US Securities Industry Ten Years After....Equity Trading 28.2% 13.8% Investment Bnk. 31.4% 25.0%...

transcript

US Securities Industry –

Ten Years After.

Brad Hintz

chintz@stern.nyu.edu

October 2, 2018

Stock-trading desks at

big banks have been

enjoying their best

year in a decade.

Overall U.S. banking industry earned a record

$48.3 billion during the second quarter, … Well

above the pre-crisis high of $38 billion . - CNN

“I am pleased first of all that we had

two consecutive quarters where we

reached a return on tangible equity

above 15%," - CEO UBS

Wealth & Investment

Management booked a

2017 Return on Equity of

21% - Wells Fargo.

Jefferies Group LLC's

second quarter results were

strong. - JEF 8-K.

We expect 2018 revenues

to be higher by +8% on

average. This will be driven

by strength in equity

trading, investment

banking, and rate-based

revenues. – Merrill Lynch

Research

Big commercial banks are

expected to post a stellar

quarter in terms of profits.

US Securities Industry - Net Revenue.

Source: SIFMA Database

US Securities Industry - Expense and Revenue Trends.

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Net Revenue Compensation Other Expense

Source; SIFMA Database.

Compensation and Headcount.

Compensation to Net Rev. Front Office Headcount

Source: SIFMA Database.Source: SIFMA Database.

Broker Dealer Leverage has Declined.

Source; SIFMA Database.

US Securities Industry Total Assets.

Source: SIFMA Database.

G-SIB Basel III Capital has Improved.

Source: Moody’s.

The Capital Base has Strengthened.

10/15/2018 9

Source: Moody’s.

Liquidity Improvement.

10/15/2018 10Source: Moody’s

Industry CDS Spread.

Source: Bloomberg

Challenges…

Revenue Yield on Global Financial Assets.

10/15/2018 13Source; Data from McKinsey Deutsche Bank Research, World Bank and Coalition. Hintz Computation.

0.000%

0.010%

0.020%

0.030%

0.040%

0.050%

0.060%

0.070%

0.080%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E CAGR

Rev. of Top 10 Banks

from Coalition ($Bln) $ 182.2 $ 110.6 $ 163.3 $ 186.0 $ 158.7 $ 175.5 $ 167.1 $ 164.6 $ 160.2 $ 156.1 $ 150.4 -1.90%

Global Financial

Assets ($Tln) $ 243.0 $ 221.0 $ 243.0 $ 259.0 $ 261.0 $ 272.0 $ 285.0 $ 294.0 $ 300.0 $ 306.6 $ 317.4 2.71%

Yld. on Global

Financial Asset 0.075% 0.050% 0.067% 0.072% 0.061% 0.065% 0.059% 0.056% 0.053% 0.051% 0.047%

Global Net Revenues from Capital Markets.

10/15/2018 14

Source: Coalition.

Few US Banks Achieve Satisfactory ROEs.

Source: Mergent Online (Univ of Arizona Library), Hintz CAPM Computation.

Cost of

Equity WFC GS MS BAC C JPM

2012 12.6% 12.7% 10.2% 0.1% 1.8% 4.1% 11.0%

2013 13.2% 13.4% 10.4% 4.6% 4.9% 7.0% 8.6%

2014 12.0% 13.0% 10.5% 5.1% 2.0% 3.5% 9.8%

2015 12.6% 12.1% 7.2% 8.4% 6.4% 8.0% 10.2%

2016 11.8% 11.2% 5.1% 7.9% 6.8% -3.2% 9.6%

2017 10.5% 10.5% 8.5% 8.0% 6.8% 6.6% 9.8%

9/30/2018 16

Global Capital Markets Banks - 2017 ROE and Cost of Equity..

Source: Data Moody’s and Mergent (Univ of Arizona Library).

US Securities Industry - ROE.

10/15/2018 17

Source: SIFMA Database.

Margins and Capital.

Capital Markets Margins.

10/15/2018 19

Industry

Segment

Margins

Calculated

Margins

Regulatory

Disclosure

FICC Trading 37.2% 24.9%

Equity Trading 28.2% 13.8%

Investment Bnk. 31.4% 25.0%

Total 33.3% 21.9% 15.2%

Large banks

claim these

margins.

Filings

show this

margin.

Statistics support

these margins.

A study of 15 broker dealers

found that one-third had over

25% of their cost base allocated

to corporate overhead.

Source: Coalition, SIFMA,

Sanford Bernstein and Hintz.

Capital Markets Pre Tax Profit Margins.

Sources: SIFMA Database, Sanford Bernstein and Hintz.

These margin estimates were determined by multiple regression of US security industry pre-

tax earnings versus six revenue sources over period 1990-2007.

Calculated Industry Margins.

Mergers &

Acquisitions

Equity

Underwriting

Underwriting FICC Trading Equity Trading

Wealth

Management

Trading margins are

improving

Segment Equity Usage.

10/15/2018 21

Source: SIFMA Database

$20,000.0

$40,000.0

$60,000.0

$80,000.0

$100,000.0

$120,000.0

$140,000.0

$160,000.0

$180,000.0

$200,000.0

Fixed Income Equity Wealth Mgnt Other

US Securities Industry Equity Capital Employed

Based on Asset Usage of Business Segments.

Equity Capital Employed.

Sources: SIFMA and Large Bank 10Ks.

But FICC is

shrinking its

capital use

Wealth Management.

Wealth Management

10/16/2018 24

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,000

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source; SIFMA Database

$10.00

$15.00

$20.00

$25.00

$30.00

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Wirehouse Discount Other

Wealth Mgt. Net Revenues. Wealth Mgt. Client Assets.

Source; Aite Group.

Wealth Management Revenue Mix Change.

10/16/2018 25

2012 2013 2014 2015 2016 2017 $-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

2012 2013 2014 2015 2016 2017

Net Int Other

Source: Company Disclosure.Source: Company Disclosure.

Big 3 Wirehouse Net Rev. Big 3 Wirehouse PT Margin.

Regional BDs

Investment Banking.

Domestic Investment Banking Net Revenues.

Source; SIFMA Database and LOB analysis.

US investment

banking has

rebounded

with the US

economy.

Global Investment Banking Revenue

Source: Coalition.

Global Investment

banking revenues

growth have been

slower in Europe

and Asia.

The Trading Businesses.

Domestic Fixed Income Net Revenues.

Source; SIFMA DataBase, Company Disclosure and Factiva

Reduction of Capital Intensive Assets.

10/15/2018 31Source; SIFMA DataBase and LOB analysis.

Illiquidity risk?

Customer Financing.

10/15/2018 32Source; SIFMA DataBase

Illiquidity risk?

Fixed Income ROE – With and Without Underwriting Revenue.

Source; SIFMA DataBase and LOB analysis.

Improving

Performance

Domestic Institutional Equities Net Revenues.

Source: SIFMA DataBase and LOB analysis

Institutional Equities Blended Commission Rate.

Source: MSIED, CSFB, Sanford Bernstein and Factiva.

$0.0050

$0.0100

$0.0150

$0.0200

$0.0250

$0.0300

$0.0350

$0.0400

$0.0450

$0.0500

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

The margin decline

in equity trading

predates the 2008

financial crisis

Equity Trade Volumes Daily Avg., Mils. of Shares.

Source; SIFMA

Institutional Equity ROE- With and Without Underwriting.

Source; SIFMA database, company disclosure and LOB analysis

Improving

Performance

Global GDP and Wealth is Growing.

Acceptable Returns on Capital.

• Wealth Management.

• Investment Banking.

• Asset Management.

Capital and Liquidity.

• Strong Capital Ratios.

• Improved Liquidity.

Regulation is Barrier to Entry.

Strong Internal Expense Control.

The Lay of the Land.

Decline in Cross Border Financial Flows.

Below Cost of Equity Returns.

• Fixed Income.

• Equity Sales and Trading.

Revenue Shift from Front Office to CCP,

Custodians and Exchanges.

Legacy Technology Systems.

Institutional Inertia Limits New Industry

Utilities and Outsourcing.

Institutional Investor View.

Institutional Investors are still not optimistic about the industry. A majority

believe that the large banks will be unable to beat their cost of capital in next

five years.

Investors believe that bank regulation will continue to tighten around the

globe and that new technologies will disrupt the banking, wealth management

and capital market.

Investors recognize that the banks have cut bank expenses and reduced

headcount. Low ROE is evidence that the industry’s efforts have been

insufficient.

Investors expect the number of bulge bracket banks and universal banks will

decline in the next five years. Source: Survey by Broadridge.

US Securities Industry Ten Years After....Equity Trading 28.2% 13.8% Investment Bnk. 31.4% 25.0%...

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