading revenues plummeted in Q4 In Q4, net revenues from fixed income trading were nearly halved, falling to $15.7 billion 1 Revenues fell despite the slight growth in average weekly US bond-trading volumes Credit continued to generate the strongest results while rates, foreign exchange, and commodities recorded mixed results at individual banks U.S. trading volumes increased 2% in Q4 compared to -2% in Q3 A slump in corporates was counteracted by a rise in MBSs and governments Equity trading revenues also suffered but not to the same degree Net revenues fell 29% to $9.1 billion 1 far below the pre-crisis peak ($2.4 billion in Q17) Several banks reported declining volumes (seasonal) and lower prime brokerage revenues Overall global trading volumes were flat Positive market conditions, including rising performance indices and lower volatility, prevented a sharper decline American markets were the exception in trading trends Trading volume grew 3%, after declining 8% in Q3 In contrast, Asian markets which had grown in Q3, experienced a reversal European markets were flat 1. Revenue figures exclude credit valuation adjustments on banks' own credit. Revenues are for nine investment banks; figures exclude Barclays Capital, BNPP, and Nomura, for which disaggregates were not available for the entire time series. Source: BCG analysis. 15

17 Fixed income trading After three strong quarters, fixed income trading revenues plummeted in Q4 as markets normalized U.S. weekly average bond-trading volumes Fixed income trading revenues 1 1,5 1, 1,411 1,277 1,226 1,179 1,148 1,173 1,153 1,65 1, % % Q46 Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q49 Q46 Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q49 Corp Bonds MBS Treasury/Agencies Note: Trading data are for average weekly primary dealer transactions. Trading revenues exclude credit valuation adjustments on banks' own credit. 1. Revenue figures are for nine investment banks; figures exclude Barclays Capital, BNPP, and Nomura, for which disaggregates were not available for the entire time series. Source: Federal Reserve Bank of New York; company reports; BCG analysis. 16

18 Equity trading Equity trading revenues dropped as volatility declined and pressure on commissions returned Global-exchange trading volumes Equity trading revenues 1 ($T) <-1% % Q46 Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q Q46 Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q49 EMEA Asia Americas Note: Trading volumes single counted; includes investment funds traded at exchanges. Trading revenues exclude credit valuation adjustments on banks' own credit. 1. Revenue figures are for nine investment banks; figures exclude Barclays Capital, BNPP, and Nomura, for which disaggregates were not available for the entire time series. Source: World Federation of Exchanges; company reports; BCG analysis. 17

20 After a disappointing Q3, underwriting and M&A revenues rebounded in Q4 Underwriting revenues increased 15% to $7.7 billion 1 But remained below the previous peak of $8.3 billion in Q2 ECM revenues grew 22% to $4. billion, bouncing back to the Q2 level Issuances jumped 37% from $163 billion to $223 billion Fueled by an extremely active market in the Americas and to a lesser degree in Asia DCM revenues picked up 6% to $3.7 billion Despite the decline in issuances of 7% (from $1,133 billion to $1,51 billion) The big growth engine investment-grade issuance continued to slump, as did government and ABS issuances JPMorgan retained its #1 position, but competitors continued to gain market share M&A activity surged as economic conditions improved and several mega-deals occurred Deal value increased 41% during Q4 to $539 billion but remained far below the Q4 27 peak The resurgence was driven by deals in the Americas, up 72%, and in Asia, up 42% In contrast, European deals fell 11% As a result of the surge in deal flow, revenues jumped 74% to $3.1 billion 1 Goldman Sachs out-earned JPMorgan, after placing a close second in Q2 and Q3 The rest of the banks lost share to the new leader 1. Revenue figures are for eight investment banks; excludes Barclays Capital, BNPP, Nomura, and Société Générale, for which disaggregates were not available. Source: BCG analysis. 19

21 Combined underwriting and M&A revenues picked up significantly but remained below their peak 15 Global underwriting and M&A advisory revenues % 1.8 ECM 5 DCM 2 M&A Q35 Q45 Q16 Q26 Q36 Q46 Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q49 1. Revenue figures are for eight investment banks; excludes BNPP, Société Générale, Barclays Capital, and Nomura, for which disaggregates were not available. 2. To be consistent with the majority of banks, for Citigroup and Deutsche Bank, write-downs and recoveries included in DCM were added back and deducted from fixed income trading. Source: BCG analysis. 2

22 M&A and equity activity jumped whereas debt slumped Effective M&A deals 1 Equity issuance Bond issuance 1,5 Peak 1, Peak % 223 2,5 2, Peak 2, , % ,5 1, 5 1, , ,489 1,57-7% ,133 1, Q47 Q28 Q38 Q48 Q19 Q29 Q39 Q49 Q27 Q28 Q38 Q48Q19Q29 Q39 Q49 Q47 Q28 Q38 Q48Q19Q29 Q39 Q49 Asia-Pacific Americas EMEA 1. Deals that were either declared unconditional (i.e. all conditions set by the acquirer have been fulfilled) or completed during the quarter. Source: Thomson SDC; BCG analysis. 21

23 In M&A, most banks lost share to the leader while in underwriting, the opposite occurred Relative share of M&A revenues Relative share of underwriting revenues (Q49 compared to Q48) (Q49 compared to Q48) Q Gained share relative to #1 #1 Q4 29 GS JPM #1 Q4 28 MS Q Citi Gained share relative to #1 MS GS JPM BoA #1 Q4 29 #1 Q CS 4 Citi CS UBS BoA 4 UBS DB 2 DB Lost share relative to #1 2 Lost share relative to # Q48 Q48 1. For comparability, BoA includes ML and JPM includes Bear Stearns across quarters. Note: Market position expressed relative to market leader (leader = 1). Disaggregates were not available for Barclays Capital, BNPP, SocGen, and Nomura. Source: Company reports; BCG analysis. 22